The dividend policy can be referred to as a financial decision that is related to the proportion of the profit earned by an organization that has to be paid to the investors or the shareholders. In the policy, the organization declares what proportion of the revenue would be distributed to the shareholders either in the form of dividends or re-invested in the organization (Usir.salford.ac.uk, 2019). In case of re-investment, what amount will be retained will depend entirely on the investment options that would be available. And for the evaluation of the opportunity, the relationship among the rate of return (RoR) on investment and the Capital Cost (CC) is assessed. Till the time the returns exceed the investment, a company would always prefer retaining the dividend for further finance. Once the re-investment has been done, the company would then distribute the residual dividend among the shareholders. For this reason, dividends fluctuate every year (Usir.salford.ac.uk, 2019).
The dividend policies of the United Kingdom
The dividend policy is being discussed and has been the subject of interest for more than half a century now and most of it has been conducted in the United Kingdom. The fact is the harder people go after the dividend policy, the more confusing it gets and things become fragmented beyond the scope of putting them together in place. Any investor would pick a firm for investment with respect to the dividend policy followed by that firm (Business Jargons, 2019).
Given below is an analysis of the dividend policies that are followed by the listed companies of the UK:
The Life Cycle Theory
The origin of this theory is based on the life cycle theory of a firm that was presented by Mueller in 1970. Here, a firm would be investing its entire limited resources for the development of potential innovations and also for the improvement of the profit. The firm is then expected to go through a rapid phase of growth (Business Jargons, 2019). During this phase, the firm undertakes risky ventures, expands the client base and makes the best use of the market potentials. After this, the firm passes through a mature stage and the money earned from its operations exceed the profitable investment opportunities. At this point, a value-maximizing firm would start distributing its profits among the shareholders (Business Jargons, 2019).
Studies conducted on this dividend policy suggest that this leads to a trade-off. This happens since the cost of capital fluctuates as per the stage of the company in the cycle. Information asymmetry is on the higher side and the cost of raising capital also goes up. With the firm becoming more matured, the asymmetry becomes less. The cost of the capital witnesses a drop as well (Business Jargons, 2019).
Dividend Signaling Theory
According to this model, the dividends are considered as a reflection of the past and future prospect of the company. A piece of common information regarding the firm is available with all the market participants. For this reason, the payment of the dividend has got no influence on the value of the company (UKEssays.com, 2019). However, there is information asymmetry. This theory is based on the concept that the better-informed people (usual managers of the company) use the dividend policy as a tool to inform those who do not have access to much information (the investors and the shareholders) on the company’s growth and earning. This means that an increase or a decrease in the dividends indicate either an improvement or a deterioration in the profit or the future prospect (UKEssays.com, 2019).
Clientele Effect and Tax Theory
The tax effect theory assumes that if the capital gains are untaxed or if the rate of tax on the dividend is greater than the rate of tax on the capital gain, investors would go for the one that does not provide cash dividend and instead retains the earning for future growth possibilities. This theory paved the way for the Clientele Theory wherein each investor has their own preference for either low or high cash dividends (UKEssays.com, 2019).
As per this, the dividends are the remaining segments of earning post covering all the investment requirements (UKEssays.com, 2019). This theory further explains that companies that are matured will have a tendency to provide a high value of dividend since there will be excess cash since the input needs would be low. And, growth firms will provide a low (or perhaps no) dividend since for them the priority would be an investment (UKEssays.com, 2019).
By paying the dividends, the companies are bound to raise money for financial fresh investments. This results in an increase of the external monitoring on the activities of the corporates. Any change in the dividend is equivalent to informing the market about the upcoming earnings of the company. Experts recommend that shareholders or investors should always prefer pay-out in cash instead of an assurance pointing to a monetary gain due to minimized risk.
What is Dividend Policy? Definition and meaning – Business Jargons. (2019). Retrieved from https://businessjargons.com/dividend-policy.html
Usir.salford.ac.uk (2019). Retrieved from http://usir.salford.ac.uk/41485/1/Ola-Final%20Submission-Feb-2017-PDF.pdf
Dividend Policies in the UK. UKEssays.com (2019). Retrieved from https://www.ukessays.com/dissertation/literature-review/economics/the-theories-of-dividend.php