(^336) Financial Management
Shareholder Preference: When equity shareholders have greater interest in current
dividend vis-a-vis capital gains, the firm may be inclined to follow a liberal dividend
payout policy. While the preference of equity shareholders has some influence over the
dividend policy of the firm, the dividend policy may have a greater impact on the kind of
shareholders who are attracted towards it. Each firm is likely to draw itself a "clientele"
which finds its payout policy attractive.
As mentioned above certain formal and casual empirical observations point in the opposite
direction. Perhaps the most famous set of results on actual dividend policy was compiled
and presented by John Lintner. Lintner interviewed the management of a sample of US
corporations in order to determine what lay behind their dividend-setting decisions. His
research led to the four following stylised facts:
l Managers seem to have a target dividend pay-out level.
l This pay-out level is determined as a proportion of long run (i.e. sutainable) earnings
of the firm.
l Managers are more concerned with changes in dividends rather than the actual
level of dividends.
l Managers prefer not to make dividend changes that might need to be reversed
(e.g. cutting dividends after having raised them in the previous period).
As the second fact implies, it is not current but long-run earnings that matter in setting
dividends such that dividends can be seen to be smoothed relative to earnings.
There are three basic types of dividend policies that are used by the companies. They
are
- Stable dividends
- Target Payout Ratio and
- Regular and extra dividends
- Stable dividends: A company following this type of a policy maintains a constant
dividend rate irrespective of the actual earnings level and the company tries to
maintain it even when during the recession the earnings go down below the actual
dividends pay, trying to signal to the investor that this is a temporary phase and
earnings will be back up when the economy revives.
Companies expect that the investors will place a premium on the shares of a
company which pays stable dividends and only increases its dividend payment
when it believes that increase can be maintained. A stable dividend policy