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Essay example - Dividend Policy Corporate Finance

Finance & Accounting
Pages 3 (753 words)
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Dividend Policy Introduction: Dividends are defined as a form of profit sharing by corporations with its investors. The dividend payout decisions rests primarily on the decision that should the earning be retained for future growth of the firm or to payout dividend to the shareholders…

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Dividend policy are a very important and crucial decision for any firm and needs to be taken in a planned manner so as to have a positive impact on all stake holders. The dividend policy needs to be clearly defined and may change every year depending upon the dynamic nature of the business. The firm can choose to retain all the earnings or pay them out as dividends or even strike a balance in the two. The Traditional Theory: The traditional theory on dividend policy was established by Graham & Dodd. The traditional relationship stresses the fact that stock value is dependent on the dividends. It presumes that higher dividend paying firms will have a greater value in comparison to the firms that pay lesser dividends. The formula stands as follows: P = [m (D+E/3)] Where P is the market price, M is the multiplier, D is dividend per share, and E is Earnings per share. The traditional approach gives a lot of weightage to dividends being paid in comparison to the retained earnings. The weightage provided by Dodd and Graham are very subjective and not have an empirical basis. The limitation of the argument is that the P/E ratio and Dividend payout ratios are supposed to be directly linked. However, we know that this is not always the case and despite of nonpayment of dividends the company share price may rise. ...
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