Firstly, dividends can be
described as the amount of reserves that can be used to pay shareholders who
have invested in the company (McLaney & Atrill, 2010). However, are dividends
actually important?
In finance, dividend policy has been one of the most significant topics, which gives it considerable attention to solve the vagueness of dividends (Alzomaia & Al-Khadhiri, 2013). Theorists such as Modigliani and Miller (M&M) (1961) believed that in an efficient market dividend policies are irrelevant and have no influence on a firm’s share price and does not affect shareholder wealth. However, many financial theorists such as Myron Gordon (1963) and John Lintner (1962) have disagreed with this theory, as M&M did not take taxes and transaction costs into consideration. They have also based their proposition on perfect capital market assumptions, which clearly does not exist in the real world. Gordon and Lintner’s “bird in the hand theory” critisised M&M’s paper as they explained that investors prefer dividends in comparison to retained earnings since the stock price risk declines as dividends increase. They believe the more money the firm pays in dividends, then the more valuable it becomes. The money that is directed to shareholders is more valuable than the money that is reinvested back into the business.
A unique solution for dividend policy does not exist, as there is strong evidence that the dividend policy is a puzzle (Black, 1976; Baker, Powell & Veit; 2002). There are many companies on the FTSE 350 that do not pay dividends. According to Smith (2013), the Chief Corporate Correspondent of the Financial Times, stated that almost 1/7 of the UK’s largest quoted companies do not pay dividends, despite shareholders searching for reliable income streams. This trend is amongst the UK’s largest quoted companies and has been increasing since 1985. As a result of the financial crisis, times have been tough and companies such as the Royal Bank of Scotland and Llyods Banking Group are not paying dividends, as they are not in the position to do so.
Furthermore, there are a lot of companies that do not pay dividends to their shareholders but are still able to create value. For example, there are many companies in the Computer Hardware industry that do not pay dividends (Financial Times, 2014). Companies such as Apple, the world’s most valuable publicly traded company had $97.6 billion in cash and securities. Apple has kept this money to spend on building data centres, buying parts for products and to pursue ambitious projects that may come along the way. Research and development (R&D) of new technological equipment is also important for Apple (Svensson, 2012). In my opinion I would say this sounds a bit greedy, doesn’t it?
So to answer this question, I believe dividends are important due to the sensitive economic environment in which we live in. We do not live in a perfect world where dividends are discarded and are not required. They can allow investors to signal credibility of their beliefs regarding the future performance of the firm in the market (Ergungor, 2004). This is important as the financial market is tough and attracting investors is crucial to raise finance to enable future success.
In finance, dividend policy has been one of the most significant topics, which gives it considerable attention to solve the vagueness of dividends (Alzomaia & Al-Khadhiri, 2013). Theorists such as Modigliani and Miller (M&M) (1961) believed that in an efficient market dividend policies are irrelevant and have no influence on a firm’s share price and does not affect shareholder wealth. However, many financial theorists such as Myron Gordon (1963) and John Lintner (1962) have disagreed with this theory, as M&M did not take taxes and transaction costs into consideration. They have also based their proposition on perfect capital market assumptions, which clearly does not exist in the real world. Gordon and Lintner’s “bird in the hand theory” critisised M&M’s paper as they explained that investors prefer dividends in comparison to retained earnings since the stock price risk declines as dividends increase. They believe the more money the firm pays in dividends, then the more valuable it becomes. The money that is directed to shareholders is more valuable than the money that is reinvested back into the business.
A unique solution for dividend policy does not exist, as there is strong evidence that the dividend policy is a puzzle (Black, 1976; Baker, Powell & Veit; 2002). There are many companies on the FTSE 350 that do not pay dividends. According to Smith (2013), the Chief Corporate Correspondent of the Financial Times, stated that almost 1/7 of the UK’s largest quoted companies do not pay dividends, despite shareholders searching for reliable income streams. This trend is amongst the UK’s largest quoted companies and has been increasing since 1985. As a result of the financial crisis, times have been tough and companies such as the Royal Bank of Scotland and Llyods Banking Group are not paying dividends, as they are not in the position to do so.
Furthermore, there are a lot of companies that do not pay dividends to their shareholders but are still able to create value. For example, there are many companies in the Computer Hardware industry that do not pay dividends (Financial Times, 2014). Companies such as Apple, the world’s most valuable publicly traded company had $97.6 billion in cash and securities. Apple has kept this money to spend on building data centres, buying parts for products and to pursue ambitious projects that may come along the way. Research and development (R&D) of new technological equipment is also important for Apple (Svensson, 2012). In my opinion I would say this sounds a bit greedy, doesn’t it?
So to answer this question, I believe dividends are important due to the sensitive economic environment in which we live in. We do not live in a perfect world where dividends are discarded and are not required. They can allow investors to signal credibility of their beliefs regarding the future performance of the firm in the market (Ergungor, 2004). This is important as the financial market is tough and attracting investors is crucial to raise finance to enable future success.
