The Dividend Decision

In corporate finance, the dividend decisions are decisions that are made by the directors of a company. The dividend decision relates to the amount and timing of any cash payments made to the company's stockholders. It is a policy that the management formulates in regard to earnings for distribution as dividends among shareholders. The dividend decision in a company determines the division of earnings between payments to shareholders and retained earnings.

The dividend decision is important one for the firm as it may influence its capital structure and stock price. These decisions may also have an impact on the amount of taxation that stockholders pay. A firm’s dividend decision is influenced by three main factors. The three factors are free-cash flow, dividend clienteles and information signaling.

Under the first theory of free cash flow theory of dividends, the dividend decision is very simple. Here the firm makes the payment as dividends, any cash that is surplus after it invests in all available positive net present value projects. This theory is criticized because it does not explain the observed dividend policies of real-world companies.

The dividend clienteles is an idea where a particular pattern of dividend payments may suit one type of stock holder more than another. Under this method if the clienteles exist for particular patterns of dividend payments, a firm may be able to maximize its stock price and minimize its cost of capital by catering to a particular clientele. This idea is criticized because the investors do not need to rely upon the firm to provide the pattern of cash flows that they desire.

The third model is information signaling which was developed by Merton Miller and Kevin Rock. This model suggests that dividend announcements convey information to investors regarding the firm's future prospects. This means that when investors have incomplete information about the firm they will look for other information that may provide a clue as to the firm's future prospects.

Questions:

• What is dividend decision?
• What are the three main factors of dividend decisions?