Paper on Dividend Policy of a Company

At the basis of importance of dividend relevance was a dividend irrelevance theory advanced by Miller and Modigliani in 1961. According to such theory, the value of the firm at the market is independent of the entity's dividend policy under ideal market conditions. Accordingly high dividend payments would necessitate sourcing of funds to support various investments through sales of that firm's stocks at the market.

Apart from the idealized approach taken by the study; preference for payment or non-payment of dividends can be explained through a number of observations. Investors may for instance shun dividends to gain from tax rebates on capital investment. Secondly managers - on the view that the market price is not representative of the internal state of affairs of the company - may propose a high dividend for signaling purposes.

Other explanations for dividend payment could lie in the agency cost as a charge for monitoring services provided by the stock market professionals. By paying dividends, managers are forced to seek investing funds from the market hence subject to professional scrutiny. As such dividend payment serves as a control system for management excesses by depleting available cash flows thus only allowing for prudent investments to be undertaken.

Having a clear delineation of the procedure of dividend proposal could thus help establish various controls in the company. Through a dividend policy that encompasses profitability, liquidity and other determinants; companies can avoid payment of excessive amounts as dividends and prevent excess liquidity that motivates imprudent managerial practices. Whether dividend policy proves effective in generating desired feedback may however be subject to investor behaviour – rationality or irrationality thereof.

Shareholders' expectations:

Shareholders' expectation relating to

dividends or capital gains depends on their economic status, effect of

differential tax system, need for regular income, etc.

Firm's financial needs:

Financial needs of the company to finance the

profitable investment opportunities.

Legal restrictions: Legal restrictions like dividend to be paid out of

current or past profits do influence dividend