The various types of Dividend policies used by companies

The discordant types of Dividend policies used by companiesDividend polity has drawn due attention from various researchers. whiz of the close famous studies in this respect is moth miller and Modigliani hypothesis (1961), which asserted that the property dividend constitution is not important because it has no effect on the associations abide by, and as such it does not affect the beau monde owners wealthiness. This is due to the fact that companies follow a Residual Dividend indemnity which is based on reinvestment of corpo straddle lolly in the available investment opportunities (Van Horne 1983 Arn of age(predicate) 2008) with convinced(p) gain present value and diffusion the surplus bullion as a hard currency dividend to sh arholders.The above hypothesis aroused a passel of controversy on the part of researchers. However, the most important examine that opposed it is that of Partington (1985) which claims that the companies do not follow in utilisation the residual dividend approach as the dividend decisions taken independently from the investment policy. Right now, controversies continue among researchers based on the subject without arriving at both decisive resultsThis chapter depart study the public dividend policy to shareholders, which is considered to be star of the most important financial decisions, in view of its direct relationship to shareholders and financing decisions and investment in the political party. The chapter entrust likewise cover the alternatives to be addressed consisting of general dividend policy and theories that linked the hard silver dividend policy with the compevery marketplace value, and in that respectfore the high society owners wealth in addition to the share dividend policy and buying back policy, besides the cash dividend policy and its relationship with the investment policy2-2 General Dividend PolicyThe beau monde Board suggests circle dividend to shareholders in an annual meetin g (Watson and Head 2004). The main interest is to suggest acceptance and secure fair dividend for shareholders legitimate with the rate of dividend distinct by the ac play along management. T presentfore, in preparing dividend distribution, the mangers do not look only for current year net profit, but they, instead, go away look for the future earnings expected, and and then for the ability of the club to maintain a perpetual rate of dividend taking into consideration the systematic growth of this ratio. On their part, the investors are aware of this truth, and they look for a profit increase in a positive vision expecting without a stability of the future dividend. When the company mends high earnings for a peculiar(a) year and do not expect the similar level of profit for next years, they will make normal dividend and give additional dividend so as not to disappoint the investors hopes in the future. The profits are wherefore divided into two dividends, a normal a nd an incremental dividend, to make notification to investors that this type of dividend is upset(prenominal) and would not continue in the future (Levy and Sarnat 1994).There are several alternatives for the profits dividend. The company may either mobilise the profits in the spend a penny of regular cash dividends, or it may cover profits in the form of shares dividends to shareholders. However, the above two types may be distributed at the same time. as well that, shareholders stick out also obtain profits when the company tends to repurchase its shares, and considers the regular cash dividend as something quite common (Broyles 2003).The percentage of the profits distributed by the company is typically governed by several considerations. In addition to the law which prohibits the distribution of profits unless the company achieves a profit after deducting reserves, the contracts of the bonds, in slip of paper the company issues these bonds, often prevents companies from in creasing the proportion of cash dividend on a certain level to secure the rights of bondholders (Watson and Head 2004).Thus, the general dividend policy may well looked upon on the basis of differentiating between the cash dividends and the shares dividend by capization of profits, or done buying back the companys shares. This is due to the fact that the investment policy is fixed. The company will thus detain profits to pay capital spending on growth and expansion or debt re deliverment, or extinguish the bonds if any, and distribute the remaining cash as a cash dividend, and also to finance any deficit in capital spending by issuing new shares or through with(predicate) outside borrowing. The company could detain the necessary coin to finance capital expenditure and re-buy part of the shares issued and distribute the remaining as a cash dividend.These alternatives will not affect the companys value, and therefore the wealth of shareholders, if the company is operating in mar ket characterized by subjectl, efficiency and depth (Merton and Modigliani 1961 Black and Scholes 1974 Peter 1996). In case such characteristics are absent of the market, one can expect arguments about the impact of dividend policy, peculiarly cash, on the value of the company, and therefore the wealth of shareholders. The second meeting (Gordon 1959 Blume 1980 Dyl and Weigand 1998 Koch and Shenoy 1999) believes that increasing the percentage of cash dividends would increase the companys value, thus increasing the shareholders wealth, opus the third group (Litzenberger and Ramaswamy 1979 Blume 1980 Litzenberger and Ramaswamy 1982 Ang and Peterson 1985) believes that increasing the percentage of cash dividend will operate to a decline in the value of the company, thereby reducing the wealth of shareholders. These groups together with their theories will be discussed when dealing with the policy of cash dividend.The profits will be transferred to return earnings account, which is used for purposes determined by the board and the approval of the General Assembly of the company. This account is usually used to maintain a stable dividend amount of cash dividends (a systematically dividend policy). During the years where the company cannot meet the amount of normal dividend, they will tend to the return earnings account to insure any deficit. The General Assembly of the company has full authority to use this account for normal or abnormal cash dividend in whole or in part. It could also be used for company repurchase share, or for capitalization this account and distribution of share dividends to shareholders. On their part, shareholders can obtain their profits through a set of policies that can be feature in a single year, but it often takes one of the sideline alternatives(Watson and Head 2004)A cash dividend policyShares dividend policyBuying back shares policy2-3 Cash Dividend PolicyThe impact of cash dividend policy on current prices of the company shar es is considered to be actually important, not only for policy makers, but also for investors, portfolio managers, and economists interested in the performance of capital markets (Watson and Head 2004). The questions to be raised here are put up managers maximize the wealth of the owners of the company through a particular dividend policy? (Lumby and Jones 1999) Are the companies with high dividend sold with premium? Should the shares of companies that retain their profits or distribute a percentage of its profits, be sold as well in a lesser price? The fact is that these questions were, and still are, the subjects of many applied studies. Until now, there seems no consensus on the answers to these questions. The reason is the front line of other relevant factors that affect the market value of the shares that enable us to measure the impact of dividend policy on profits alone. This essence that researchers did not so far prepare both proper and adequate tests and studies to dis tinguish between different hypotheses.The arguments among researchers about the dividend policy direction on that part of the cash dividend to be distributed to shareholders and its impact on the companys value and therefore the wealth of the owners of the company. Miller and Modigliani (1961) see that the cash dividend does not affect the value of the company, as the companys value will not be impact by how earned profits are divided but rather affected by the ability to achieve profits. Thus, there is no point in thinking of how to divide profits between dividends and return earnings, while thinking must be directed towards maximizing these profits through the optimum investment policy as the way by which the cookie is divided will not lead to increase its size.In the opinion of others (see, Olson and McCann 1994 Lipson, Maquieira et al. 1998), the manner in which profits are divided between dividends and return earnings affects the companys value through an increase or decrease in the demand for the company shares, as the investors with high incomes usually prefer companies without cash dividend if the value of taxes on cash dividend outflanks the taxes on capital gains, while investors typically prefer companies that cash high dividends if they do not pay taxes or who were in low category of taxes. Also, investors in growing companies may not ask the company to distribute high cash dividends and accept, instead, low cash dividends. This is because the internal return rate in these companies is usually greater than the monetary values of obtaining funds from sources other than return earnings, and thus maximize the wealth of shareholders through the detention of all or most of the profits and use them to finance projects which deplete positive present value. Investors in non-growing companies, on their part, look for high dividends (see, Walter 1963). From the foregoing discussion, it is viewed by many scholars that the harmony between cash dividend poli cy with investor concupiscencees will affect the market value, due to any increase or decrease for the company shares emanating from this harmony or compatibility, which will be glistened on the price of its shares.The decision of cash dividend policy, particularly its cash portion, is one of the challenges facing company managers, because the distribution decision defines the funds to be given companys shareholders, and therefore the funds to remain for managers in the company to reinvest (Lumby and Jones 1999).The cash dividend policy can be considered as an action plan for the company to be followed when the company needs to make a decision regarding cash dividends, so that this plan could provide several options from which the company can choose to reach the desired goal. Such a plan is laid taking into account the following two main goals Maximizing the wealth of shareholders and meeting the company needs to finance its investments.There are several factors affecting the deci sion to choose the most appropriate alternative among the alternatives available in the action plan. These factors are legal, contractual, internal shareholders and market considerations. These factors reduce the available alternatives for the company in order to achieve its aims through a cash dividend policy practice. The available alternatives accept the companys range of cash dividend policies the company could follow (Gitman 1997 Brigham and Houston 2004) . These includeFixed dividend policy rateRegularly dividend policyRegularly low fixed dividend with particular(a) or added dividend be cash dividend policy.These policies will be discussed in detail as followsFixed Dividend Policy reckonThis percentage is determined by apportionment of dividends on profits earned. The percentage distribution of 80% of the net profits derived mean that the company will distribute 80% of its profits and reserves 20% of retained earnings. Since corporate annual profits are not fixed, adopting this policy will lead to a sport in the amount of dividends because the stability of the dividends rate from non fixed profit leads to a difference in the amount of the annual dividends, which is the main criticisms of this policy. Since the fluctuation of the quantity of dividends is one of the benchmarks that measure the risks of the company and because the non fluctuation of the profits is usually seen as something positive for current and future performance of the company, the prices of company shares that follow such a policy may be adversely affected by this policy.Regular Dividend PolicyThe company, according to this policy, pays fixed rates as a dividend each year. For example, they may pay $0.2 per share each year, which will be fixed next years. This policy gives a positive indicator about the company because of the stability of the quantity of dividends, guide to reduce the risks of uncertainty. The companies that follow such a policy tend to increase the dividends rate whenever they feel that the increase in profits is stabilise and continuing in the future.Low regular fixed policy with special or added dividendSome companies follow a policy of systematic low dividend with additional dividends when the companys profits are unstable and highly volatile so that the companys profits are high in a given year but low in another, which makes it sticky for it to follow a regularly high-level profits distribution policy be able to maintain it. The company, therefore, seeks to pay low dividends characterized by being consistent and continuous and then pay other additional and unusual dividends in the years where it can secure high profits. The company thus has been able to achieve consistency and pertinacity in the level of profitability, which are indicators of great importance on the part of investors, who consider this as something necessary for building confidence with the company.Remaining cash dividend policyThe optimal cash dividend rate for an y company is best determined by the differentiation between a numbers of factors (Brigham, L. et al. 1999)Shareholders predilection for cash dividend or capital gains.Investment opportunities available for the company.Optimal structure mix for the companys capital ( cash sources).External financing costsThe last three factors combined affect the remaining dividend policy which is based on distributing cash dividends which exceeds the companys to finance all company investment opportunities that induce positive present value.The company should make the following three steps when applying the remaining cash dividends policy (Brigham and Houston 2004)Identifying all the available investment opportunities which have positive present value and in which the company wishes to invest.Determining the optimal structure mix of capital that achieves the lowest cost.Using the profits to finance new projects with positive present value because of their low cost in comparison with new share issu es in case they represent the best compounding of capital.Based on this concept, and as long as the money call for by the company to reach the optimal mix of the capital structure is the equity funds , and not money borrowed, and as long as the need for funds exceeds the companys achieved profits and return earnings, the company will not make any dividends distribution for shareholders (Van Horne 1983). except in case the funds needed are less than the return earnings, the company will take its cash needs and distribute the exceeded money as a cash dividend for shareholders.Besides that, if the optimal capital structure mix does not make it incumbent upon the company for financing or allowing to borrow without leading to the level of damage risks of the company, the company then may distribute profits to shareholders because of lack of need and also because these profits are considered as surplus (Arnold 2008).2-3-1 Factors affecting cash dividend policyA combination of factors a ffect the cash dividend policy and put pressure on the management when a dividends proposal is submitted to the General Assembly to be taken as a justification of reference for the Assembly when ratifying or adjusting this proposed. These most important of these factors are arguably (see, Damodaran 1997 Gitman 1997 Brigham, L. et al. 1999 Brigham and Houston 2004) the following legal, contractual, internal, growth and the expected expansion, shareholders preferences for cash dividend or capital gains and capital market considerations. These factors are explained here in some detailsLegal restrictionsCash dividends should not exceed the total of retained earnings plus net profits for the current year. This is known as the Impairment of Capital Rule. If the companys net profits adjoin to $500 thousand and it the retained earnings of $ 2 millions, then it should not distribute profits more than $ 2.5 million but if there is retained loss within equity amounting to $200 thousands, then it should not distribute more than $300 thousands.Contractual restrictionsUsually borrowing contracts restrict the amount of profits allowing the company to distribute to shareholders to ensure the rights of the lenders. When the company issues borrowing bonds, the contracts usually include both permissions and restrictions from the date of bonds issuance till bonds date off. The bonds contract often will not allow the company to distribute cash dividends only if they exceed the amount earned in a certain amount. The contract might also prevent the company from increasing the percentage distribution of normal profits or may determine the profits that could be distributed by the companys net profits for distribution. The company accepts such conditions on themselves to reduce the risks of borrowing from the viewpoint of the lender, thus reducing borrowing costs. There are also restrictions on cash dividends imposed upon issuance of the preferable shares of the company. In this respe ct, it is natural to restrict the distribution of any dividends to ordinary shareholders unless they pay all preferable share profits.Internal constraintsThe companys ability to pay cash dividends is affected by the quantity of molten funds available, not by profits and return earnings only. Although the company could resort to borrowing for financing the cash dividend or issuing new shares to finance the dividend process, the companies often do not do that because of high costs for this decision. The company can use it in urgent cases to stabilize the amount of dividends, since the fluctuation of the value of dividends may fuck off a cost that could be higher than the distribution finance costs. Thus, the companys ability for cash dividends or desire to distribution is often constrained by liquid funds available.Company expected growth and expansionThe volume of capital expenditure required for financing expansion and growth significantly affects cash dividend policy adopted by t he company. If the company is in continuous expansion and phylogeny, using modern technology, they will need all the funds available to finance operations. On the other hand, the companies that have reached the stage of maturity are more able to distribute cash dividends than companies in growth.Shareholders preference for cash dividends or capital gainsOne of the management functions is to maximize the company owners wealth therefore we should take into account the owners interests when preparing the cash dividend policy. The companys ability to distribute cash profits and desire to do so are often constrained by several important factors affecting the interests of company owners (Brigham, L. et al. 1999)Tax status of the companys ownersIf most of the companys owners are affluent are in high tax brackets, the company will resort to a dividends policy whereby it can reduce the impact of taxes on the shareholders profits.Investment opportunities available for company ownersIf shareh olders can obtain returns for re-investing their profits exceeding the companys returns, the company must distribute a greater proportion of profits to enable shareholders to maximize their wealth by reinvesting these profits. But if the companys returns are more than shareholders returns, then the company must transfer the maximum part of their profit to return earnings for reinvestment in order to maximize the shareholders wealth.The steady control of former shareholdersIf the company tends to distribute all, or most, of profits achieved over the years, it will find itself forced to issue new shares to finance the expansion and development projects. This would first lead to mitigate and minimize the control of the companys former owners of the company and then the profits to be gained would be reduced because of the increasing number of company owners due to the issuance of new shares. This situation could be remedied through the allocation of shares, by allowing old shareholders to subscribe for new shares, each according to his/her contribution and gift them priority in this respect. The company could also resort to another alternative, i.e. to reduce the proportion of cash dividends if they want to retain full control over old shareholders and show no inclination towards increasing the number of shareholders.Stable and clear dividend policyInvestors give special importance to the stable and clear dividends policy. Also, they give special importance for the continuity of these dividends because they believe that the stability, increase, and continuity of dividends would surely lead to reduce risks from the standpoint of investors. Therefore, investors tend to discount returns of companies whose policies of distribution are characterized by stability, increase and continuity at a discount rate less than other companies. This means that they highly evaluate these companies in other words, they ask for a less rate of returns, thereby reducing the companys ca pital cost.Profit information contentInvestors are interested in the informational content of the profits. Through these profits, they can read the management forecasts for company future profits. As the mangers have more precise information about the company investors, on their part, will give special attention to the informational content of the profits.2-3-2 notional Framework for Dividend policy and its impact on market valueWe can clarify the theoretical framework for the relationship between the dividend policies (cash, shares and repurchase) and market value of the company through the Irrelevant speculation was brought by M M in 1961. They suggested that there was no relationship between the dividend policy and market value. Many researchers have supported this theory, but also others have suspicion about it. The advocates researchers believe that companies should follow residuals dividend policy while the opponents researchers divided into two divisions, the first believe s that there is a positive relationship between the dividend policy and the company market value, others said that this relationship is negative.The relationship between the dividend policy and the company market value is also affected by other dimensions which create a number of other theories, where we find that the uncertainty created a bird in the hand theory , the presence of taxes helped to find a Tax Effect Theory, either shareholders loyalty has created a Clientele Effect Theory, Management try to send some information through the dividend policy covered by Signaling Effect Theory, while the separation of management and owners (shareholders) has created Agency cost Theory. Therefore, we can draw the theoretical framework for the study through the following formTheoretical Framework (figure 2-1)Share DividendPositive RelationshipNegative RelationshipIrrelevantMarket ValueRelationshipDividend PolicyIrrelevant TheoryRelevantResidual Dividend PolicyBird in the Hand TheoryTax Eff ect TheoryClientele Effect TheorySignaling Effect TheoryAgency Cost TheoryCash DividendShare Repurchasing2-3-2-1 Irrelevance PropositionThere is a belief among many finance and economics specialists that cash dividends policy is not important because it is not relevant and does not affect the owners wealth. The source of this belief is a study conducted by Miller and Modigliani (1961). This study concluded that the dividends policy has no effect on the companys value, so the managers will not be able to maximize the owners wealth through a dividends policy.The irrelevance proposition concept for dividends policy on the owners wealth stems from the fundamental idea that companies which distribute continuous high cash dividends to shareholders and secure a trivial bit higher share prices (Archer, Choate et al. 1983 Lumby and Jones 1999). As a result, the investors capital gains are very restrict in this company as he would receive the same returns received by other investors holding another companys shares with low dividends while its prices become high because of the return earnings, and so he obtains high capital gains which compensates the limited cash dividends. In both cases, the shareholders wealth is the profits obtained by cash dividend plus capital gains realized from rising share prices. In case there are no taxes or whether taxes on capital gains are equal, the investor will not be affected, whether the company has established cash dividends or kept the profit in return earnings and the investor has obtain capital gains when selling his shares as a result of the rise of the companys shares by cash undistributed profits with no change in the other effective factors.This theory is based on the following assumptions (Merton and Modigliani 1961)There are no taxes, or the taxes rate on cash dividends and taxes rate on capital gains are equal.There is no transactions cost for the process of selling or buying shares so that, if the investor needs cash, he will be able to sell his shares without losing any commissions and fees instead of cash dividends.The investor is absolutely logical in his decisions.There are no agency costs. This means that the company managers that distribute low cash dividends do not use the company profits to achieve personal goals that may harm the company (Jensen 1986).The company operates under a full and efficient market, which means that the information is available and accessible to all at the same time without any costs, and the stock prices reflect information and absolutely influenced by it at the moment provided.There is no information gap, including that the company operates under a full and efficient market. The future candidate on the performance of the company is homogeneous among all investors, as so do information and expectations among managers and investors. agree to irrelevance proposition, the dividend policy affects only the level of foreign financing required to finance future projects with positive net present value. This means that each dollar distributed to shareholders represents a capital loss of a dollar. According to this hypothesis, the only constraint to the companys market value is the companys investment policy, not the companys dividends policy followed. This is because the investment policy is responsible for future profits (Miller and Modigliani 1961). Accordingly, the companys decision on the distribution of cash or non-profit distribution would not affect the market value of the company and therefore would not affect the owners wealth. This hypothesis recommends that managers should give greater importance to the investment policy and let the dividends policy follow the investment policy, which is known the Residual Dividend Approach.The advocates of the irrelevance proposition hypothesis (Black and Scholes 1974 Miller and Scholes 1978 Merton and Myron 1982 Merton 1986 Peter 1996) adopt the idea that the investor can build his own cash dividends p olicy regardless of the companys dividends policy. This is known as Homemade Dividend(Merton and Modigliani 1961) where the investors can obtain income through selling part of his shares equal to the value of cash profits that could have been distributed by the company, if the company does not have cash dividends and the investor himself wishes to receive cash dividends to meet his consumer needs. He may wish also to reinvest cash dividends distributed by the company in case the investor shows no desire for cash dividends. By following this method, the investor will not be affected by the companys dividends policy, and therefore would not be compelled to abandon the stocks of companies followed by a dividends policy which is not consistent with his wishes.One of the criticisms against the irrelevance proposition hypothesis is that it cannot be practically acceptable. The theory of building a dividends policy for each investor based on efficient market, with no transaction costs for buying and selling (Dempsey and Laber 1992), is not practical. In addition, the investor will pay taxes on cash dividends or capital gains, making the adoption of a specific dividends policy for each investor something costly. Besides, the investment in companies whose cash dividends policy is consistent with the investors needs is less expensive than building a special dividends policy. The hypothesis has been built on the basis that the investor is quite rational when taking his decisions. The psychological tests have proved, however, that human beings are not rational one hundred percent with regard to decision-making. Shefrin and Statman (1984) in their study said that investors have an unreasonable preference regarding the profit dividends this is not consistent with the irrelevance proposition hypothesis. The irrelevance proposition hypothesis is also criticised for assuming equality between the cash dividends and capital gains, while cash dividend is a cash in hand without an y uncertainty risk, and the capital gains is cash in the future with a lot of risks. So, how can they be equal?The irrelevance proposition hypothesis has been built on a set of assumptions and data that have already been indicated. It is understood here that any change in these assumptions and data would naturally lead to a change in the basic hypothesis and therefore to a change in the results. Accordingly, and in practical terms, the financial markets in general do not agree with these assumptions.