Topic: The best dividend policy is to use dividend payments to force managers to conform to the wishes of company shareholders.
People buy stock of a company with the expectation that they add value to their wealth. Normally, this value is added in the form of cash or appreciation in the value of stock. Cash is paid by the company in the form of cash dividends or to buyback specific number of shares of the company. On the other hand, capital gains are realized at the time of sale of the stock. Dividend policy deals with how earnings of a company are distributed in the shareholders of a company. In this report, we would discuss one dividend policy is more preferable than other’s under certain conditions. “Over the last century, three schools of thought have emerged. One faction sees dividends as attractive and as a positive influence on stock price. A second block believes that stock prices are negatively correlated with dividend payout levels. The third group of theories maintains that firm dividend policy is irrelevant in stock price valuation.” (Frankfurter & Wood Jr., 2002). We would discuss different theories supporting any of above school of thought and logic behind it and how dividend policy could be used to conform to the wishes of company shareholders. In the end, we would discuss the impact of stock split and stock dividend on shareholders wealth.
Decision of the form and amount of dividend a company could issue depends upon unappropriated profits of a company and expected future earning potential of a company. Firms which had undergone successful projects in the past and has potential good projects in future whose expected rate of return is higher than hurdle rate, then company should retain its earnings instead of distributing it to shareholders so that this surplus money could be invested in good projects in future. On the other hand, if a firm doesn’t have good projects, it should distribute surplus funds to...