Dividend Policies Practices

In this section, an attempt has been made to review of the major studies concerning dividends and stock prices and management views on dividend policy.

Lintner (1956) conducted a study on corporate dividend policy in the American context. He investigated a partial adjustment model as he tested the dividend patterns of 28 companies. According to John Lintner’s  study, dividends are ‘sticky’ in the sense that they are slow to change and lay behind shifts in earnings by one, or more periods. According to J lintner, dividend is a function of earnings of that year, existing dividend rate, target payout ratio and speed of adjustment . The followings were the basic objectives of the study:-

a)      To identify occasions when a change in dividends might well have been under active consideration even though no change was made.

b)       To determine the factors existing most actively into dividends.

He concluded that a major portion of a firms dividend could be expressed in the following manner.

DIV_t*=PEPS_t                                                  (1)

andDIV_t-DIV_t-1=a+b(DIV_t* - DIV_t-1)+e_t       (2)

Adding DIV_t-1 on both sides of equation (2)

DIV_t= a+bDIV_t*+(1-b)DIV_t-1+et                   (3)

Where,

DIV_t*=Firm’s desired payment

EPS_t= earnings

P= Targeted payout ratio

a= constant relating to dividend growth

b=adjustment factor relating to the previous period’s dividend and new desired level of dividends where, b<1

The major findings of this study were as follows:-

1.      Firms generally think in terms of proportion of earnings to be paid out.

2.      In order to modify the pattern of dividend, investment opportunities, liquidity position, funds flow are not considered.

Firms generally have target payout ratios in view while determining change dividend rate or dividend per share.

Modigliani and Miller (1961) conducted a study on the irrelevance of dividend. This is popularly, known as mm approach. It is sometimes termed as Dividend Irrelevance model.

According to mm, dividend policy of a firm is irrelevant as it does not affect the wealth of the stockholders. They argue that the value of the firm depends on the earning power of the firm’s assets or its investment policy. Thus, when the investment policy is given, the dividend decision-splitting the earnings into packages of retentions and dividends does not influence the value of equity shares. In other words, the division of earnings between dividend and retained earnings is irrelevant from shareholders viewpoint.

In general, the argument supporting the irrelevance of dividend valuation is that dividend policy of the firm is a part of its financing decisions. As a part of the financing decisions of the firm, the dividend policy of the firm is a residual decision and dividends are passive residual.