Site Loader

1.  SIGNALLING POWER
OF DIVIDEND ON FIRMS’ FUTURE PROFITS

 

The main objective of this paper is to point out the
signalling effect of dividends through different dividend policies which impact
the value and performance of the firm. The author has taken references from
several research papers to give a holistic view on the topic.

We Will Write a Custom Essay Specifically
For You For Only $13.90/page!


order now

Two stands have been presented regarding dividend affecting
the future profits of the firm:

a)      NO
IMPACT –It is based on the MM model which
suggests that dividend is irrelevant in determining the firm’s value and only
investments are considered. However, it is based on the assumption of no tax
and hence the theory collapses in the real world as companies do need to pay
corporate taxes.

 

b)      HAS
AN IMPACT – It has been explained
through different theories:

·    
Taxation:
Tax on capital gains is less compared to dividends. This difference can
influence the after-tax return of the investors who will expect higher returns
for the tax difference and thus their willingness to invest in the firm.

·    
Clientele effect:
Firm’s dividend decision policy depends on the type of investors it wants to
attract. People with already tax liability would invest in low return stocks
for lower tax rates.

The clientele effect and taxation show the stock purchase
behaviour of the shareholders on the basis of dividend pay-out.

·       Agent theory: The dividend payment ensures that the shareholders are
happy and hence reduce their interference in the management. The managers are
monitored by the credit institutions through credit ratings further satisfying
the shareholders.

                     Also, good credit rating helps the firm to get loans from the
market more easily because if the company pays dividend, it shows its
capability to meet its obligations to shareholders and the creditors.

·    
Share repurchase:
Though often used as a substitute to dividends, share repurchase do not have
the same signalling effect as it may signal poor or no investment opportunities
for the firm and hence, low future profits. It also results in a capital
restructure.

·     Signalling theory: Due to information asymmetry between the investors and
management regarding future earnings, dividends can help in information
signalling. An increase in dividend may signal a growing firm, thus changing
the expectations of the investors regarding the future profits. However, it could be a signal of a disinvesting
firm as well.

 

Conclusion –
Firstly, the study has given proofs regarding why the firms pay dividend at all.
It also proves with evidence from past research that dividend does signal the
future profits of the firm and in turn proving
that it effects the investment decisions of the investors as well.  However, it is beneficial only if the investor
is able to read it correctly to maximise his profits.

 

 

2.  A
STUDY ON THE IMPACT OF DIVIDEND ANNOUNCEMENT ON STOCK PRICE

 

Dividend announcements have signalling effect and usually
an increase in the dividend payments or first-time payouts signal strength of
the company suggesting excess capital and future profits.

Thus, they are important for the investors from the point
of maximising the shareholder’s fund which is effected by the stock prices. Many
researchers have already concluded that there is a positive relation between
dividend announcement and stock price movements. So, the paper studies the
impact of dividend on the stock prices of specifically 20 PSUs and takes 3
periods into account – the day of the announcement and 10 days pre and post the
announcement.

Methodology:

The study was conducted using ‘Event Study Methodology’ and
has taken two hypothesis into account:

a)    No
significant difference of pre and post announcement of dividend on stock price
returns- null hypothesis

b)    A significant
difference of pre and post announcement of dividend on stock price returns.

According
to the t-test undertaken, two values are important:

p-value – it
talks about the probability of getting the same result the next time. So, here
if p= 0.05, it means there is 5% chance of no real difference, and so if p0.05, the null hypothesis is
accepted.

t-value – it compares
one group’s average with one single number (1) or other group’s average (2).
The reliability of the t values can be found out comparing it with p-value to
know if it is significant or not

According
to results, the p-value is 0.05 in all models. Thus, H2 hypothesis is rejected and shows that
dividend does impact shareholder’s wealth.

 

Conclusion:
Having better market value can enable banks to attract more funds easily if
required. Better market value will also satisfy the clientele of investors
positively. Increase in dividend can reflect higher expectations of higher
future and signal growth. It impacts the image of the company which can help in
attracting more investors at less cost thus increasing the profit margin of
banks. Though the market value and shareholder’s wealth do not depend only on
the dividend policies, it does have a strategic impact on both.

5.  DIVIDEND
PAYOUT AND FUTURE EARNINGS GROWTH

 

Many
market observers believe that higher dividend payments mean low availability of
cash for future investments and thus decrease in future earnings growth. It has
been supported by several theories like the Gordon theory which states that
with constant expected rate of return higher dividend results in decrease in
future earnings. The pecking order theory suggests that companies with growth
opportunities would prefer low dividend pay-outs to ensure availability of cash
to finance investments. However, the findings of Arnott and Asness suggests the
opposite.

The Arnott and Asness study was based on
aggregate results which is capitalisation weighted and hence the result is
affected by performance of only few large companies. This study is based on
company level analysis where all companies are treated equally. As against the
Arnott and Asness study which focused on 5 and 10- year ahead future earnings,
the following one focuses on shorter horizons of 1-, 3- and 5- year long
horizons. This was done to decrease the survivor bias as the observation period
increases.

 

The research gave the following results:

·       
It shows positive relationship between current pay-out
and future earnings growth. Also, when controlling other variables, it shows
that larger companies with higher earnings yields have lower future earnings
growth.

·       
Specific time periods: it shows that the time
periods are also responsible for the results and the positive relationship
between pay-out and future earnings growth has strengthened in recent years.

·       
Share repurchases is usually considered as an
important and alternate way to distribute cash. The study thus compared the two
to see its impact on the future earnings. The results showed that though share
repurchase had positive relation with future earnings growth, it was much
stronger in companies with dividend pay-out.

 

The possible explanation for the above results
have been given in the free cash flow theory. It states that if companies have
abundant free cash flows, the managers may over-invest which explains the low
dividend- low growth relationship. Also, in one test by Lang and Litzenburg,
they found that companies with limited growth opportunities experience larger
share price increase. It also explains the agency cost which is higher for low
or non- dividend paying companies.

 

Conclusion: The study showed that the
result was same even when taking other factors like alternate measures of
earnings, several time periods and influence of share repurchases into account.
It thus proved the positive relationship between dividend payments and future
earnings growth at the company-level. It also gives potential explanation for
the same wherein this relationship is more prominent with companies with
limited growth opportunities as it prevents over-investment. 

Post Author: admin

x

Hi!
I'm Katherine!

Would you like to get a custom essay? How about receiving a customized one?

Check it out