Let's talk about Dividend Policies and Decisions
The dividend decision or policy of a company relates to the determination of the percentage of earnings paid to equity holders as dividends, the profit retention policy of the firm which depends on the firms dividend payment ratio, the form the dividend payment would take as well as the appropriate time to distribute the dividends.
Having established that, we need to know that the determination of the division of earnings between payments to stockholders and reinvestment in the firm is a function of a firm's dividend policy. Retained earnings are one of the most significant sources of funds for financing corporate growth, whereas dividends constitute the cash flows that accrue to stockholders.
In this case, a higher dividend rate means less retained earnings and consequently, a slower growth rate in earnings and stock prices. Thus, the determination of the allocation of profits between dividends and retained earnings can have critical influence on the value of the firm.
However, dividend policy can only become very important if investors show a preference for dividends over capital gains and also given the managerial objective of share price maximization. Noteworthy is that the proof of the importance of dividend policy requires the consideration of various theories on dividend policies. Residual and irrelevance theory are the two most important of these theories.
While residual theory of dividends states that policy decision regarding dividends do not require active managerial deliberations, the irrelevance theory states that investors are indifferent to the choice between dividends and retained earnings.
These two theories however, point to the fact that firms may be able to influence share prices by following appropriate dividend policies. Two determinants of a dividend policy are then the alternative investment opportunities available to a firm and the capital gains/ current yield preferences of it's stockholders.
In the light of this, firms with few investment opportunities relatively, tend to face a slow down in their growth rates. Hence, they'll be better off with a high dividend payment ratio. Similarly, firms with proportionally more tax-exempt institutional stockholders may choose higher dividend payout ratios.
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