1. Meaning of Dividend
- Dividend is the portion of net profit of a
company distributed to its shareholders as a return on their investment.
- It may be in the form of cash dividend, stock dividend (bonus shares), or other distributions.
- It reflects the profitability, financial health, and confidence of the company.
2. The Dividend Decision
- The dividend decision refers to determining the proportion of earnings to be distributed as dividends and the portion to be retained in the business (retained earnings).
- Trade-off:
a. High dividend = happy investors but less retained earnings (less future growth).
b. Low dividend = more funds for reinvestment but shareholders may be dissatisfied
3. Factors Determining Dividend Policy
- Legal restrictions (e.g., Companies Act).
- Liquidity position (availability of cash).
- Stability of earnings (regularity of profit).
- Growth opportunities (need for reinvestment).
- Cost of external financing (if raising
outside funds is costly, firm retains more).
- Tax considerations (corporate tax, dividend tax,
capital gains tax).
- Shareholder preferences (current
income vs future capital gain).
- Inflation (higher inflation may reduce
dividend payout).
- Control considerations (to avoid dilution of ownership,
firm may retain earnings).
- Market trends & signaling effect
(dividend changes affect stock price).
4. Theories of Dividend
(a) Relevance Concept of Dividend
- Dividend decisions affect the value of the firm.
- Shareholders prefer current dividend over uncertain future capital gains.
- Key models: Walter’s Model, Gordon’s Model.
(b) Irrelevance Concept of Dividend
- Proposed by Modigliani & Miller (M–M Theory).
- Dividend policy has no effect on firm value.
- Firm value depends only on investment policy & earnings, not on how profits are distributed.
5. Walter’s Approach (Relevance Theory)
Assumptions:
- All financing is done through retained earnings (no external financing).
- Rate of return (r) and cost of equity (k) are constant.
- Earnings and dividends are constant in future.
- No taxes.
Formula:
Where:
- P = Market price per share
- D= Dividend per share
- E= Earnings per share (EPS)
- r= Internal rate of return (return on investment)
- k= Cost of equity capital
Implications:
- If r > k → firm should retain profits (growth firms).
- If r < k → firm should distribute dividends (declining firms).
- If r = k → dividend policy is irrelevant.
Example:
6. Gordon’s Model (Corrected Formula)
Assumptions:
- Firm is equity-financed.
- No external financing.
- Dividend grows at a constant rate g.
- Cost of equity k constant.
Situations:
1.
Zero
growth (g=0):
2.
Constant
growth (g constant):
3.
Multiple-stage
growth:
- Use DCF for each stage separately and sum PV.
Example:
7. Modigliani & Miller Approach (Irrelevance Theory)
Assumptions:
- Perfect capital markets, no taxes or transaction costs.
- No investor can affect price.
- Investment policy fixed.
Proposition:
- Dividend policy does not affect firm value.
- Value depends only on profitability & investment decisions.
Formula:
Implication:
- Shareholders can sell shares if they want cash → dividend irrelevant.
8. Types of Dividend Policy
(a)
Regular Dividend Policy
- Fixed dividend every year. (Good for conservative investors).
(b)
Stable Dividend Policy
- Constant dividend per share – e.g., Rs.
5 per share always.
- Constant payout ratio – fixed % of earnings
distributed.
- Stable rupee dividend + extra dividend
– stable base dividend with bonus in good years.
(c)
Irregular Dividend Policy
- Paid only when profits allow.
(d)
No Dividend Policy
- Company retains all earnings.
(e)
Residual Dividend Policy
- Dividends paid only after financing all investment opportunities.
9. Share Split
- A share split is dividing the face value of existing shares into smaller denominations without changing total capital.
- Example: 1 share of Rs. 100 face value split into 10 shares of Rs. 10 each.
- Purpose: Increase liquidity, make shares affordable, widen investor base.
