Dividend Policy

Zoom Session 6
 Key points
01 What is Dividend Policy?

02 Why is dividend policy important?

03 Theories of investor preferences

04 Signaling effects

05 Clientele effects

06 Residual model
What is Dividend Policy?
This policy includes whether to pay dividend or reinvest them in
the firm’s operations?
The policy comprises of:

1. High payout or low?

2. Stable dividends or irregular?
3. Frequency?
4. Should the policy be announced?
 Dividends Vs Capital Gains
• Payout ratio is the target percentage of net income paid
out as cash dividends.
• Do investors prefer to receive dividends; or would they
rather have the firm plow the cash back into the busi-
ness, which presumably will produce capital gains?
 Dividends Vs Capital Gains

•
If the company increase payout
ratio, the impact will be as shown
on right.
Any change in the payout policy
𝐷1
will have two opposing effects.
• As a result, the optimal dividend
policy must strike the balance
between current dividends and

•
future growth
that maximizes the stock price g
There are five theories:

1. Theory of dividend irrelevancy: Investors are less concerned about payout.

2. Theory of Bird in the hand: a high payout is preferred by investors.
3. Tax preference: Investors favor a low payout, consequently a growth.
4. Signaling Theory: investors regard dividend changes as signals of
management’s earnings forecasts
5. Clientele effect: The tendency of a firm to attract a set of investors that like
its dividend policy.
Any Questions??