Oxford brookes university
Corporate Finance Concepts
Critical literature review and discussion of dividend policy
Prepared by: Quang Vinh Pham
Dividend policy, according to Baker et al. (2001), refers to the payout strategy that corporate directors have to comply with when settling the size and type of cash allotments to their shareholders over time. Therefore, the decision of dividend can influence the amount of earnings distributed against the amount retained and used for reinvestment. On the other hand, Miller and Modigliani (1961) state that under the assumptions of perfect capital markets, the payment of dividend has no impact on the value of companies as well as the enhancement of shareholders’ wealth and, accordingly, is irrelevant. However, from Kozul and Orsag’ (2012) perspective, in reality, firms operate on markets with such imperfections as taxes, asymmetric information, agency issues and many more. Hence, it questions the applicability of Miller and Modigliani’ thesis in the real world and raises a debate of firms’ motives to pay dividends (Denis and Osobov, 2008). After recent changes in dividend policies of two big firms namely Apple Inc and Dell Inc, the argument of why firms amend their dividend policies has lured even more concerns of finance researchers. In detail, while Apple began to pay dividend for the first time since 1995 in March 2012, Dell also made their first dividend payment in the same year. These events are considered informative and valuable by both markets and analysts. This paper discusses the topic of dividend determinants and firms’ tendency to pay dividend.
CRITICAL LITERATURE REVIEW
1. Factors influencing dividend policies
1.1. Agency costs
Following Breuer et al. (2014), agency problems arise as one factor that may have influence on corporate dividend policy. This is in line with the agency theory which claims that the act of paying dividends can mitigate agency issues caused by information asymmetry and the dispersion of corporate ownership and control between directors and shareholders (Singhania and Gupta, 2012). One of the explanations illustrated by Al-Malkawi’s (2008) is that firms’ allocation of cash resources induces a decline in the magnitude of internal funds accessible to managers pushing them to acquire external financing from capital markets. Accordingly, Easterbrook (1984) reveals that on the purpose of ensuring the amount of essential funds, managers are encouraged to make a disclosure of information as well as decreasing agency costs because of the presence of creditors. Furthermore, Kozul and Orsag’ (2012) imply that it is possible for firms with dispersion of ownership to control agency costs by offering a high dividend payment. Similarly, it is demonstrated by Al-Malkawi’s (2008) that companies which endure a smaller number of agency problems due to higher levels of managerial ownership tend to have less incentives to use dividends to minimize the agency costs. Besides, as agency problems also arise when managers attempt to engage in such activities as investing in projects that could be detrimental for shareholders but allow them to gain personal compensation instead (Jensen and Meckling, 1976), the author points out that dividend payments could alleviate the issue by reducing the free cash flow from being spent on investments which produce no returns. Correspondingly, Breuer et al. (2014) show that a reduction in free cash flow available to managers can be resulted from increases in dividend payout leading to a decrease in overinvestment, thereby; conflicts between managers and shareholders are relieved. Generally, Taleb (2012) conclude that dividend payments enable firms to keep managers’ performances under surveillance. In brief, the existence of agency costs has an appreciable impact on the determination of dividend policies. 1.2. Profitability
From Kozul and Orsag’ (2012) perspective, firms often distribute...
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