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Abstract Dividend policy has been one of the areas of corporate finance to be analyzed with a rigorous model, and

it has since been one of the most thoroughly researched issues in modern finance. There are a number of theories of dividend behavior, and empirical studies provide little evidence for one over the other. Also the conceptions concerning corporate dividend theories are different. The main part of the discussion is related to the evaluation of financial research, because at all times researchers have tried to solve the dividend puzzle by using new theories and insights. Introduction In the field of corporate finance, the finance manager has to take three important decisions, namely investment decision which is related to where the given company should make investment; financing decision which is concerned with the determination of how the required fund would collected; and dividend decision which may arise when the firm makes profits. Should the firm distribute its all earnings to the shareholders or should it be reinvested into the business? Financial managers must give concentrations on how much the companys earnings are required for investment in projects with positive NPV and the possible effects of their decision on shares prices. Dividend policy is formulated by the board of directors of a company in order to make decision how much earnings would distributed among the shareholders as their reward for making investment in the given company in the form of dividend and how much would be retained within the company as a retained earnings. Dividend policy is an important area of research in corporate finance. Even though a number of researches have been conducted on dividend policy, a limited number of studies have revealed the applicability of the dividend theory on some listed companies in an organized stock exchange. What is Dividend? The term dividend is defined as a return from investment in equity shares. The profit made by the firm which is distributed to the shareholders termed as dividend. Every firm after making profit either retain the money for further investment or distribute it among the shareholders. The firm should decide whether to keep the money as retained earnings or pay the dividend. It may be in cash, share and combination of both. Types of Dividend Cash Dividend The most common way to pay dividend is in the form of cash. A company should have enough cash in its bank account when cash dividends are declared. If the company doesnt have enough cash at the time of paying cash dividend, arrangement should be made to borrow funds. Payment of cash dividend shouldnt lead to liquidity problem for the company. The cash account and the reserve account of a company will be reduced when the cash dividend is paid. Both the total

assets and the net worth of the company are reduced by the distribution of cash dividend. Beside the market price of the share affected in most cases by the amount of cash dividend distributed. Cash dividend has the direct impact on the shareholders. The volume of the cash dividend depends upon earnings of the firm and on the management attitude or policy. Cash dividend has psychological value for stockholders. Each and everyone like to collect their return in cash rather than non-cash means. So cash dividend is not only a way to earnings distribution but also a way of perception improvement in the capital market. Stock Dividends If a company is strapped for cash, they might opt to issue dividends in the form of additional shares of stock over a regular cash dividend. In theory, this actually represents a net draw - the total number of shares would increase but, if the overall valuation remained the same, the share price would drop accordingly. Stock dividends are better viewed as a form of a stock split. You gain nothing from a stock dividend (perhaps the company gains Property Dividends A property dividend is a dividend paid in a form other than cash or the companys own stock. A property dividend is generally taxable at its fair market value. For example, when a corporation spins off a subsidiary, shareholders might receive assets or shares of that subsidiary. Distributing the stocks or assets of the subsidiary (rather than cash) allows shareholders to benefit directly from the market value of the dividends received. Dividend Policy The term dividend policy refers to the practice that management follows in making dividend Payout decisions or, in other words, the size and pattern of cash distributions over time to Shareholders This issue of dividend policy is one that has engaged managers since the birth of the modern commercial corporation. Surprisingly then dividend policy remains one of the most contested issues in finance. There are three main approaches to dividends: residual, stability or a hybrid of the two. Residual Dividend Policy Companies using the residual dividend policy choose to rely on internally generated equity to finance any new projects. As a result, dividend payments can come out of the residual or leftover equity only after all project capital requirements are met. These companies usually attempt to maintain balance in their debt/equity ratios before making any dividend distributions, deciding on dividends only if there is enough money left over after all operating and expansion expenses are met. For example, let's suppose that a company named CBC has recently earned $1,000 and has a strict policy to maintain a debt/equity ratio of 0.5 (one part debt to every two parts of equity). Now, suppose this company has a project with a capital requirement of $900. In order to

maintain the debt/equity ratio of 0.5, CBC would have to pay for one-third of this project by using debt ($300) and two-thirds ($600) by using equity. Dividend Stability Policy: The fluctuation of dividends created by the residual policy significantly contrasts with the certainty of the dividend stability policy. With the stability policy, quarterly dividends are set at a fraction of yearly earnings. This policy reduces uncertainty for investors and provides them with income. Suppose our imaginary company, CBC, earned $1,000 for the year (with quarterly earnings of $300, $200, $100 and $400). If CBC decided on a stable policy of 10% of yearly earnings ($1,000 x 10%), it would pay $25 ($100/4) to shareholders every quarter.
Hybrid Dividend Policy

The final approach is a combination between the residual and stable dividend policy. Using this approach, companies tend to view the debt/equity ratio as a long-term rather than a short-term goal. In today's markets, this approach is commonly used by companies that pay dividends. As these companies will generally experience business cycle fluctuations, they will generally have one set dividend, which is set as a relatively small portion of yearly income and can be easily maintained. On top of this set dividend, these companies will offer another extra dividend paid only when income exceeds general levels. Advantages 1) Dividend payout serves as a sign of the company's stability. When a company maintains a dividend payout for a long period of time, it gives investors more confidence on the company's future earnings. 2) Some companies offer Dividend Reinvestment Plan (DRIP) in which the existing shareholders can use their dividend payments to purchase more shares of stock from a company. 3) Dividends allow investors to profit from their investment without having to sell their stocks. For example, if the company declares a dividend payment of $0.50 per share and you own 2,000 shares, you will be entitled to receive $1,000 of income, even if the share price goes down. Disadvantages 1) The payment of dividend is at discretion of the company management. Even if the company makes a good profit, it is under no obligation to pay a dividend. 2) If the company pays a large sum of money for dividends, there will be less money left for the company to reinvest and grow the business.

Dividend Policy Theory and Practice Dividend Relevance Theory: Dividends compensated through the firms tend to be viewed absolutely both from the investors and also the firms. The organizations which don't pay rewards are graded in oppositely through investors hence impacting the share value. The individuals who help importance of dividends obviously state that normal dividends decrease uncertainty with the investors i.e. the revenue of the organization is reduced at a lower price, ke thus raising the market benefit. Nevertheless, its exactly reverse in the situation of improved uncertainty because of non-payment of returns. Two crucial models assisting dividend importance are given through Walter and Gordon. Walter's model: James E. Walter's product shows the importance of dividend plan and its showing on the value with the share.Walters formula for determining MPS is as follows: P = (DPS/k) + [r (EPS DPS)/k]/k P = market price per share DPS = dividend per share EPS = earnings per share r = firms average rate of return k = firms cost of capital Gordons model: Myron J. Gordon also reinforced dividend importance and thinks in typical dividends impacting the share value of the organization. Dividend Irrelevance Theory: Modigliani and Miller (1961) argued that share valuation is a function of the level of corporate earnings, which reflects a companys investment policy, rather than a function of the proportion of a companys earnings that are paid out as dividends, i.e. the wealth of a companys shareholders is determined by the earning power and risk of its assets not by the dividend payout decision. M & M established that dividend policy is irrelevant under certain assumptions about perfect capital markets, such as there is no difference between dividend and capital gain from the view point of taxes; securities trading is free from transaction cost and floatation cost; symmetrical and cost less information are available for all investors; there is no conflict between managers and shareholders in respect of interest; and all investors are treated as price takers in the market ( Al-Malkawi , Rafferty and Pillai, 2010). The Bird-In-The-Hand Theory: The essence of the bird-in-the-hand theory of dividend policy (advanced by John Litner in 1962 and Myron Gordon in 1963) is that shareholders are riskaverse and prefer to receive dividend payments rather than future capital gains. Shareholders consider dividend payments to be more certain that future capital gains thus a "bird in the hand is worth more than two in the bush". Gorden contended that the payment of current dividends

"resolves investor uncertainty". Investors have a preference for a certain level of income now rather that the prospect of a higher, but less certain, income at some time in the future. Dividend Signaling Theory In practice, change in a firm's dividend policy can be observed to have an effect on its share price an increase in dividend producing an increasing in share price and a reduction in dividends producing a decrease in share price. This pattern led many observers to conclude, contrary to M&M's model, that shareholders do indeed prefer dividends to future capital gains. Needless to say M&M disagreed.

Dividend policy is concerned with the determination of level of dividends for the shareholders of a company. A companys dividend policy has a significant impact on its financial health. For example it affects liquidity, the cost of capital, the market value of shares and the market perception of a company. There are many important issues of this dividend policy are presented by this study. Here, the company and investors both are benefited by using this dividend policy. Company dividend decisions are thus not the simple process of deciding how much cash is left after all commitments and plans have been executed, and paying that amount to shareholders. The considerations of signaling, agency and the effects of market imperfections upon optimal dividends are important dimensions about which financial managers must be aware. Dividend not only presents cash flows to the shareholders but also contains useful information with regard to the firms current and future performances. Such information affects the shareholders perceptions of the firm risk. Some companies that can guarantee high returns on their capital have a zero dividend policy, providing value to shareholders through the increased market value of their shares. So the finance manager is more responsible to control this dividend policy. The finance manager has to decide the dividend policy very carefully. A wrong dividend policy may put the company into financial troubles and the capital structure of the company may get unbalanced. The finance manager has to formulate the dividend policy in such a way which coincides with the ultimate object of the finance function of maximizing the wealth of shareholders and value of the firm. Although the theory with regard to the relevance of dividends is still evolving, the behavior of most firms and stockholders suggests that dividend policy affects share price. Finally, it can be said that, the organization and the investor both can earn more profit by using appropriate dividend policy and they have to use this practically according its different theories.