BACHELOR OF MANAGEMENT WITH HONOURS

JANUARY / 2022

BBPW3203

FINANCIAL MANEGENT 2

NO. MATRIKULASI : 860917526259001

NO. KAD PENGENALAN : 860917 – 52 – 6259
NO. TELEFON : 014 – 350 5423
E-MEL : [email protected]

PUSAT PEMBELAJARAN : OUM SANDAKAN

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TABLE OF CONTENTS

1.0 DIVIDEND POLICY 3–4

2.0 FACTORS AFFECTING DIVIDEND POLICY 4–7

3.0 STOCK DIVIDEND 7–9

4.0 SUMMARY 9–9

5.0 REFERENCES 9 – 10

6.0 PART 2 12 – 13

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PART 1
1.0 DIVIDEND POLICY

Dividend policy is one of the important factors for assessing corporate performance. The
behavior of the dividend policy is one of the most debatable issues in financial literature and still
maintains a noticeable place in emerging markets (Hafeez et al., 2018). While controversy remains
among researchers and financial analysts, dividend policy is characterized by the ambiguity that
makes it impossible to understand all its aspects. Dividends are considered an important factor in
the self-funding process and the company's investment decisions if those decisions depend on
available cash from operating activities, and the impact these decisions may have on the
investment opportunities available to the company (Kanakriyah,2020).

Dividend policy refers to how much cash is distributed to shareholders. Dividend policy
can be determined by two important factors, the first is the decision to pay dividends to
shareholders and the second is to retain profits to reinvest them in future projects. Corporations are
responsible for balancing the needs of corporate owners to maximize wealth with the need to
provide adequate funding for growth projects, which is a major role in controlling executive
opportunism.

Dividend policy have 3 type which are constant payout ratio policy, constant nominal
dividend and special dividends payout policy.

A constant payout ratio is when a specific percentage of a company's earnings is

distributed to shareholders as dividends. Many companies prefer a continuous dividend policy
because it makes it easier for management to decide how much earnings should be kept. A
constant dividend payout ratio policy is a dividend policy in which the percentage of earnings paid
out in the form of dividends remains the same. In other words, a fixed dividend payout ratio policy
maintains the same percentage of earnings as dividends paid to shareholders. Paramo Mitra (2013)
noted that the policy is related to the company's ability to pay dividends. If the company incurs a
loss, no dividend will be paid, regardless of the wishes of the shareholders. Following this policy,
retained earnings are automatically used for internal financing. At any given payout ratio,
increases in dividend amounts and retained earnings decrease as earnings increase and decrease as
earnings decrease. The policy simplifies dividend decisions and has the benefit of protecting the
company from overpaying or underpaying dividends. It ensures dividends are paid when profits
are made and avoided when losses are incurred.

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 Constant nominal dividends are also known as regular dividends. This type of policy
assumes that the company will maintain a nominal dividend amount regardless of the company's
income. Under the regular dividend policy, the company pays dividends to shareholders every
year. If the company's profits are very high, the excess profits are not distributed to shareholders
but are retained by the company as retained earnings. If the company loses money, shareholders
will still receive dividends under the policy. A regular dividend policy is suitable for companies
with stable cash flow and stable income. Companies that pay dividends in this way are considered
low-risk investments because while dividend payments are regular, they may not be very high.

The last one is the special dividend. Special dividends are non-recurring distributions of
company assets, usually in the form of cash to shareholders. Special dividends are usually larger
than normal dividends paid by the company and are usually associated with a specific event, such
as an asset sale or other unexpected event. Special dividends are also known as additional
dividends. Special dividends are usually declared after unusually strong company performance as
a way to distribute profits directly to shareholders. Special dividends may also arise when a
company wishes to change its financial structure or spin-off a subsidiary to its shareholders. It's
also usually paid in one lump sum, and companies don't usually receive any special dividends.
However special dividens also have some disadvantages, such as lowering the company's share
price by the amount of the dividend. If an investor sells the stock at a lower price directly after
paying the dividend, they will offset the special dividend gain. Some investors also believe that if a
company pays a special dividend, it signals a lack of new growth opportunities ahead and could
lose faith in the stock.

2.0 FACTORS AFFECTING DIVIDEND POLICY

Managers

Lintner (1956) once reported that managers attach importance to the stability of
dividends. They don't like to cut or omit dividends. On the contrary, the company usually sets
the target dividend payout ratio, and regards the current year's earnings and the dividend of
the previous year as the basic dividend policy determinants. Current and future earnings, the
stability of earnings and the demand of shareholders are considered as the basic factors for
Indonesian companies to pay dividends (Baker and Powell, 2012).

Al-Najjar and Kilincarslan (2017) reported that listed companies in Turkey usually adopt
long-term dividend payout ratio, so the stability of dividend is concerned which relatively
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lower than developed markets in the United States. They also reported that the concentration
of ownership would affect the target payment rate. Mehar (2005) pointed out that for listed
companies in Pakistan, dividends are positively correlated with insider ownership and
negatively correlated with liquidity.
Profitability
Fama and French (2001) reported that large companies with high profitability and low
investment opportunities tend to pay dividends. In the United States, profitability, investment
opportunities and scale are three important characteristics that distinguish dividend-paying
companies from non-dividend-paying companies (Benito and Young 2001). In addition to
profitability, investment opportunities and scale, Yarram (2015) reported that dividends of
Australian companies are also positively related to corporate governance. Yusof and Ismail
(2016) also reported similar findings of Malaysian listed companies. In addition, they also
said that profitability and liquidity significantly affect Malaysia's dividend. As concluded by
Lintner (1956), a firm’s profit is one of the most critical factors that affect dividend payouts.

Myers and Majluf (1984) asserted that profit-making companies increased their
demand for debt because companies used internal funds for investment. They explained this
view through the pecking order financing hypothesis. According to pecking order theory,
enterprises prefer to invest with internal resources when external financing is needed. They
are more willing to issue debt than equity to reduce information asymmetry and transaction
costs.

Agency costs

In addition, by distributing cash to shareholders, internal funds available to managers

are reduced. As a result, managers may be forced to seek external financing. As noted by
Easterbrook (1984), agency costs come in two forms. The first is the cost of overseeing
managers, borne by shareholders. The second form of agency cost is the risk aversion of
managers. Risk-averse managers are less risk-averse and prefer to choose projects with lower
expected returns than higher-risk projects. Shareholders, on the other hand, have inverse
preferences and want managers to act as risk-averse and take on high-risk businesses because
shareholders believe that riskier businesses will enrich them (Easterbrook, 1984).

Another problem that may be affected by dividend payments, according to Jensen and
Meckling (1976), is the conflict between shareholders and bondholders. Shareholders act as

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proxies for bondholders, so paying high dividends to shareholders may be seen as a forfeiture
of bondholders' wealth. As a result, bondholders may prefer to limit dividend payments.
Managers must go to the capital markets to raise funds while paying dividends. In this way,
financial analysts and other investment professionals can also examine the actions of
managers. As a result, it will be less expensive for shareholders to monitor managers. Some
argue that paying dividends increases insider scrutiny of managers. On the other hand, it may
force managers to make undesired decisions, such as increasing leverage, which is a risky
behavior (Easterbrook, 1984).

In other words, shareholders should have an incentive to weigh the pros and cons of
paying more dividends. The larger the number of shareholders, the more dispersed the
ownership; thus, as Rozeff (1982) argues, it becomes more expensive to monitor managers.
Fragmented ownership leads to increased agency costs. In companies with more dispersed
owners, higher levels of dividend payments are needed to control agency problems, because
when the company's ownership is widely dispersed, the level of shareholder control is also
reduced. In this way, they can mitigate agency problems and reduce managers' available cash
to protect themselves from confiscation (Alli, Khan, and Ramirez, 1993).

Another measure of agency cost is the firm's free cash flow, which indicates potential
agency problems if the firm retains a larger free cash flow. In emerging markets such as
Malaysia, agency issues are expected to be a more serious topic for companies due to the
nature of ownership structures and legal issues for investors in these markets. The lack of
evidence to support or reject this claim in emerging markets, especially Malaysia, was one of
the motivations for this study.

Size of company

Another factor that can influence a company's decision to pay a dividend is its size of
the company. Research shows that about 87% of large companies pay dividends, compared
with 49% of small companies (Mozes & Rapaccioli, 1995). A study by Lloyd, Jahera, and
Page (1985) shows that a firm's size plays an important role in its dividend policy. In other
words, the bigger the company, the easier it is to access the capital markets, because big
companies are more mature than small companies. As a result, the reliance on internal
funding is reduced and firms can pay higher dividends (Lloyd, Jahera, & Page, 1985).

Many research shows that large companies can easily increase capital at a lower cost
than small companies. In this way, there will be less reliance on internal funds and they will

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manage to pay higher dividends to shareholders. Many studies have recognized that company
size is an important determinant of dividend payments. Based on these studies, the
relationship between dividend payments and firm size is expected to be positive (Barclay,
Smith, & Watts, 1995). Mahadwartha (2002) concluded that in Indonesia, dividend payments
are inversely proportional to firm size. In other words, the bigger companies are in Indonesia,
the less dividends they pay their shareholders. Mahadwartha reasoned that, in large
companies, management may use free cash flow for profit, and shareholders have less power
to oversee managers. As Gugler (1997) argues, in the United States, most large corporations
pay dividends to control managers' self-interested investments. Since small firms must
reinvest to achieve growth; therefore, less money will be available to pay dividends (Ingram
& Lee, 1997).

Growth opportunity

Furthermore, Fama and French (2002) also assert that a firm's dividend payment is
influenced by the firm's growth opportunities. Based on the maturity hypothesis, as a
company becomes more mature, its opportunities for growth and investment decrease. In
other words, when a company faces diminishing growth opportunities, it starts increasing its
dividend. Fewer growth opportunities will create more available cash flow; therefore,
dividends will increase. For mature companies, the most important result is their lower
systemic risk.

In addition, capital expenditures will also be reduced due to fewer investment

opportunities and less risk. They concluded that dividend increases are a sign of firm maturity
(Grullon, Michaely, and Swaminathan, 2002). The dividend increase sends two messages.
Dividend cuts convey good news, while bad news is lower profitability. The results show that
the positive market reaction indicates that news about profitability is dominated by news
about risk (Grullon, et al., 2002). Additionally, Grullon et al. (2002) assert that increased
dividend payments also convey a message about management's commitment not to
overinvest. Results of Grullon et al. Consistent with free cash flow assumptions, but
inconsistent with signaling theory.

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3.0 STOCK DIVIDEND
Stock dividend is a method used by companies to distribute wealth to shareholders,
which is paid in the form of stock instead of cash. When the company has insufficient cash on
hand, it mainly pays stock dividends instead of cash dividends. The board of directors decides
when to announce shares and how to pay dividends. Similar to cash dividends, stock
dividends do not increase shareholders' wealth or market value. Although it increases the
number of outstanding shares of the company, the price per share must be reduced
accordingly. The understanding that the company's market value remains unchanged explains
why if more shares are issued, the share price must fall. Stock dividend also called bonus
shares in India.

Shareholders

One of the point views for the shareholders in stock dividends is tax benefit. Stock
dividends received by shareholders are not taxed as income. The payment of stock dividends
is usually interpreted by shareholders as a sign of higher profits. If a company always follows
the policy of paying a fixed dividend share and continues this policy after the stock dividend
is announced, the total cash dividend of shareholders will increase in the future. Announcing
stock dividends may have a beneficial psychological impact on shareholders.

Stock dividends also help to increase future dividends of existing shareholders. If the
regular cash dividend is continued after the additional stock dividend is announced, the cash
dividend available to shareholders will increase in the future. For example, if a shareholder
owns 100 shares of a company, the company declares Re.0.50 as a regular dividend and
receives an additional dividend of 6%. Then shareholders will Rs.53 (100 x 0.50+ 6% of Rs.
50) the increase in dividend being Rs. 3.

Stock dividends help preserve proportional ownership for shareholders. When the
company issues further shares, new investors buy shares. This will reduce the ownership of
existing shareholders who do not have the funds to buy more shares. But stock dividends
provide existing shareholders with additional shares, thereby retaining proportional
ownership for them. However, shareholders fail to realize that the stock dividend will not
affect their wealth, so the stock dividend itself has no value to them.

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Company
The announcement of dividends allows companies to declare dividends without
exhausting the cash needed to finance profitable investment opportunities within the
company. In some cases, even if the company's intention is not to retain earnings, stock
dividends are the only means to pay dividends and satisfy shareholders' desires. In order to
increase trading activities, sometimes companies declare stock dividends with the intention of
lowering the market price of stocks and making them more attractive to investors.

Generally, paying stock dividends predicts higher future profits. After paying a stock
dividend in the form of additional shares, the company's earnings should increase. If profits
don't rise, earnings will be diluted. Since earnings dilution is not desired, a stock dividend
will only be declared if the directors expect earnings to increase to offset the additional
shares. However, stock dividends raise shareholders' expectations of the company. Their
expectations for the company's profitability and future stock profits are quite high. Hence,
this puts pressure on the company to satisfy shareholders.

4.0 SUMMARY

Dividend policy is considered one of the most important financial decisions that can
affect a company’s financial performance. Dividend policy have 3 type which are constant
payout ratio policy, constant nominal dividend and special dividends payout policy. There
have 5 factors that’s affecting divided policy which are managers, profitability, agency costs,
size of company and growth opportunity. A stock dividend represents a distribution of shares
in lieu of or in addition to the cash dividend to the existing shareholders. This has the effect
of increasing the number of outstanding shares of the company. Stock dividend will bring
shareholders tax benefit, increase future dividends of existing shareholders and help preserve
proportional ownership for shareholders. Stock dividends also bring company predicts higher
future profits.

5.0 REFERENCES

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Ali, K.L., Khan, A.Q. and Ramirez, G.G. (1993), Determinants of Corporate Dividend
Policy: A Factorial Analysis. The Financial Review, 28, 523-547.
https://doi.org/10.1111/j.1540-6288.1993.tb01361.

Al-Najjar and Kilincarslan (2017). Corporate dividend decisions and dividend smoothing:
New evidence from an empirical study of Turkish firms. International Journal of
Managerial Finance 13(3) DOI:10.1108/IJMF-10-2016-0191

Baker, H. K., & Powell, G. E. (2012). Dividend Policy in Indonesia: Survey Evidence from
Executives. Journal of Asia Business Studies, 6, 79-92.
http://dx.doi.org/10.1108/15587891211191399

Barclay, Smith, & Watts, 1995.The determinants of corporate leverage and dividend policies

Easterbrook (1984), Two Agency-Cost Explanations of Dividends. The American Economic

Review, Vol. 74, No. 4 (Sep., 1984), pp. 650-659 (1f0 pages)

Fama, E. F., & French, K. R. (2001). Disappearing Dividends: Changing Firm

Characteristics or Lower Propensity to Pay? Journal of Financial Economics, 60, 3-
43. http://dx.doi.org/10.1016/S0304-405X(01)00038-1

Grullon, Michaely, and Swaminathan (2002). Are Dividend Changes a Sign of Firm
Maturity?, The Journal of Business 75(3):387-424

Hafeez, M. M. et al (2018). Impact of Dividend Policy on Firm Performance. International Journal

of Advanced Study and Research Work, 1(4), 1-5.

Haim Mozes (1995). The relation among dividend policy, firm size, and the information
content of earing announcements, Journal of Financial Research, vol,18, issue 1 75-
88

January 1995Journal of Applied Corporate Finance 7(4):4-19. DOI:10.1111/j.1745-

6622.1995.tb00259.x

Jensen and Meckling (1976), Theory of the firm: Managerial behavior, agency costs and
ownership structure, Journal of Financial Economics Volume 3, Issue 4, Pages 305-
360

Kanakriyah (2020). Dividend policy and companies’ Financial Performance. The Journal of
Asian Finance, Economics and Business, Volume 7 Issue 10, 531-541.

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Lintner, J. (1956). Distribution of Incomes of Corporations among Dividends, Retained
Earnings, and Taxes. The American Economic Review, 2, 97-113.

Mahadwartha (2002). Predictability Power of Dividend Policy and Leverage Policy to

Managerial Ownership in Indonesia: An Agency Theory Perspective. From:
https://www.researchgate.net/publication/228237876_Predictability_Power_of_Divi
dend_Policy_and_Leverage_Policy_to_Managerial_Ownership_in_Indonesia_An_A
gency_Theory_Perspective

Mehar (2005). Corporate Goverance and dividend policy. Pakistan Economic and social
review. volume XLIII, No. 1 (Summer 2005), pp93-106

Myers, S. C., & Majluf, N. S. (1984). Corporate Financing and Investment Decisions when
Firms Have Information that Investors Do Not Have. Journal of Financial
Economics, 13, 187-221. From: https://doi.org/10.1016/0304-405X(84)90023-0

Paroma Mitra (2013). In search of mathematical form for a production function of whhel
machining. Journal of applied finance and economics, Vol 1, Issue 1-2, pages 41-50

Rozeff (1982). Growth, Beta and Agency Costs as Determinants of Dividend Payout Ratios,
Journal of Financial Research, Vol. 5, No. 3, pp. 249-259, Fall 1982.11 Pages
Posted: 19 Oct 2005

Seth, N., Deshmukh, S. & Vrat, P. (2005), 'Service quality models: a review', International
Journal of Quality & Reliability Management, vol. 22, no. 9,pp. 913-949.

William P. (1985). Agency costs and dividend payout ratios. From:

https://doi.org/10.1111/j.1540-6288.1985.tb00256.xCitations: 18

Yarram (2015). Corporate governance and financial policies: Influence of board

characteristics on the dividend policy of Australian firms. Managerial Finance,
2015, vol. 41, issue 3, 267-285

Yusof and Ismail (2016). Determinants of dividend policy of public listed companies in
Malaysia, Review of International Business and Strategy 26(1):88-99
DOI:10.1108/RIBS-02-2014-0030

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6.0 PART 2

Explain on why a company may look to divest part of its operations

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Explain the economic reasons for acquisitions. Provide relevant examples (based on real

situations) to support the explanation.

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