Dividend policy refers to a company's decision to pay dividends to shareholders. Companies pay dividends for reasons such as rewarding shareholders and signaling future profitability. There is no consensus on whether dividend policy directly affects share value, as share prices are influenced by many factors. While dividends may attract certain types of investors, changing dividend amounts could also convey new information to the market. Ultimately, the complex interplay of clientele effects, signaling, and other share price determinants makes the impact of dividends on value difficult to isolate.

1. Dividend Policy
What are dividends?
Why do companies pay dividends?
Does dividend policy affect value?
Why could dividends affect value?
What are the influences on the dividend
decision?

2. What are dividends?
Cash payments to shareholders
Paid out of after-tax profits
Interim dividend
Final dividend
Final dividend voted on at AGM

3. Dividends can be paid from past and
present earnings but cannot be paid from
any capital reserve
Companies whose external liabilities
exceed their assets cannot legally pay
dividends.
Profits vs cash flow

4. Why do companies pay dividends?
Reward to shareholders?
What is the Total Shareholders’ Return
(TSR) made up of?
Why else might companies pay dividends?

5. Do all companies pay the same
amount of dividends?
Amount paid is discretionary
Zero dividend policy
% of after-tax profit
Constant dividend or constantly growing
dividend

6. Marks and Spencer plc (M&S Annual Report 2009)
Year 2009 2008 2007 2006 2005
EPS 32.3p 49.2p 39.1p 31.3p 17.6p
(basic)
Div 17.8p 22.5p 18.3p 14.0p 12.1p
per
share

7. Marks and Spencer dividends
What do you notice about M&S dividends?
What do you think has influenced the level
of dividends paid to shareholders?

8. What influences the level of
dividend?
 Variability of profits
 But dividends are cash flows
 Investment opportunities
 Ability/willingness to raise external finance
 Influence of investors
 Nature of business/stage of business in lifecycle
 Market expectations?

9. Alternatives to cash dividends
 Scrip dividends
Saves cash
Lowers gearing
 Share repurchase
Reduces liquidity
Increases underlying share value
 Non-pecuniary benefits
Discounts
Complementary goods/services
Eg Channel Tunnel, Legal and General

10. Do dividends affect Value?
Residual Theory
 Dividend payments depend on the investment
opportunities available to the firm
 This implies that investors are indifferent
between dividend payments and increases in
share prices due to reinvested earnings
 The dividend decision is a passive decision??

11. Dividend Irrelevance
Modigliani and Miller 1961
the value of the firm is determined by the
earnings power of its assets and the split
between dividends and retained earnings is
irrelevant.
Shareholders can manufacture their own
level of dividends
Assumptions
no tax
no transaction costs

12. Why might Dividends affect Value?
Dividends may be preferred to an increase
in share price
Certainty
Liquidity
Tax impact
Different tax treatments between dividends and
capital gains
Clientele effect

13. The Clientele Effect
Dividends themselves do not affect share
price
Companies with particular dividend
policies attract groups of investors
according to their tax situation
A change in dividend policy will bring
about a change in share price due to the
demand and supply by different investor
groups for that type of investment.

14. Why might Dividends affect Value?
Dividends as a basis for company
valuation
Dividend Valuation Model (Gordon)
MP of a share = PV of future dividend payments
P0 = D1/(ke – g) P0 = Current Share Price
D1 = next yr’s dividend
ke = cost of equity
g = annual growth rate of divs

15. Example
Shareholders require a 12% return on their
investment and the company has just
paid a dividend of 80p per share.
Dividends have grown on average by
3.4% per year. What is the theoretical
share price using the dividend growth
model?

16. Why might Dividends affect Value?
Something else?
Market expectations
Signalling
Information asymmetry

17. Signalling Effects
Dividends carry information to the market
(information asymmetry)
Dividends are usually stable
A change in dividend policy may make
investors believe that management is
announcing a change in future profitability
but …..

18. Do dividends affect share prices
(value)?
All research is inconclusive
Dividend policy can be observed and
share prices can be observed
But
Other factors cause movements in share
prices
It is difficult to separate out the clientele
effect from the signalling effect

19. What have we discussed today?
Influences on dividend payments
The debate about the link between
dividends and share price (value)
Why we cannot answer the question about
the link between dividends and value