Residual Theory of Dividend

How much dividend a company should distribute will depend on how much investment opportunities it has available at present. If there are positive NPV projects available then instead paying dividends to shareholders the same can be used in financing the positive projects. In the case shareholders wealth maximized by reducing dividend at all.  Shareholders will be compensated for this reduction on nill dividend now by a gain in the form of higher dividend in the future.

Dividends are thus residual payment in the sense that this is paid provide sufficient earnings are retained in the company to finance new investments. This residual theory treats dividend as a passive decision which is completely depended on how much amount or whether company employs earnings is in financing profitable projects. Thus the dividend will vary from year to year. But such fluctuations in dividend have no effect on shareholders as they are compensated of present loss, if any of dividend by future capital gain”(Waring, 1983).

Some Other Types of Dividend

C. Bond Dividend 

“It is a kind of dividend in which stockholders receive bond. It is distributed only that condition    when the company declares dividend helps to postpone the payment of cash. These are given when the   firms are unable to take the burden of interest of loans” (Van Horne, 1971).

D. Property Dividend

“Property dividend is a kind of dividend which is given in the form of property instead of cash. This method is given in the form of property instead of cash. This method is rarely used in practical. Company owning products and securities of subsidiaries are the examples that have been paid as property dividend”(Van Horne, 1971).

E. Interim Dividend

“Generally dividend is declared in the end of the financial year. This is called regular dividend.  But when management declares dividend before the end of financial  years, it is called interim dividend”(Van Horne, 1971).

F. Scrip Dividend 

“Scrip dividend is a form of promissory note promising to pay the holder at a specified later date. The scrip may be interest bearing or not. Issuing of this note indicates that the company has shortage of cash to distribute as a dividend. This type of dividend is very popular to use” (Van Horne, 1971).

What are Cash Dividend and Stock Dividend

a. Cash dividend

“The portion of earnings paid in cash to the investors in the proportion of their share is called cash dividend. Most of the firms pay dividend in cash to the investors in the proportion of the firms pay dividend in cash.” In the context of Nepal, Cash dividend is the most popular form of dividend so it is very popular in commercial banks and other firms. However it depends upon the earnings of the firm, management decision, Government policy, Nepal Rastra Bank policy and other various internal and external factors.

b. Stock Dividend

Stock dividend is only the paying stock equaling to the dividend that is to the dividend that is to be received by shareholders. “A stock dividend is paid in additional shares of stock instead of in cash and simply involves a book-keeping transfer from retained earnings to the capital stock account” (Weston and Copeland; 1986)

Firm pays stock dividend instead of cash dividend. It represents nothing more that a Book keeping shift within the shareholders ‘equity account on the firm’s balance sheet. It is simply the payment of additional shares of common stock to shareholders .It represent nothing more than a book keeping shift  within the shareholders equity  proportional ownership in the firm remains unchanged. Accounting authorities make a distinction between small-percentage stock dividends large percentage stock dividends and large percentage stock dividends.

i. Small-percentage stock dividends:-

If a stock dividend represents an increase of less than 10 percent of the previously outstanding common stock, it is referred to as a small percentage stock dividend entails transferring an amount from retained earnings to common stock and additional paid-in- capital.

ii. Large-percentage stock dividends:-

Large-percentage stock dividends (typically 20 percent or higher of previously outstanding common stock) must be accounted for differently while small-percentage stock dividends are not expected to materially reduce the market price per share of stock. In the case of large percentage stock dividends, therefore, conservatism argues for reclassifying an amount limited to the par value of additional shares rather than amount related to the pre-stock dividend market value of the stock.

The effects of stock dividend are as follows:

·         It doesn’t affect the shareholders proportional ownership 

·         Theoretically it is valueless to shareholders.           

How to investigate old studies

Review of literature means reviewing research studies or other relevant propositions in the related area of the study so that all the past studies, their conclusions and deficiencies may be known and further research can be conducted. Since completely new and original problems are rare it is necessary to show how the problem under investigation relates to previous research works done under similar topic, however a previous study not be exactly replicated. It is believed that the review of literature is literature which is helpful to show the needs of the research work and to justify the work. It tries to clear the conceptual thought and bank related terms. So this chapter has been organized through the study of different books; articles published in journals and master’s level thesis as below:

•        Conceptual Framework
•         Review of Empirical Studies    
•         Research Gap

Conceptual Framework

Every investor invests their money to buy share of firms with the hope of sharing profit earned by firm since they want to receive maximum returns on their investment. It depends upon management policy that how much total profit to distribute as dividend and how much to retain in the business. But this is fact that all the profit made by firms actually belong to stockholders. Whether profit are distributed in the firm of dividend or reinvested in the business, benefits go to shareholders directly or indirectly.

Studies on dividend decisions and limitations

Dividend decision is the one of the most important decision and it play vital role in every organization. Investor of the organization expects return from their past investment as dividend. By the dividend policy it became an effective way to attract new investors. This study is helpful to understand the dividend payment policy of the commercial bank in Nepal. It will helpful to the policy maker, shareholder and management of the selected commercial bank. It will be important for the government policy maker, controller, monitor and supervising department to regulate the commercial Bank in Nepal. This study will help to the further researchers.

Following are the limitations of the study:

• Most of the data are used secondary nature; therefore the reliability of study findings depends on the reliability of the data.
• The analysis of the study covers only five years period inclusion of other fiscal year data may provide different result.
• There are many factors that affect market price of stock. However we consider only dividend related factor.
• The study is conducted only in six commercial banks hence the results may not represent to all the commercial banks.

The study has been organized into five chapters. Chapter 1 deals with subject matter of the study consisting back ground of study, focus of study, statement of the objective of study, significance of the study, limitation of the study and organization of study. Chapter 2 deals with the review of the different literature of the study field. Therefore it includes conceptual frame work along with the review of major books, journal, research work and thesis etc. Chapter 3 deals with research population and sample, source and technique of data collection, data analysis tools and limitation of the methodology. Chapter 4 deals with presentation and analysis of data and information through a define course of research methodology. Chapter 5 deals with summary of study, the conclusion and major finding of the study. The bibliography, annexes are incorporated at the end of the study.

Some problems in dividends decisions

Miller and Modigliani (1961) have given a theory stating that the shareholders should be indifferent between amount distributed and retained in the firm. However, in practice, the assumption of capital market perfection does not exist that lead to the situation where dividend policy is relevant. The idea of relevance is vague as well.it is rather hard to define whether dividend per share has positive effect or its effect is negative one.

It is found that there is no satisfactory result about dividend decision of commercial banks in Nepal. Likewise, dividend distribution does not match with the earning of the commercial banks, there does not exist a proper relationship between dividend and quoted market price of share. Similarly, commercial banks with lower returns record stable price of share and banks making sound returns do not stable in share price.

It is because, among the various reasons, the government rules and regulations, ownership patterns, attitudes of management, forms of management may be the partial causes of such a situation. In practice, every firm follows some kinds of dividend policy and there is no unique dividend policy which is appropriate for all firms. So they follow different policies. In general, it is assumed that there is relationship between dividend and stock price but dividend and stock prices established by much finance scholars need to be tested in the context of Nepal.

Dividend is the motivating factor for the investor. But Nepalese commercial Bank has no satisfactory result on dividend decision. The dividend decisions are affecting by government rules and regulations.

• What is the dividend, earnings, payout ratio, price earnings multiple and market price of common stock of commercial banks in Nepal?
• Is there any relationship between dividend decision and market price per share?
• Whether dividends have impact on market price of stock?

Meaning and illustration of Dividend

Dividend is the portion of net profit if financial statement shows net profit, the Board of director (BOD) declare dividend to share holder. The payment of corporate dividend is at the discretion of BOD. Dividend may be paid in cash and Stock. The claims of all creditors, the government and preferred stock holders must satisfy. Dividend policy determines the division of earnings between payments to stockholders and reinvestment in the firm (Weston, Copeland and Shatri: 2004). Dividend policy is a major decision of firm a firm's dividends into two parts: the retained earnings and dividends.

The retained earning means to provide funds to the firm for long term growth from its net earnings. Retained earnings are most significant internal sources of financing the growth of firm. On the other hand, dividends are desirable from shareholder point of view as it tends to increase their current wealth. Dividends constitute the use of the firm's funds. Thus, the two objective of dividend policy distribution of dividend and retained of earning for growth, through desirable, are in conflict. There is reciprocal relationship between retained earnings and cash dividends. A higher dividend rate means less retained earning lesser dividend rate means high retained earnings. If retained earnings is less the growth will be slower and lower market price per share. So, the financial manager must very carefully decide the allocation of earning between dividends and retained earnings, as their decision affects the value of firm and as a result, the value of firms cost of capital.

Dividend policy and stock price has always correlation; if the company pays high dividend the stock price increase and vice-versa. But in some cases out of their inter relation. The price may remain constant or decrease low.

The main Focus of the study is dividend policy practice in Nepalese commercial Bank. But different other studies are going to be done  for these purposes, i.e. comparison of EPS, DPS, and MPS and other relevant studies as for requirement. Someone says dividend payment has no impact on valuation and someone says to be active variable for valuation of stock price.