10.2 Cash Payments by the Company 33110.2.2 Dividends and Other Distributions
The payment of dividends is one of the main ways to reward existing sharehold-
ers, and a company firm is usually expected to pay dividends during the normal
course of business.
Reasons to pay dividends. Dividends are again paid for a wide range of reasons.
In a corporate group, the payment of dividends and intra-group asset transfers
are commonplace.
For companies whose shares have been admitted to trading on a regulated mar-
ket, the payment of dividends is an important signalling tool as increasing divi-
dends over a long period of time can be perceived as evidence of sustainable earn-
ings growth. This can reduce perceived risk and increase share price (and make it
necessary to use share buy-backs for one-off distributions; share buy-backs are
more flexible than dividends because they have not become associated with raised
expectations with regard to future payouts).^8 Many investors prefer companies that
pay dividends as they rely on dividends for their income; even this can increase
share price in practice.
This means that shareholders fulfil their monitoring role (Volume I) partly by
expecting the payment of dividends. According to Easterbrook, “expected, con-
tinuing dividends compel firms to raise new money in order to carry out their ac-
tivities. They therefore precipitate the monitoring and debt-equity adjustments that
benefit stockholders.”^9 This means also that the dividend policy of the firm is a
way for managers to impose discipline on themselves.
There can be even other reasons to pay dividends and distribute funds to share-
holders. For example: distributable assets are often distributed to existing share-
holders before an IPO; a company whose shares are traded on a regulated market
can pay dividends and make other distributions to existing shareholders as a take-
over defence; dividends can be paid after a successful takeover, because it will
help the buyer to repay takeover bridge loans; and the payment of dividends can
be used instead of a division to split the company into two businesses (for divi-
sions, see section 10.4.4).
The practice of dividend policy and the legal aspects of distributions can be
contrasted with corporate finance theory. The theory is that dividend policy should
not affect the overall market value of a company’s shares if the markets are per-
fect.^10
Distributable assets. The term used in the Second Company Law Directive is
“distribution”. There are general constraints on the “distribution” of funds to
shareholders.^11 The term “distribution” includes, in particular, the payment of
(^8) See ibid, citing Oswald D, Young S, Cashing In On Share Buybacks, Accountancy
(2003) p 55.
(^9) Easterbrook FH, Two Agency-Cost Explanations of Dividends, 74 (1984) Am Econ R p
650, cited in Ferran E, Principles of Corporate Finance Law. OUP, Oxford (2008) p 235.
(^10) See Ferran E, op cit, citing Miller MH, Modigliani F, Dividend Policy, Growth and the
Valuation of Shares, J Bus 34 (1961) p 411.
(^11) Articles 15–24 of Directive 77/91/EEC (Second Company Law Directive).