DIVIDEND POLICY

DISCUSSIONS
By
 D M L Kasilo
 [MBA CPA PhD]

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1 DIVIDEND DEFINED

 Dividends are periodic distributions

of earnings to the owners of
preference shareholders or common
shareholder of a firm.
 Dividends can be paid in form of
cash, shares, merchandise or a
combination of them.

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2.1 Cash Dividends Payment
Procedures
Amount of Dividends
 Normally the amount of
dividends to be paid is guided
by a corporation’s dividend
policy
 Dividend policy?
How much Dividends should be
paid for each ordinary share?
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Board of Directors

 The Board of Directors decides on the

amount of dividend according to the
corporation's dividend policy, the
date of record, and the payment date.
 Dividend policy dictates How much
Dividends should be paid for each
ordinary share!

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Significant Dates 1: Declaration
Date
 On the Declaration date, the dividend is
declared at a board of directors meeting.
 On this date the directors issue a
statement similar to the following: " On
November 15, 2011, the directors of the
Mega Corporation met and declared a
regular quarterly dividend of 50 cents
per share, plus an extra dividend of 25
cents per share, payable to the holders
of record on December 15, payment to
be made on January 2, 2012."

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Significant Dates 2: Holder-of-
Record Date
 A date set by directors when
declaring dividends such that every
person whose name is recorded as a
shareholder/stockholder will receive
the amount of dividends at a specified
future date.

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Significant Dates 2: Holder-of-
Record Date
 Holder-of-record date: At the close
of the business on the holder-of-
record date, December 15, the
company closes its stock transfer
books and makes up a list of the
shareholders on that date.
 These shareholders will receive
the dividends on January 2, 2010.

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Significant Dates 3: Ex-dividend
date
 Ex-dividend date: Suppose you
bought 100 shares on December
13, 2011. Would the company be
notified in time?
 To avoid conflict, the brokerage
industry has set up the convention
of declaring that the right to the
dividend remains with the stock
until 4 days prior to the holder-of-
record date;
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Significant Dates 4: Ex-dividend
date
 On the fourth day before the
record date the right to the
dividend no longer goes with the
stock.
 This date is called the ex-dividend
date. The ex-dividend date in this
example is December 11, 2011

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Significant Dates 5: Payment Date

 Payment date: The company mails the

checks to the recorded holders on
January 2, 2012. This date is also set
by directors.
 This is the day when payment of
dividends to all stockholders will be
effected according to the Holder-of-
Record Date

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2.3 Dividend Policy Theories

Introduction 1
 In the Financial Management
literature, a number of key
Questions regarding dividends
policy theories and practices have
yet to be answered:
 (i) Does dividend policy matter?

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Dividend Policy Theories

Introduction 2
 (ii) What effects do dividends
payments have on share prices
 (iii) Is there a model that can be
used to evaluate alternative
dividend policies in view of share
value?

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Dividend Policy Theories

Dividends Reinvestment Plans

 Some corporations offer Dividend
Re-investment Plans (DRIP) to their
present shareholders whereby
shareholders are enabled to use
dividends received to acquire
additional shares at no transaction or
brokerage costs:

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Dividends Reinvestment Plans 2

.. costs:
 A firm appoints a brokerage firm to buy
own shares being traded at an Organized
Stock Exchange (e.g. DSEM) on behalf of
shareholders who have registered
themselves for the Dividend Reinvestment
Plan and does not change brokerage fees
to their shareholders.
 Firm allows them to buy Newly Issued
shares directly from the firm at no
Transaction costs.

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The Residual Theory of Dividends

 This school of thought suggest that

the dividend paid by a firm should
be viewed as a residual that is the
amount left over after all acceptable
investment opportunities have been
undertaken (NPV or IRR methods) :
 Determine optimum level of capital
expenditure required for available
investment opportunities

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The Residual Theory of Dividends:
Dividend Policy Irrelevance

 Using capital structure proportions

(weights), estimate amount of equity
financing needed
 Because cost of retained earnings, kr,
is cheaper than cost of new ordinary
shares, ks; them use retained
Earnings to meet equity financing
requirement.

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The Residual Theory of
Dividends: Dividend Policy Irrelevance
 Distribute as dividends what will be
left in the RE account OR pay no
dividends if nothing remains in the
RE A/C.
 Following up that since the return to
ordinary shareholders, ks, does not
depend on dividends (whether paid or
not paid does not matter); then the
dividend policy is irrelevant

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2.3.3 Dividends Irrelevance
Arguments
( Merton H Miller and Franco Modiglian, Oct.
1961)
 With the dividend Irrelevant Theory, M & M
show that in a perfect World of certainty
(no taxes, no transactions costs, and no
other market imperfections) an investors'
required return, ks, and therefore the value
of the firm are not affected by a firm's
dividend policy because:

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Dividends Irrelevance Arguments

dividend policy because:

(i) The firm's value is determined solely
by the earning power and risk of its
assets
(ii) If dividends do affect value, they do
so because of their information
content which signals management's
earning expectations and

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Dividends Irrelevance Arguments

(iii) A clientele effect exists that causes a

firm's shareholders to receive the
dividends that they expect: Shareholders
wishing to receive stable dividend incomes
will invest into those firms (become clients
of) paying stable dividends, etc.
(iv) These M & M views on irrelevance of
dividends are consistent with the Residual
Theory of Dividend.

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2.3.4 Dividends Relevance Arguments

(Myron J Gordon and John Lintner, May 1963)

The Dividends Relevance Theory suggest that
shareholder prefer current dividends, and there
is a direct relationship between a firm's dividend
policy and its market value.
 Fundamental to this theory is their 'Bird-in-the-
hand Argument' - that investors are risk averse
and attach less risk to current than future
dividends or capital gains.
 Simply "A bird in the hand is worth than Five
(any quantity) in the bush"

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Dividends Relevance Arguments

 Current dividends reduce investors risk,

make them discount a firm's earnings at
lower rate, ks; this results into a higher
firm's value.
 Obviously when dividends are reduced or
not paid, investors uncertainty (risk)
increases, forcing them to discount
earnings at higher rates - hence reducing
the firm’s value.

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2.3.5 Factors Affecting Dividend Policies

Six factors are generally considered when

formulating dividend policies:
(i) Legal Constraints
Restrictions for paying dividends, e.g. from
legal capital elements (what about Cap
212?).
(ii) Contractual Constraints
For instance a highly geared firm may hand
contracted not to pay dividends until the loan
is fully paid.

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2.3.5 Factors Affecting Dividend Policies

(iii) Internal Constraints

Is the firm having adequate cash? This is
because profits are not cash.
(iv) Growth Prospects
For instance if a firm is in a growth stage,
it may need all the funds, it can get to
finance growth and therefore pay no
dividends.

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2.3.5 Factors Affecting Dividend Policies

(v) Owner Consideration

Generally, dividend policy formulation must take into
account the interest of the majority of shareholders in
respect of wealth maximisation goal.
(vi) Market consideration
Since value of the firm is reflected by the market price
of a share, it is important to consider the impact of the
dividend policy on the market response - think of the
information content of dividends payment.
 Fixed or growing dividends usually have positive
market responses (higher prices per share) as
opposed to fluctuating dividends.

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3 TYPES OF DIVIDEND POLICIES

 3.1 Introduction
(i) A firm’s dividend policy is a plan of
action or a set of guidelines to be
followed whenever dividend decisions
must be made.
(ii) Since shareholders tend to abide to the
dividends relevance theory, and abide to
the bird in the hand principle – respond
most favourably to positive information
that signal to them that the firm is okay
and minimizes their uncertainty.

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3.1 Introduction to dividend policies

(iii) Therefore dividend policy

formulation must consider three key
issues:
(a) the behavioural aspects of its
shareholders in particular
(b) maximisations of the wealth of the
owners / shareholders goal; and
(c) providing adequate financing for
growth in particular
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3.2 Types of Dividend Policies
 Five generally used dividend policies that
can fulfil the two objectives [3.1] in the light
of legal, contractual, internal, growth, owners
related, and market related factors are
summarised below.
3.2.1 Constant-Payout-Ratio Dividend Policy
With a constant pay-out-ratio dividend policy,
a firm establishes a certain percentage of
earnings – say 25% - that will always be
paid to shareholders whenever dividends
are paid.

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3.2.1 Constant-Payout-Ratio Dividend
Policy
 The dividend pay-out ratio is the firm’s cash
dividend per share divided by its earnings per
share.
 = (Cash dividends) / ((Net profits –
Preference dividends)
 It follows that the cash pay out ratio is the
proportion (% age) of Cash dividend per
share to Earnings per share i.e how much
of the earnings per share is paid as cash
dividends Or the proportion of profits paid
as cash dividends (prove this statement!)

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Constant-Payout-Ratio Dividend Policy

 With this dividend policy, dividends

paid each year will always fluctuate
depending on the amount of
positive earnings per share or
profits; and with no dividends when
the firm suffers a loss (create and plot
fluctuating dividends – y-axis; against
time – years – x-axis to underline
typology of this dividend policy)

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3.2.2 Regular Dividend Policy

 This policy sets a target amount of dividends per

share provided Earnings per Share (EPS) does not
exceed a certain target EPS;
 and
 if EPS improve beyond the target EPS preferably
for an agreed number of years, the amount of
dividend per share would be increased.
 For instance, dividends per share would be Tshs
550 per share provided EPS does not exceed Tshs
1,200; and when it goes beyond Tshs 1,200 for a
consecutive three years, the dividend per share
would rise to Tshs 750; etc.

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3.2.3 Low-Regular-and Extra Dividend
Policy

 A firm that uses a low-regular-and

extra dividend policy pays low
regular dividend, which is
supplemented by optional additional
payment of what is called extra
dividends whenever corporate
earnings improve!

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3.2.4 Stock Dividends

 Firms do pay stock dividends to

existing shareholders instead of
cash dividends e.g. one share for
every two shares
 Usually this approach is used when
there are no adequate cash! Learn
the financial accounting treatment of
stock dividends

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3.2.5 Residual Theory of
Dividend Policy
 The theory and application of this policy
has been discussed in presenting the
dividend policy irrelevance theory above.

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 Can I apply dividend Policies?

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