Dividend Policy at Fpl Group, Inc.

Related Topics or Theories

M&M Proposition: It states that the market value of a firm is independent of its capital structure. The dividend policy is irrelevant. The value of FPL is determined by its real assets and not by how these assets are financed. According to M&M, there is no difference for FPL’s investors to either increase dividend or cut dividend. But M&M holds only under certain conditions which are not realistic in real life, such as no taxes and no bankruptcy costs. These two costs actually have great influence on a firm’s net income. If the company wants to issue new shares to cover the cost of dividend payout, it will affect shareholders and management’s decisions.

Taxes: There are three reasons why investors may prefer low dividend payouts due to tax effects. The first reason is that long-term capital gains have a maximum tax rate of 20%. This is different from dividends which are taxed at incremental effective rates. As a result, investors who do not need immediate cash would prefer companies which invest retained earnings back into the business and not pay dividends. The second tax effect deals with the time value of money. The value of a dollar paid in taxes in the future has a lower effective cost than a dollar paid today. Finally, beneficiaries, one who receives the stock upon death, pay no taxes on the capital gains at all. Therefore, they escape the tax altogether. FPL investors may want to defer the payment of taxes or attempt to avoid taxes all together on their gains and have FPL not increased its dividend.

Signaling: Theoretical models show that dividends can be an effective signal of a firm’s true value. The market generally reacts positively to dividend increase announcements, and negatively to dividend cuts. As a result, the unexpected dividend increase will cause stock price to rise and dividend decrease will cause stock price to fall. The utilities industry is known