Financial management - Essay Example

Dividends are the consequences of performances actual or expected. The market’s perception with regard to the change in dividend policy will have impact on the investment decisions of the investors which will reflect in stock prices. Therefore, dividend per se is not the dominant determinant factor, but it constitute as a signal to the performance of the company when it is changed and this perception is the key driver for performance of the stocks in the markets. Dividend policy The dividend decisions are guided by various factors relating to the business at the discretion of the management.

Similarly, the motives behind the change in dividend policies could be influenced by taxation policies of the government, influence of major shareholders in dividend decisions, structure of the management, retention of management control, fulfilling the expectations of the market or simply meeting the guidelines already given. On many occasions the process of price discovery in market is frustrated by earnings management or insider trading in relation to declaration of dividends. However the fundamental factors governing dividend policy in a company are stability in earnings, growth in profitability, opportunities available for reinvestment of the profits made based on marginal efficiency of additional capital and type or composition of the shareholders and their expectations.

However, any increase in the rate of dividends is generally appreciated by the market and the prices of the shares react positively to such announcements. For a meaningful analysis of dividend policy the dividend history of the companies in relation to earnings (EPS) and dividend yield over years, leverage or debt to equity ratio and the management policy in distribution of earnings needs to be studied. Also, comparison with the industry standards will reveal the relative position of the company in the industry.

Different types of investors will react differently to the dividend policy. For example, retired people expect consistency in payment of dividends since they need regular income from their investments in the absence of earnings from employment or other sources. Therefore, any negative change in dividend payout will adversely affect the stock prices. Relevance of dividends to market value of the stocks highly correlated in such cases. Determinants of dividend policy The question of whether a company's dividend policy is relevant or irrelevant to its market value has implications in firming up the dividend policy of a company.

Primarily the question has to be analyzed with regard to the motives behind the changes in dividend policy from the perspective of the management of the companies taking into account the market expectations, future capital investments proposed, the earnings guidance already given and the tax considerations involved. The companies have to formulate their dividend policies in tune with the needs for the development of the business since the shareholders are the most important stakeholders in the business.

Future expansions, mergers & acquisitions could be easily managed if the shareholders’ confidence on the company is maintained at the highest level. It is very important to note that the policy does not focus primarily on distribution of dividends per se. It is