The significance of Dividend Policy

The significance of Dividend Policy

As I was reading the news an article popped on my screen which gave me the topic of today’s blog. Honda Motor Co Ltd.’s shares had a 5.3% increase reaching their highest level since the beginning of January. This abrupt change came one day after the company’s announcement that it would buy back up to ¥90bn ($789m), thus increasing the yield for the shareholders. Moreover, companies such as Apple and Microsoft spend huge amount of their residual income on repurchasing shares and distributing dividends rather than reinvesting this pile of cash. The first one, has the title for the world’s biggest dividend payer, as it currently hands out as much as 13.22 billion dollars annually. When it comes for Microsoft, the lie on the third place of the list cited above allotting 12.02 billion to shareowners. Added to this, it has announced four buyback shares -40 billion dollars each – in the past few years, in an effort to boost its share price.

But on what extent are these dividend policies influencing the price?

In a time of crisis is it possible and diligent to sustain high dividend payments?

In this blog we will take a closer look to the main factors which influence the dividend distributed by the companies listed on an emerging stock market, Athens Stock Exchange. Secondly, the way these strategies are perceived by the potential investors will be argued. Lastly, the findings will examined to come to a conclusion on which theory is hinged to the investors’ way of thinking.

Let’s pull up our sleeves and start digging, shall we?

First of all, the most prevalent restriction which affects the dividend policy is the regulation. In Greece - just like in every other country- the legislation imposes a threshold amount of capital reserves that must be kept diminishing the residual income left to distribute. Moreover, the law forbids the payment of a dividend in case that the cash inflows are not adequate to cover the short term liabilities.

Secondly, the preferences of the stakeholders should not be negligible when planning a dividend policy. To be more precise, if a corporation is consisted mainly by shareholders who are heavily levied, then it is more likely that the managers will prefer to retain the earnings in order to reinvest them .In that way, they can align with their primary goal which is the shareholder’s wealth maximization. Furthermore, a company whose investors are merely pensioners will focus on the short term profitability, paying high dividends.

Thirdly, a major factor which is interlinked with the dividend policy is the stability of sales and the profitability. It is widely accepted that with small deviation in their sales pay biggest dividends .As shown in the table below companies established in industries of utilities and telecommunication give higher annual yield in opposition to the industry of technology where enterprises prefer reinvesting their residual income. Let’s take a more quantifiable approach. The China Mobile Ltd. distributed a dividend of 2.778 dollar per share in contrast with Microsoft Corporation which payed only 0.42 dollar per share.

S&P 1500 sector	Issues	Yield	% of payers	Issues paying	Yield of payers
Telecommunication Services	15	4.67%	66.7%	10	4.75%
Utilities	61	3.59%	100.0%	61	3.59%
Consumer Staples	74	2.62%	78.4%	58	2.70%
Energy	94	2.14%	59.6%	56	2.26%
S&P 1500	4501	1.92%	66.0%	991	2.27%
Financials	287	1.91%	88.9%	255	2.12%
Materials	102	1.90%	81.4%	83	1.97%
Industrials	219	1.89%	79.0%	173	2.00%
Health Care	154	1.53%	36.4%	56	2.20%
Information Technology	257	1.45%	37.7%	97	2.04%
Consumer Discretionary	238	1.43%	59.7%	142	1.89%

Source: S&P Dow Jones Indices

Lastly, we must point out the overriding influence of the company’s stage in its life cycle. Until the company has reached the stage of ‘’maturity’’ its cash inflows are not enough to provide dividends, as their only objective is survival. After that stage, companies struggle to find investments with positive Net Present Value and since their fraught with piles of cash they prefer to distribute it to their shareholders.

After this brief analysis of the main factors which are hinged to the dividend policy we can scrutiny the outcomes of the survey conducted on 943 Greek firms and the dividends they payed during the period 1993-2007. The results gave us some insights about what theory is mostly supported by the investors. All variables stated above were statistically significant. Specifically, firm size and profitability have positive relation to dividend distribution while lack of investment opportunities and business risk are negatively linked. The findings were consistent with the signalling theory. This actually means that dividend policies provide information to potential investors about the firm’s earnings. Moreover, high dividends give some insight about future earnings in an implicit way. According to this theory a high ratio of dividend per share in the present signals an incremental dividend policy in the future.

To conclude, although these outcomes are statistically significant we have silently made an assumption; all other factors are ceteris paribus. Nevertheless, post crisis data have shown that most Greek companies distribute dividend in order to mitigate the risk of defaulting, ignoring in the same time the significance of the signalling theory. Thus, it is an obligation of both the investors and the companies to find the correct balance in the dividend policy and the affect it should have.

Until next time,

Georgios Marios Roussos