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CHANAKYA NATIONAL

LAW UNIVERSITY
PATNA

Project of corporate law- II

Importance of dividend payment for investors

Submitted To: - MRS. NANDITA S. JHA {FACULTY- CORPORATE LAW}


Submitted By: -Saurav Kumar Choudhary (B.A.L.LB)

VIIITH semester Roll.no.-1372

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DECLARATION

I hereby declare that the project work of Corporate Law that is “Importance of dividend
payment for investors” submitted to Mrs. Nandita S. Jha, Chanakya National Law
University, Patna, is an original work done by me under the guidance of Mrs. Nandita S. Jha,
Faculty-in-Charge (Corporate Laws), CNLU, Patna. The content in this project have not
been submitted to any other University or Institute for any purpose.

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ACKNOWLEDGEMENT

It is my greatest pleasure to be able to present this project of CORPORATE LAW-II. I found


it very interesting to work on this project. I would like to thank my teacher, Mrs. Nandita S.
Jha for providing me with such an interesting project topic and for her constant support and
guidance.

I would also like to thank my librarian for helping me in gathering data for the project. Last,
but not the least, I would heartily thank my family and friends for their unwavering support
without which this work would not have been possible.

I hope that the readers will appreciate this project work.

Saurav Kumar Choudhary

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INDEX

A. RESEARCH METHODOLOGY……………………………....................…………. …...5

B. OBJECTIVE OF STUDY……………………………………………….............………….5

C. RESEARCH QUESTION…………………………………………….……...….................5

D. HYPOTHESIS………………………………………………...…….…………...................5

CHAPTERISATION

1. Dividend…………………………………….……............................................................6

2. Importance of dividend payment for investors …………………………………………..8

3.Conclusion…………………………………………………………………………….......11

4. Bibliography…………………………………………………………………………......12

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Research Methodology
The researcher has primarily relied on the “Doctrinal Method”. The research is based on
comprehensive study of sources which are primarily study of various regulations,reports,
web resources, news articles, etc. Analytical, critical and Comparative methods are used as
major tools of study in support of the arguments.

Objectives of Study:

 The objectives of the study are to understand in detail the concept of dividend.
 To know the importance of distribution of dividend from the prospective of the
investors.

Research Questions

1. What is Dividend?
2. What is the method of distribution of dividend?
3. What is the importance of dividend distribution?

Hypothesis
The hypothesis of my project is Dividend policy is concerned with financial policies
regarding paying cash dividend in the present or paying an increased dividend at a later
stage.

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Dividend

A dividend is a cash payment from a company's earnings; it is announced by a


company's board of directors and distributed among stockholders. In other words, dividends
are an investor's share of a company's profits, given to him or her as a part-owner of the
company. Aside from option strategies, dividends are the only way for investors to profit
from ownership of stock without eliminating their stake in the company.1

When a company earns profits from operations, management can do one of two things with
the profits. It can choose to retain them - essentially reinvesting them into the company with
the hope of creating more profits and thus further stock appreciation. The other alternative is
to distribute a portion of the profits to shareholders in the form of dividends. (Management
can also opt to repurchase some of its own shares - a move that would also benefit
shareholders.2

A company must keep growing at an above-average pace to justify reinvesting in itself


rather than paying a dividend. Generally speaking, when a company's growth slows, its stock
won't climb as much, and dividends will be necessary to keep shareholders around. This
growth slowdown happens to virtually all companies after they attain a large market
capitalization. A company will simply reach a size at which it no longer has the potential to
grow at annual rates of 30-40% like a small cap, regardless of how much money is plowed
back into it. At a certain point, the law of large numbers makes a mega-cap company and
growth rates that outperform the market an impossible combination.

In 2003 are perfect illustrations of what can happen when a firm's growth levels off. In
January 2003, the company finally announced that it would pay a dividend: The fact that
Microsoft started to pay dividends did not signal the company's demise; it simply indicated
that Microsoft had become a huge company and had entered a new stage in its life cycle,
which meant it probably would not be able to double and triple at the pace it once did.

1
Narasimhan, M.S. and S. Vijayalakshmi (2015), “Impact of Agency Cost on Leverage and Dividend Policies”,
The ICFAI Journal of Applied Finance, Vol. 8, No. 2, March, pp. 16-25.
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ibid
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Who determines dividend policy3

The company's board of directors decides what percentage of earnings will be paid out to
shareholders, and then puts the remaining profits back into the company. Although
dividends are usually dispersed quarterly, it is important to remember that the company is
not obligated to pay a dividend every single quarter. In fact, the company can stop paying a
dividend at any time, but this is rare, especially for a firm with a long history of dividend
payments. (To learn more about this problem, read Is Your Dividend At Risk?)

If people were used to getting their quarterly dividends from a mature company, a sudden
stop in payments to investors would be akin to corporate financial suicide. Unless the
decision to discontinue dividend payments was backed by some kind of strategy shift, say
investing all retained earnings into robust expansion projects, it would indicate that
something was fundamentally wrong with the company. For this reason, the board of
directors will usually go to great lengths to keep paying at least the same dividend amount.

How stocks that pay dividend resemble bonds:-

When assessing the pros and cons of dividend-paying stocks, you will also want to consider
their volatility and share price performance as compared to those of outright growth stocks
that pay no dividends.

Because public companies generally face adverse reactions from the marketplace if they
discontinue or reduce their dividend payments, investors can be reasonably certain they will
receive dividend income on a regular basis for as long as they hold their shares. Therefore,
investors tend to rely on dividends in much the same way that they rely on interest payments
from corporate bonds and debentures.Since they can be regarded as quasi-bonds, dividend-
paying stocks tend to exhibit pricing characteristics that are moderately different from those
of growth stocks. This is because they provide regular income, similar to a bond, but still
provide investors with the potential to benefit from share price appreciation if the company
does well.

3
Miller, M. and K. Rock (2016), “Dividend Policy under Asymmetric Information”, Journal of Finance, Vol. 40,
No. 4, pp. 1031-1051.
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Importance of dividend payment for investors

Reasons why dividends matter for investors include the fact they substantially increase stock
investing profits, they provide an extra metric for fundamental analysis, they reduce overall
portfolio risk, they offer tax advantages, and they help to preserve purchasing power of
capital.

Growth and Expansion of Profits4

One of the primary benefits of investing in dividend-paying companies is dividends tend to


steadily grow over time. Well-established companies that pay dividends typically increase
their dividend payouts from year to year. There are a number of "dividend aristocrats," or
companies that have continuously increased their dividend payouts for more than 25 years
consecutively. Since 1980, the dividend average compounded annual growth rate for S&P
500 companies that offer dividends has been 3.2%.

One of the basics of stock market investing is market risk, or the inherent risk associated
with any equity investment. Stocks may go up or down, and there is no guarantee they
increase in value, but while investing in dividend-paying companies is not guaranteed to be
profitable, dividend stocks offer at least a partial return on investment that is virtually
guaranteed. It is very rare for dividend-paying companies to ever stop paying dividends, and
in fact, most of these companies increase the amount of their dividends over time.

Many investors fail to appreciate the huge impact dividends have on stock market profits.
Since 1926, dividends have accounted for almost half of stock investing profits in the
companies that make up the S&P 500 Index. This means the inclusion of dividend payments
has roughly doubled what stock investors have realized in returns on investment as
compared to what their returns would have been without dividend payments.

Additionally, in this low-interest-rate environment, the dividend yield offered by dividend-


paying companies is substantially higher than rates available to investors in most fixed-
income investments such as government bonds.

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Miller, M.H. and F. Modigliani (2014), “Dividend Policy, Growth and the Valuation of Shares”, Journal of
Business, Vol. 34, No. 4, October, pp. 411-433.
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Reducing Risk and Volatility5

Dividends are a major factor in reducing overall portfolio risk and volatility. In terms of
reducing risk, dividend payments mitigate any losses that occur from a decline in stock
price. But the risk reduction benefit of dividends goes beyond that basic fact. Studies have
consistently shown that dividend-paying stocks significantly outperform nondividend-paying
stocks during bear market periods. While an overall downmarket generally drags down
stocks across the board, dividend-paying stocks usually suffer significantly less decline in
value than nondividend-paying stocks. A stark example of this fact was displayed during the
overall market downturn in 2002, when nondividend-paying stocks fell by an average of
30%, while dividend-paying stocks only declined on average by 10%. Even during the
severe 2008 financial crisis that precipitated a sharp fall in stock prices, dividend stocks held
up noticeably better than nondividend stocks.

Owning stocks of dividend-paying companies also substantially reduces overall portfolio


volatility. A 2000-2010 comparison of dividend-paying companies versus nondividend-
paying companies in the S&P 500 Index shows a marked contrast in levels of volatility.
The beta of dividend-paying companies over this period of time was 0.98, slightly less than
the overall market average. The beta of nondividend-paying companies for the same time
period was 1.48, showing a much higher volatility rate than the overall market average.

Dividends Offer Tax Advantages6

The way dividends are treated in regard to taxes makes dividends a very tax-efficient means
of obtaining income. Qualified dividends are taxed at substantially lower rates than ordinary
income. Per IRS regulations as of 2011, for individuals whose ordinary income tax rate is
25% or higher, qualified dividends are taxed at only a 15% rate. And for individuals whose
ordinary income tax rate is below 25%, qualified dividends are completely tax-free.

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ibid
6
Mishra, C. and V. Narender (2013), “Dividend Policies of SoEs in India – An Analysis”, Finance India, Vol. X,
No. 3, September, pp. 633-645.
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Dividends Preserve Purchasing Power of Capital7

Dividends also help out in another area that investors sometimes fail to consider: the effect
of inflation on investment returns. For an investor to realize any genuine net gain from an
investment, the investment must first provide enough of a return to overcome the loss of
purchasing power that results from inflation. If an investor owns a stock that increases in
price 3% over the course of a year, but inflation is at 4%, then in terms of the purchasing
power of his capital, the investor has actually suffered a 1% loss. However, if that same
stock that increased 3% in price also offers a 3% dividend yield, the investment has
successfully returned a profit that outpaces inflation and represents an actual gain in
purchasing power for the investor. The good news for investors in dividend-paying
companies is that many dividend yields outpace inflation.

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ibid
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Conclusion

A company can't keep growing forever. When it reaches a certain size and exhausts its
growth potential, distributing dividends is perhaps the best way for management to ensure
that shareholders receive a return from the company's earnings. A dividend announcement
may be a sign that a company's growth has slowed, but it is also evidence of a sustainable
capacity to make money. This sustainable income will likely produce some price stability
when paid out regularly as dividends. Best of all, the cash in your hand is proof that the
earnings are really there, and you can reinvest or spend them as you see fit.

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BIBLIOGRAPHY

BOOKS & ARTICLES


1. Mishra, C. and V. Narender (2013), “Dividend Policies of SoEs in India – An Analysis”
2. Miller, M.H. and F. Modigliani (2014), “Dividend Policy, Growth and the Valuation of
Shares”,
3. Miller, M. and K. Rock (1985), “Dividend Policy under Asymmetric Information”
4. Mohanty, P. (2015), “Dividend and Bonus Policies of the Indian Companies”
5. Narasimhan, M.S. and S. Vijayalakshmi (2002), “Impact of Agency Cost on Leverage and
Dividend Policies”

WEBSITES

https://www.investopedia.com/articles/fundamental/03/102903.asp

https://fifthperson.com/5-reasons-why-dividends-are-important-to-investors/

https://www.moneycrashers.com/why-dividends-are-important-to-the-portfolio-of-every-
investor/

https://content.capitaloneinvesting.com/mgdcon/knowledgecenter/Trade/dividends/the-
importance-of-dividends.htm

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