Dividend Policy, Growth, and Valuation of Shares

The main points  include; getting to know the Miller-Modigliani theorem as it forms the base for the discussion, discussion on whether the firms that do not pay dividends are worth anything at all, influence of tax in the firm investment and investors’ decisions, understanding the possible impact of transaction costs to the non-dividend paying firms, how the change in dividend may be interpreted by investors, how the investors can stay safe from the creditors’ ugly actions, dividend acting as a firm’s source of capital, how a firm can balance the investors’ demand for dividends the determination of the portfolio implications of different dividend policy to the investors.

Why are the main points important?

The miller- Modigliani theorem states that the dividends that are paid out by corporations must not necessarily affect the value of the shares or the investors’ return since the higher the amount of dividend paid out, the less the capital receives in capital appreciation irrespective of the results from the business decisions in the corporation (Black, 1996 p.9). That theorem operates on the assumption that the dividends paid out are not by any chance influencing the business decisions of the corporation.

For the case of firms that do not pay any dividends to the stakeholders, there is a wide range of avenues that the stakeholders can use to obtain the cash from the corporation without necessarily receiving the dividends (Black, 1996 p.9). The corporation can decide to give the stakeholders some jobs in the cooperation at an inflated salary. It is important for the stakeholders to note that they can enjoy a wide range of benefits from the corporation that would fill the gap that was left by the unpaid dividends. At other scenarios, the corporation may order goods from other firms that are owned by the stakeholders at some inflated prices.

The tax policies in a system will play a great role in determining on which will be the best decision for the investors and the corporations. In an economy where the tax rates imposed on dividends are higher than in the capital gains, then the firms that pay no dividend will attract more taxable investors. The companies that try to retain the earning receive special tax. However, the firm that opts to invest in its business does not necessarily have to pay tax as much as it is issuing securities.

Availability of transaction costs does not justify whether the dividend payment is important or not. A non-dividend-paying corporation can have some automated systems that will help the investors raise cash, but those systems might cost as much as the dividend paying systems. It is very important for the corporation’s management to conduct a proper analysis of the prospect. The amounts of dividend keep fluctuating depending on the forecasts of the firm’s prospects.

Companies’ creditors get hurt anytime the firm pays dividends to the investors.it is important for the company to pay out dividends since the company’s assets can fall on the hands of the creditors at any time. That fact motivates the investors to invest in the dividend-paying companies. Dividends can act as the least cost source of funding available to the firm (Black, 1996 p.10). The firm can cut the dividends to risk in project investments that might bring high returns to the company in the future.

The corporation should analyses the kind of investors that it has since for the investors who are subject to high taxation will always hold stocks of a low dividend while the investors who are subject to high taxation will always hold the stocks of a low dividend. Therefore, it is important for the cooperation to try and balance the interests of different investors. Corporations have to be very keen when choosing the dividend policy that they are going to adopt. For rational investors, they will always select the dividend policies for their portfolio that are going to maximize their returns after tax (Black, 1996 p.11).

Why are the main points relevant?

All the main points discussed are trying to bring up the rationale for the existence of firms that pay the dividends to the investors and those that do not pay dividends to the investors. From the arguments that have been laid from the perspective of each main point, the reader can Cleary understand why different firms develop different dividend policies as they try to suit and incorporate different investors’ needs. Different approaches to reasoning have been demonstrated through the main points. All the main points cut across the dividend puzzle.

Conclusion

In conclusion, the issue of dividend payment by the companies can be viewed from different points, both the corporations’ side and the stakeholders’ side. The miller- Modigliani theorem tries to justify that dividend payment by companies does not affect the return on investors and shares value.

Article Summary: Dividend policy, growth, and valuation of shares

What are the main points?

The main points include; the effect of dividend policy with perfect markets, rational behavior, and perfect certainty, determination of then available approaches that are used in the valuation of shares, the informational content of the dividends, how a firm can enhance constant growth rates, the dividend policy and the market imperfections.

Why are the main points important?

Dividend policy impact on the shares price is essential to the corporation, investors, and economists. Dividend policy assumes that there is a perfect capital market, the investors always display rational behavior, and that there is perfect certainty in the market. The perfect capital market holds that no any investor is large enough to affect the price ruling of each share. Rationality in the behavior of the investors interprets that the investors will always desire more wealth to less. The perfect certainty assumption interprets that the investors’ return in the future is determined and specific. The above assumptions give a chance for the valuation of the shares. That interprets that the price per share will be such that the rate of return will remain the same in the market in a given duration (Miller and Modigliani, 1961 p. 412). The investors can switch from the low-return shares to the high return shares in an effort of increasing their terminal wealth.

A corporation must come up with the best strategies in the process of trying to finance their investment. They have the option of reducing the dividend payouts and relying on the retained earnings or else raising the dividends and floating more new shares. In a company’s policy of investments, the dividend payout policy that the company opts to adopt will neither affect the shares’ current price nor the shareholders’ total return. In the economic sense, the dividend policy might be irrelevance given the investment policy. In the real sense, the value is solely determined by real considerations rather than the financial illusions. The shares valuation can use the approach of discounted cash flow, the approach of the stream of earnings, the approach of current earnings and the investment in the future, and the approach of the stream of dividends (Miller and Modigliani, 1961 p.415).

Constant growth rates in profits can be generated when a firm specializes in the investment opportunities approach. In case the firm only prefers the external source of financing, then the initial dividend payouts will be high and will later grow at a decreasing rate. However, for a firm that opts to use the internal source of funding, then the dividend payout growth rate will be much higher than in the case of external financing (Miller and Modigliani, 1961 p.424). Hence the firm must make those considerations anytime it has intentions of seeking some source of financing to motivate and maintain the investors as well as making the firm attractive for the new investors.

To some extent, the informational content of dividends will play a big role in influencing the price of shares in the market. For instance, in the world of reality, a change in the dividends is in most cases followed by a change in the shares’ market price. The investors make different interpretations following a change in the dividends. At times they may interpret that the firm’s management is prospecting the future investment opportunities. Different individual investors are subjected to different tax brackets. Some of them will prefer capital gains to receive dividends. All those differences come from the existence of market imperfections.

Why are the main points relevant?

All the main points are revolving around the growth and the valuation of shares in a firm. The attractiveness of a firm to the investors will be originating from the share growth rates and the capital gains in investments. The share valuation and growth is mostly done theoretically in the world of perfection, but this is so different from the world of imperfection. Rational firms and rational investors always fight for the good dividend policies that will favor them and the growth of shares in the market.

Conclusion

In conclusion, there exist different approaches that can be used in the valuation of shares. The dividend policy that a firm adopts can either motivate or demotivate the investors. However, in some sense, the dividend policy is seen to be irrelevant as compared to the firms’ investment policy. The investors in the market always make their interpretations when a change in the dividends occurs.

Works Cited

Black, Fischer. “The Dividend Puzzle.” The Journal of Portfolio Management, vol. 23, no. 5, 1996, pp. 8-12, jpm.iijournals.com/content/23/5/8. Accessed 6 Nov. 2018.

Miller, Merton H., and Franco Modigliani. ”Dividend Policy, Growth, and the Valuation of Shares.” The Journal of Business, vol. 34, no. 4, 1961, p. 411.