Dividend Policy

In keeping with the main theme of my previous blog posts (shareholder wealth), this post will concentrate on the topic of dividend policy. Many companies are faced with the dilemma of deciding the size of dividend that should be issued or if any dividend should be issued at all rather than retaining funds within the business to help fund future projects for example. From the point of view of the shareholder, wealth can be created from capital gains (an increase in value of the shares owned) or from receiving dividends per share owned by the shareholder.

The 'bird in the hand theory' developed by Linter and Gordon suggests that investors prefer dividends to capital gains as a form of creating shareholder wealth due the uncertainty associated with future capital gains in comparison to the definite gain associated with receiving a dividend. This theory suggests that companies offering high dividends will benefit from a rise in value of their shares as investors will seek to purchase shares in companies offering high dividends and sell shares that offer low or no dividends. Due to the lack of internal information available to investors, the issuing of dividends can be used by investors as a parameter to determine the performance of a company, assuming that a company offering high dividends is performing well and vice-versa.  But is this general assumption accurate? Not necessarily. A company issuing high dividends may be doing so due to a lack of potential future attractive investments being available which in turn could have a detrimental effect on future investment returns. On the other hand, a company offering low or no dividends may have chosen this strategy in order to allocate funds to finance promising investments rather than raising finance externally. These investments could in time prove to bode very well for future returns for the investor. This demonstrates that the size of dividend offered is not sufficient to judge the performance of a company.

A recent example in the news regarding the dividend policy of a company is that of Apple, who announced their first dividend payment since 1995. One may ask why it has taken so long for a company which has recently been dubbed 'the world's most valuable company' to issue dividends to its shareholders? However, it is important to note the meteoric rise in Apple's share value over the past ten years from $10 to over $600. Investors in Apple may not have had the luxury of regular dividends but there is no doubt of the capital gains associated with investing with the company, particularly early investors. This example also contradicts the theory by Linter and Gordon who suggested that companies may suffer from a decrease in share value if they do not issue dividends. Does the case of Apple suggest that dividend payments are not as significant as previously thought when considering shareholder value maximization? It certainly could be argued that way, although I don't believe that this is a typical example as Apple is an extraordinary company. One could argue that if Apple did pay dividends regularly over the past 15 years or so that they may not have been in a position to expand as rapidly as they have done. This goes back to the argument that a company offering no or low dividends may be doing so in order to allocate funds to finance future projects. Either way, I was an Apple shareholder I know I think the news of a proposed dividend would merely be the icing on the cake in comparison to the substantial increase in share value over recent years!

In conclusion, the decision to offer dividends is obviously a contentious topic for the top management of a company and there are many different factors that will ultimately influence the decision. Although offering high dividends to investors may please them in the short term, consideration of future performance must be taken into account as it may not be possible to maintain these high levels of payment, which might become expected, especially if the financing of future projects is jeopardised by the fact that money was spent on issuing dividends.