Dividend Decisions
The Dividend Decision is a decision made by the directors of a company. It relates to the amount and timing of any cash payments made to the company's stockholders. The decision is an significant one for the business firm as it may influence its capital structure and stock price. In addition, the decision may ascertain the amount of taxation that stockholders pay.
There are three primary components that may influence a firm's dividend decision:
1. Free-cash flow
2. Dividend business enterprises
3. Information signaling
The free cash flow theory of dividends:
Under this theory, the dividend decision is very simple. The business firm merely pays out, as dividends, any cash that is in addition to after it invests in all available positive net present value projects.
The critical review of this theory is that it does not clarify the observed dividend policies of real-world companies. Most companies pay relatively consistent dividends from one year to the next and managers tend to opt to pay a steadily raising dividend rather than paying a dividend that fluctuates dramatically from one year to the next. These criticisms have conveyed to the evolution of other models that seek to explain the dividend decision.
Dividend business enterprise:
A peculiar pattern of dividend payments may accommodate one type of stock holder more than another. A retiree may opt to invest in a business firm that renders a consistently high dividend yield, whereas a person with a high income from employment may opt to avoid dividends due to their high marginal tax rate on income. If clienteles exist for particular patterns of dividend payments, a business firm may be able to maximize its stock price and minimize its cost of capital by catering to a particular clientele. This model may assist to interpret the relatively uniform dividend policies followed by most listed companies.
A key criticism of the idea of dividend clienteles is that investors do not require to rely upon the business firm to render the pattern of cash flows that they desire. An investor who would like to receive some cash from their investment constantly has the choice of selling a part of their holding. This debate is even more persuasive in recent times, with the advent of very low-cost discount stockbrokers. It remains possible that there are taxation-established clienteles for certain types of dividend policies.
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