Dividend policy has been seen as one of the important
decisions of the company's management; it affects the value of shares and the
value of the company. In emerging market, due to asymmetric information,
investors often rely on the dividend as a signal that the company's prospects
for the future. Therefore, establishing a specific policy of dividend is
considered as advantage for both the shareholders and the company.
First of all, I will mention dividend policy in a perfect
capital environment. According to Merton Miller and Franco Modigliani (1961),
in a perfect market (no taxes, no issuance costs, transaction costs and stock
information costs), dividend policy does not affect to value of shareholders'
equity. The underlying assumption of this view is that investment decisions are
not influenced by the company's dividend policy. Therefore, in this case, the
investment policy of the company is the most important because it determines
the future income stream of the company and decides the value of the company.
And the income stream which is split between dividends and retained earnings
does not matter. However, if compare this view with the actual situation of the
stock market, I can see the contradiction. The fact that the dividend increase
is generally considered as good information which leads to an increase in stock
price, and vice versa when companies reduce or not pay dividends, the stock
price will further decline. Thus, the dividend policy may contain information
and can be regarded as a signal about the development ability in the future of
the company. However, in reality, almost all companies are trying to maintain a
stable dividend. Therefore, dividend policy should not really be a positive
signal for the future. Investors began to consider external factors such as the
income by cash which the company can use to pay dividends.
On the other hand, Miller and Modigliani's view is based
on a perfect capital market assumption. In fact, dividends and capital gains are
taxed; the issuance and trading of securities have to bear costs and information
asymmetry between company managers and investors. First of all, almost economists
agree that in a world without taxes, the investors will be indifferent to
receiving dividends or capital gains. But in reality, income from dividends is
taxed higher than income from capital gains. So the logic would conclude that investors
may not like to receive dividends. This will be reflected in the stock price. Other
factors are constant; the stock price of the company paying the dividend is
less than the stock price of the company retains earnings for reinvestment.
Moreover, the higher the dividend payment also means that companies have to raise
capital when needed capital from outside investors. Then the company must bear
the cost of issuance and ownership dilution (when issued shares). These costs may
cause the company does not want to pay high dividends. Therefore, before decide
about dividend policy, companies need to consider many factors such as
investment ability, business risks, requirement of shareholders and so on.