BUSF_A01.qxd

Conclusions on dividends

Agency

Agency problems (and costs) tend to arise where shareholders and directors have

different objectives. Schooley and Barney (1994) provide some evidence that where

senior managers are also shareholders, the agency problem, in the context of divi-

dends, tends to be reduced. See also the Allen, Bernardo and Welch (2000) study men-

tioned in the section on the clientele effect above.

Reinvestment of dividends

MM made the point that shareholders could negate the effect of dividends by rein-

vesting them in the business concerned. Some UK businesses make this relatively

easy for their shareholders to do. For, example, both the engine-building business

Rolls-Royce plcand the DIY retailer Kingfisher plcgive their shareholders the choice

of a dividend in cash or in additional shares.

A number of businesses will use dividend cash to buy their own shares, in the Stock

Exchange, on behalf of shareholders who wish to have this done for them, at low cost

to the shareholder. These include, for example, British Petroleum plc, Royal Dutch

Shell plc(Shell oil), Unilever plc,Rio Tinto plcandFirst Choice Holidays plc.

Pecking order theory

The evidence on the pecking order theory was reviewed in Chapter 11. There we saw

that there is not strong evidence that this theory applies in practice.

12.7 Conclusions on dividends

As with capital gearing, we do not know whether the traditionalists or MM are correct

in their assertions. We do, however, have a certain amount of empirical evidence on

the subject and so we might be able to reconcile the two views.

MM’s assertion that patterns of dividends are irrelevant has some credibility. The

assumptions are not entirely convincing but they do not seem sufficiently unreason-

able to invalidate the irrelevancy assertion completely. However, the evidence seems

not to support the MM view, in that valuation seems to be related, in practice, to

levels of dividends.

It may well be that MM were broadly correct in saying that dividends do not affect

values, except that evidence exists that dividends change investors’ perceptions of the

future of the business.

From the evidence there does seem to be a clientele effect in that the dividend

policy associated with particular shares appears to attract an identifiable group

of investors. Recognition of the clientele effect by directors could well explain their

reluctance to alter dividend payment levels. Given that the clientele effect seems

significant, investors need to know the dividend policy of the business. Probably the

most effective way of informing investors of this policy is to establish a fairly constant

pattern and to stick to it. Failure to show consistency is likely to lead to uncertainty

for investors and to the necessity for shareholders to leave one habitat in favour of