In this weekly blogger it will explore dividend policy. There is a question, what is dividend policy?
Dividend policy is to determine the proportion of profits that paid out to shareholders.
Shareholders usually buy share from stock market, and the share of the company usually
pay out dividend periodically. Most of people think that the reason why
companies need to pay dividend back to shareholder is to return money back to
shareholder to maximise their wealth.
However, this is an interesting question to everyone. Do a
company want to maximise shareholder wealth? The answer is yes, but they may
have other purposes when paying dividends, such as to keep shareholders buying
their shares. Indeed, there are two different situations that the company may
face, which are obtain attractive investments and a project that difficult to
obtain or too expensive. If a company is paying a small amount of dividend which
represents the company is using the amount of money to invest into a project.
On the other hand, if a company is paying a huge amount of dividend to
shareholders, it may be a signal that the company does not have any project to
invest to.
When a company decide to pay a dividend, what do they need
to consider? Modigliani & Millar
(1961) suggest that company should determine by investment policy, not the
amount of earning distributed, which means the amount of paying dividend has no
effect to company value. The dividends represent a residual payment and therefore
it is irrelevant to pay more dividends when the company try to increase their
value. However, Modigliani & Millar assumption
only applies in a perfect capital markets, no issue cost for securities and no
tax.
Looking at a warehouse club company Costco, the announcement
that Costco will spend 3 billion USD to pay a special dividend to shareholder,
as higher tax rates that may kick in come January, from this announcement
Costco share price rose 6.3% dramatically.
It can be seen that Costco is based on a tax issue to raise dividend
to shareholder, which cannot apply Modigliani
& Millar (1961) assumption. However, the amount of the dividend, a low dividend
is considered bad news to the company. Costco spent $3 billion on special $7 dividend per share, which
demonstrates this is a good new to Costco as they have performed well previous
year. Through this action it will display an unstable dividend compare to last
few years, it will lead investors who aims for short team may intend to sell
their shares when the company drop their amount of dividend in times. Therefore
to all companies are willing to pay dividend should be stabilize their dividend
in order to lost potential investors.
