Corporate Dividend Policy - Dividend Policy, Business Economics & Finance Video Lecture | Business Economics & Finance - B Com

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open tuition calm this chapter is going
to go through an Locker dividend theory
now the chapters entitled corporate
dividend policy but then the best way to
go through and think about it is looking
at the theories behind the level of
dividend that we are going to pay as a
business to the shareholders and whether
or not that pattern of dividends that we
pay has any bearing on the wealth of the
shareholders and what we're going to go
through and do is as I said look at two
theories so when we're looking at the
theories there are two to behold okay so
what we're gonna look at first of all is
mmm somebody Glee Arnie and Miller's
theory on dividends and then we'll go
through that and begin to then look at
the traditional theory on dividends
before we then go through there and
discuss what level of dividends should
we actually paint now the key bit is
that it is all very theoretical
therefore there are assumptions and some
of those assumptions will not hold and
if they don't hold that then means that
the theory doesn't hold does it but with
most theories roll out to make
assumptions and if we keep those
assumptions in place then the theory
does actually work okay but it's just
the level of assumptions that might not
be theoretically correct in today's
modern world so what we've got there if
we look at M&M and Italy Arnie and
Miller I think it's their 1963 Theory if
memory serves me right you can correct
me upon if I am so wrong but the key
thing that Medaglia Arnie and Miller
found with their theory is that they
went through the unstated that the
pattern
of dividends he's irrelevant okay so
when we're looking at paying out a
dividend out of our businesses earnings
it doesn't matter what the level of the
dividend is from one year to the next
the shareholders will be indifferent and
if they are indifferent about that level
or pattern of dividend then the share
price will not be changed okay let's
just explain that in a little bit of
detail so we're saying that a company
pays out a dividend of ten cents per
year this year based upon its level of
profits next year the company makes more
profits than what it did this year has
less to invest in terms of new projects
so therefore therefore pays out a much
higher level of dividend so throws up
there to twenty twenty-five cents per
share okay
the following year then what happens is
that the company then has more to invest
them because it has made higher profit
so therefore it decides well let's keep
some money back within the business and
use that to finance those new projects
in the future so the dividend is now
fallen so it's gone from say ten cents
up to twenty-five cents and now it's
dropped down to five cents per sure okay
now what Medaglia Arnie and Miller said
was that that pattern the fact that it's
gone up it's gone down it's gone up it
can go down he's irrelevant it makes no
difference to shareholder well from the
reason why that they went through and
Asuma was that they said that the value
of the business is the present value of
the future dividends okay looking at the
dividend received in the future
discounting it back to present value
that should therefore in present value
terms remain the same regardless of the
level of dividends and the reason why is
because when you take that dividend and
invest it in your positive NPV project
then you are generating the wealth for
those shareholders
so unless the business can go through
and find something alternative to due to
the dividend ok so unless it can go
through there and find a positive NPV
project and invest that money to
generate that positive NPV project then
it should pay the money out as a
dividend okay so if you can find
something to do with the money that's
been generated from the earnings invest
it but invest it to give the shareholder
the required rate of return that they
require if you're giving the required
rate of return that that shareholder
requires then fine okay they will be
indifferent they will be happy knowing
that they will then get a higher return
in the future once that money has been
invested okay however that does just go
through there and create some issues
doesn't it because if you are a
shareholder and you were relying on that
dividend income and all of a sudden that
dividend is withheld because there is a
positive NPV project that the business
is going to invest in then you've got no
cash ok that dividend is not received by
you the shareholder so what the big Lee
Arnie and Miller argue then will they
argue that you could go through there
and create your own income by selling
the shares and you would therefore be no
worse off in terms of wealth because
you're selling the shares without any
transaction costs okay so there's no
buying and selling cost when it comes to
selling the shares it's a perfect
substitutes substituting dividend income
for capital growth on the show however
as well there's other assumptions there
in that you will then be in difference
in terms of how you are taxed because if
you get dividend income then you will go
through there and have income tax but
that will then be taxed differently if
you're subjected to some form of capital
gains tax so what we have to go through
and do that is we assume that there are
no transaction costs because that will
ensure that when you sell you're sure to
generate you that cash income you will
not lose out on wealth by paying broker
fees and also that there is no tax okay
because if there is tax you will be
indifferent between capital growth and
is it your dividend income in terms of
how you are planning your tax
efficiently okay also as well they
assumed the shareholders a perfect
information because if your dividend is
being cut and the the business announced
that your dividend is being cut because
they are investing in positive NPV
projects you need to have all the
information about what that NPV project
actually is how much wealth is going to
be created and when you will get that
return in terms of the increased wealth
okay so it's fine to hold but the
dividends as a business provide that you
are giving perfect information and that
money is being invested to give the
required rate of return for those equity
shareholders it will be if you invest it
in positive NPV projects and if you
therefore payout a higher dividend at
some point in the future okay so key
thing that we can take from there is
that with M&M there's that pattern of
dividends is irrelevant it's not saying
the dividend itself is irrelevant it's
saying that the pattern is irrelevant
provided therefore then that you go
through and pay a higher dividend in the
future it's a compensate for the fact
that you did not receive that dividend
today so what we can go through and do
that is to bring in if you like a a
final conclusion is that what we should
be doing there is that we should invest
in all of our positive
MPV projects and then what we go through
there's you pay out the remainder as a
dividend okay like we said earlier if
you can't find anything to do with the
earnings there's nothing to invest in
then pay all out as a dividend however
if there are lots of projects on the
table invest in all of those projects
and then what is left then go through
the and pay that as your dividend it
doesn't matter what happens and so is
the possibility goes up or down provided
that you are investing at that required
rate of return of the equity holder okay
again there are some assumptions as you
can see there are those assumptions okay
yeah a bit crazy doesn't happen in the
real world there are transaction costs
how I know if the brokers make their
money there is tax
how did government's make their money
okay there isn't perfect information as
the information is withheld okay so that
then brings us to the traditional theory
okay
and the traditional theory just goes
through that and says that the pattern
of dividend is important okay
there's information content isn't the
within your dividend if we're paying out
a higher dividend it's used it because
the business has done well made higher
earnings okay if a dividend Falls then
that is probably because the business is
performed less well than what we
expected and therefore the share price
will fall conversely when the business
you've paid at a higher dividend than
expected because it doesn't better than
expected you would expect the share
price to go through there and increase
wouldn't we okay
so there is information content within
that dividend
okay the level of earnings is important
with regards the dividend that you pay
okay but what we have to go through and
do that is the reason why it's important
is because we need to go through that
and talk about what we've done so
already we mentioned about how there's
information content within dividend
that's also referred to as signaling
okay there is a signal within that
dividend okay for if it's them well
they'll pay a high dividend therefore
there's confidence in that business and
the share price will go up if the
earnings have fallen and there is a
lower dividend paid as a consequence
there'll be less confidence within the
business and therefore the share price
will go down so the level of dividend is
going to influence the share price
because of the signal it gives to the
investors okay whereby previously when
we went through and looked on the far
side there at MIDI Glee Rd and Miller's
theory it didn't matter about the level
of dividends whether we paid a high
dividend one year a lower dividend that
the following year or even no dividend
in the year following that because what
we're saying is that that reduction and
dividend is because we are taking the
funds within the business the earnings
and investing them in positive NPV
projects that will give a higher rate of
return to the investor in the future and
therefore we will pay out that higher
dividend in the future okay imagine
doing that in the real world turning
around and saying well the reason why
we're paying out less of a dividend this
year because even though our earnings
have fallen is because we're keeping the
money back and we're going to invest it
in some positive NPV projects and
therefore you'll get a higher return in
the future
so should I Holly just turn around and
go yeah whatever okay yeah the reason
why you paying a lower dividend it's
because the earnings are fallen the
reason why the earnings are falling is
because the sales are fallen and for
what we're not too happy with how you're
performing therefore we're either gonna
try and get rid of the the directors or
maybe to sell our shares and move
elsewhere you know if you sell your
shares that the price begins to go down
doesn't it okay
the other area as to why the traditional
theory says that the dividends that are
paid is important is also there because
of what's referred to as the clientele
effect and all the clientele effect says
is and it's bringing it back if you like
to the fact that by saying there's
there's no tax there is tax okay because
different individuals will invest within
different businesses because they like
that pattern of dividends that are being
paid whether it's a percentage of your
earnings whether it's a dividend that
grows every single year they like that
certainty they like that knowledge okay
and the reason why is because maybe it
might go through there and suit the
their tax portfolio and their tax
planning okay if you change the dividend
then you will change the clientele okay
because they will go elsewhere because
they're therefore they're not happy with
that level of dividend because that
might then mean that they have to pay
more tax and therefore they're not happy
with that higher level of tax and
therefore they'll go through sell that
sure if lots of your clientele decide to
sell your shares then the share price
will fall okay so you need to keep the
shareholders happy the shareholders will
know what dividend they want they will
communicate that to you as that the
directors in the business and therefore
you need to make sure that you maintain
that pattern of dividend
okay so the traditional theory states
that it is important that you maintain
and communicate your dividend policy to
your shareholders whether that is a
pattern that exists based on a
percentage of earnings a percentage
growth every single year then therefore
that needs to be maintained okay if you
change it it shows a bad signal and it
also might upset your clientele okay
the last point in the notes in terms of
the traditional also talk specifically
about tax and that is talking
effectively linking it into the cleon
tell theory whereby we're talking income
tax versus capital gains tax okay some
shareholders as clearing tower will
invest because you don't pay any
dividends and you are relying on giving
a shareholder their return by capital
growth and therefore they will be
subject to capital growth tax or capital
growth capital gains tax okay
alternatively you might be an invest in
the reason why because you like that
pattern of dividends and therefore you
are subject to income tax I'm not
dividend okay you don't want that
pattern to change so that therefore you
are now relying on capital growth and to
then pay capital gain sucks so therefore
you would decide to sell your share
because that doesn't suit you as they
clear on tell of that business okay so
there's just bits and pieces to think
about in terms of the two theories
Medaglia and Miller and the traditional
have a look at what you've got there in
terms of the assumptions that we
mentioned here again I think multiple
choice objective test our questions
could ask you what the assumptions are
select all of the following this apply
you might be asked what what type of
Theory does does this information give
you so given a specific bit of dividend
content from from the real world and
start linking that in so whether that is
showing what happens within M&M or
whether that's showing there what
happened with regards to is it there
your your traditional theory
so we've just covered if your
the the higher-level aspect of your
dividend theory do make sure that you go
through and read the study text and a
little bit of detail make sure that you
practice the questions the only thing
that we can then go through there and
are then I will chat you through it is
effectively saying we'll look you've got
the M&M theory you've got what we look
at from a traditional perspective we've
already really mentioned it it is what
do we then talk about as your actual
dividend policy you know we're talking
there about what are the options that
you have as a director of a company in
terms of paying dividends okay so you've
got that is it does it mention you your
steady pattern of dividends so that
could be that couldn't it did we say
before constant growth it could be a
constant payout so a constant payout
from your earnings you might pay ten
percent of your earnings every single
year oh you might have a dividend that
grows a particular rate every single
year okay
key bit though is that both of those
involve cash we have to have the cash
don't we to be able to pay that dividend
also as well if you want to get really
into it as well as having the cash you
also need the distributable profits so
you can go through a payout a dividend
even if you've made a loss within the
year provided that you've got plenty of
reserves that are distributable within
the statements of financial position but
I'm not going to get involved too much
in terms of the intricacies of what is
and what isn't distributable if we just
think that retained earnings is effect
distributable reserved and the other
ones aren't okay that's the simplest way
to think much more detailed than what
you have there okay but if you have got
the distribute to a Prophet's but you
haven't got the cash then the other
option that you could go through and
have is a scrip dividend okay so a scrip
dividend is quite simply whereby they
say well look you can't take the cash if
you want but you could take a share if
you want instead okay and therefore you
get the value of a share it might be a
little bit more valuable if there's good
opportunity for growth in the future and
the share price will grow and therefore
you as an investor will make more money
than what you would have if you'd have
taken the cash okay and the other one
that you've got there your other option
is that you pay no dividend so maybe in
some high-growth startup businesses that
will grow very rapidly and therefore
that they they have investors that want
a return on their investments it's very
difficult to pay a dividend isn't it
because when you're a high-growth
startup business you haven't really got
much cash to be able to pay to the
shareholders you know the cash that you
have you should be reinvesting within
the business to help that high-growth
startup grow okay so you could paint no
dividend at all and then explains the
shareholders that they will be relying
on capital growth in terms of the value
of a business again difficult to think
about the value of a base that
particularly if it's a high-growth
startup goods unlikely to be listed is
it okay but hopefully as that business
grows rapidly
it might then become listed sooner
rather than maybe if it didn't invest
heavily to start off with and therefore
you can get that capital growth an
earlier point within the business
lifecycle and what you may otherwise do
if you were actually trying to pay off a
dividend so don't pay a dividend
explains the shareholders from your
friends and family if it's a startup
business isn't it about the aims and the
purposes of the business
and then hopefully when the business
gets listed or as sold on at some point
in the future you'll make your money
there from the growth in the value of
the business okay so it's not really a
chapter whereby that there's any
computations within it it's more a
theoretical chapter so when you look at
anything to do with theory you've really
got to read and understand the theory so
whether that's listening to this video a
few times that's up to you read in the
study text but whatever you do practice
the questions in the chapter in the
study text and also go through as well
practice the questions within the
revision kit of your chosen tuition
provider other than that that's all that
we need to look up in terms of your
corporate dividend policy bye for now