rm ASSIGNMENT-3

Q1. DIVIDEND POLICY CAN BE USED TO MAXIMIZE THE WEALTH OF THE

SHAREHOLDER. EXPLAIN.

ANSWER:
MEANING: Dividend is derived from the Latin word “Dividendum”. This means “that which is to
be distributed”. Earnings distribution to the shareholders according to their ownership
proportion is called as Dividend.

• All the shareholders of the company have share in dividend based on their ownership
proportion in the company. Dividend decision or dividend policy is defined as the ratio of
retained earnings to the distributed earnings.
• Dividend decision is interrelated with other three decision viz investment decisions,
financing decisions and liquidity decisions. Companies decide the proportion of earning to
be distributed as dividend and proportion of earnings to be retained with the objective of
wealth maximization of shareholders.
• The companies should find out the optimum dividend payout with risk return trade off
leading to the objective of shareholders wealth maximization. The firms have to decide
the form and timing of dividend payment.

Types of dividends:
1. Cash Dividend
2. Stock Dividend or Bonus Issue
3. Bond Dividend
4. Scrip Dividend or Promissory Note
5. Property Dividend

1. Cash Dividends: Such types of dividends are paid in cash, usually quarterly.
2. Stock dividend: Shareholders obtain new stock in the corporation as a form of a
dividend. Like a “stock split”, the number of shares increases, but no cash changes hands.
Bonus shares are therefore, shares allotted by capitalization of reserves or surplus of a
corporate enterprise. Such shares are issued to the equity shareholders according to
their holdings of the equity share capital of the company. But in India issue of stock
dividend is not allowed. Dividend has to be paid in cash. According to SEBI's guidelines
on issue of bonus shares, bonus shares cannot be issued in lieu of issue bonus shares
frequently in addition to cash dividend.
3. Scrip Dividend: It is the dividend given in the form of promissory notes to pay the
amount at a specific future date. The promissory note is known as scrip's or dividend
certificates. When a company is a regular dividend paying company but temporarily its
cash position is affected due to locking up of funds, which is likely to be released shortly, this
opinion is preferred. Scrip may or may not be interest bearing.
4. Bond Dividend: When company do not have adequate money to pay dividend in cash, it
may issue bonds for the amount due to the shareholders by way of dividends. It has
longer maturity date than Scrip dividend. It always carries interest. Thus, bondholders
get regular interest on their bonds besides payment of bond money on the due date. But
this practice is not visualized in India nor legally permitted.
 5. Property Dividend: In case of such dividend the company pays dividend in the form of
assets other than cash. This may be in form of company's products. This type of dividend
is not common in India.

CLASSIFICATION OF DIVIDEND
Classified dividend based on the following categories Based on type of securities It can be
classified as Equity dividend and Preference dividend. Equity or Ordinary shareholders receive
equity dividend as they are the real owners of the company with voting rights. Equity dividend
is not fixed and depends on the earnings of the company. Investments in the preference share
of the company make the preference shareholders to receive fixed preference dividend.
Preference shareholders have preferential right for dividend while equity shareholders have
preferential right in capital during wound up. Based on source of payment According to section
2(35) of the companies act, 2013, dividend can be paid from the following sources.
(i) From the profit of the current year
(ii) From last year profits
(iii) From the reserves and surplus
(iv) From the money given by central and state government for dividend and
(v) From the capital or assets of the company called as Liquidation dividend.

IMPACT OF DETERMINANTS OF DIVIDEND ON

SHAREHOLDERS WEALTH FOR WEALTH MAXIMIZATION:
The scope of financial management and the functions of finance manager have undergone
changes in the last few decades but the goal or objective of the company remains unchanged.
The main objective of the firm is shareholders wealth maximization. It is represented by the
positive net present value of the financial decisions.
• According to Azhagaiah & Sabaripriya (2008) Shareholders think the wealth is created by
increase in the firm’s market price of the share. Even many reseachers have proved the
same. All the four financial decisions viz, Investment decisions, financing decisions.
• Dividend decisions and Liquidity decisions decide the value of the firm.

• All the four decisions together contribute in the wealth creation for shareholders.

• Dividend decision is one of the important financial decisions that contribute in shareholders
wealth creation. There are some dividend theories which prove that dividend decision
affects the market value of the firm while others disprove it.
• Those who proved the relationship between dividend decision and value of the firm often
link dividend decision with the investment opportunities of the firm. If there are good and
profitable investment opportunities, retention of earnings would be a better option than
dividend distribution.
• This would increase the value of the firm. If there are no better investment opportunities,
dividend distribution would be a better choice for the management. Shareholder wealth is
created if there is increase in the market value of the firm.
• It is the function of all the four decisions of the firm. Finance manager should identify
 optimum dividend policy that maximizes shareholders wealth by increase in the market
value of the firm. This study would analyse the impact of dividend determinants on the
shareholders wealth.

The interest in shareholders’ value is gaining momentum as a result of several

recent developments:
• The threat of corporate takeovers by those seeking undervalued, under managed assets
• Impressive endorsements by corporate leaders who have adopted the approach
• The growing recognition that traditional accounting measures such as EPS and ROI are not
reliably linked to the value of the company’s shares
• Reporting of returns to shareholders along with other measures of performance in business
press.
• A growing recognition that executives’ long-term compensation needs to be more closely tied
to returns to shareholders.
The “shareholders value approach” estimates the economic value of an investment (e.g shares
of a company, strategies, mergers and acquisitions, capital expenditure) by discounting
forecasted cash flows by the cost of capital. These cash flows, in turn, serve as the foundation
for shareholder returns from dividends and share price appreciation.

A going concern must strive to enhance its cash generating ability. The ability of a company to
distribute cash to its various constituencies depends on its ability to generate cash from
operating its business and on its ability to obtain any additional funds needed from external
sources. Debt and equity financing are two basic external sources. Borrowing power and the
market value of the shares both depend on a company’s cash generating ability.

• The market value of the shares directly impacts the second source of financing, that is,
equity financing. For a given level of funds required, the higher the share price, the less
dilution will be borne by current shareholders. Therefore, management’s financial power to
deal effectively with corporate claimants also comes from increasing the value of the shares.

This increase in value of shares can be brought about by rewarding shareholder with returns
from dividends and capital gains.

The most famous statement about the relationship between dividend policy and corporate value
claimed that, in the presence of perfect markets, “given a firm's investment policy, the dividend
payout policy it chooses to follow will affect neither the current price of its shares nor the total
retur
return to its shareholders.