Theories Of Dividend Policy Theories

Dividends Policy Theories

In the last decades, the valuation of companies and capital markets have been increased rapidly due to show the dynamic growth of the financial markets and the company’s growth [1]. The financial manager of any company should face three crucial decisions: the first one capital budgeting, what are the real assets the company should acquire?. The second one is the financing decision, how these real assets should be financed?. The last decision is concerned about when the company starts to generate more and more profit should the company keep this profit to reinvest it again and keep it in its retained earnings? Or it should distribute a portion of it and keep the rest for a new investments? Or should the company distribute

The second one says that dividends have an impact on company’s value. The last school says that there is an uncertainty if the dividends affect the value of the company [3]

Dividends Relevance Theories:
These are the theories whose propagators argue that the policy of dividend on any firm have an impact on the value of the firm. They are 2 theories:
• Walter’s model by James Walter.
• Gordon’s model by Myron Gordon,

Walter’s

When a firm pays dividend therefore, its advantage is offset by external financing and this means that the terminal value of the share declines when dividends are paid and the wealth of shareholders remain unchanged.
The criticism on this theory is based on the presence of market imperfections from tax differentials to floatation costs to transaction and agency costs to no or low taxes on dividends. [4] [2]

Dividend Uncertainty Theories:
The Bird in Hand Theory:
Gordon concludes that even when r=k, the dividends policy does affect the value of the share based on the view that: under conditions of uncertainty, investors tend to discount distant dividends (capital gains) at a higher rate than they discount near dividends. Here, the investors are risk averse, and therefore have a preference for near dividends than future ones.
So the uncertainty of dividends increases with futurity. When dividends is considered with respect to uncertainty the discount rate cannot be held constant, it increase with uncertainty. These investors prefers to avoid uncertainty and would be willing to pay a higher price for share that pays the higher current dividends and all thing held constant. So the appropriate discount rate would increase with the retention ratio. [2, 4,