week7 learning reflection about dividends policy

Dividend policy is one of the three major financial policy in companies, it occupies an important position through the cycle of the value in enterprises. Since in 1961, Modigliani & Miller proposed the famous theory "Dividend Irrelevance", arguments for the company's dividend policy has not been disappeared. In their opinion, they thought that in a perfect market without tax, share value of one company is not determined by the amount of earnings distributed to shareholders, just related to the company’s investment policy and plan. In 1976, Black put forward the "dividend puzzle", making it become one of the biggest mysteries of modern financial management. Among numerous mysteries, whether the stability of the dividend payment had a positive effect to the promotion of enterprise value has become one.

Thus in 1956, Lintner made a practical study of dividend policy in those listed companies, he had carried on an empirical research of cash dividends from the enterprises, which showed that the listed companies in the United States tend to issue more stable cash dividends .And he considered that only when managers believed the change of earnings is sustainable, managers would adjust the dividend payment level; On the contrary, if the change is not sustainable, they would not take some adjustments to the dividends. In the year of 1985, Baker and other professional people, through the investigational research on the dividend policy, they found that as for dividend decision managers was very concerned about the stability of the dividend policy. Followed by Pruitt and Gitman (1991) who also adopted the similar study and then they found a similar conclusion.

Also in the 60th and 70th of the 20th century, other scholars who disagreed with the Dividend Irrelevance, they put forward other theories about Dividend Relevance one after another, such as famous “Bird-in-the-hand”Theory proposed by Gorden in 1956 and Tax and Clientele Effects Theory by Farrar and Selwyn in 1967. Since 1970s, the rise of information economics makes the classical economics have a big breakthrough. Financial scholars had altered the direction of their researches, and formed the two mainstream theory of modern Dividend Policy, dividend policy theory of Signaling transmission and the agency cost.

In the Signaling Theory, there existed the asymmetric information and investors may not have access to the internal information, which was not beneficial to their investment decisions and they would not forecast the companies’ performance and prospects. Because managers usually have more internal information about business prospects, dividend is one important method of delivering internal message to the world by their managers. If they expect to have good prospects for the development of the company when the future earnings will increase substantially they would transmit this information timely to shareholders and potential investors by increasing dividends; On the contrary, if they predicts that the developing prospect of the company is not very good, the sustainable future profits are not ideal, so they tend to maintain or even lower the dividend level, it seems like sending a negative signal to the shareholders and potential investors. Therefore, dividends can transfer the information about company's future profitability, this leads to dividends having a certain effect on share prices. When the level of companies paying dividends being enhanced, the company's share price will rise; When the level drops, the company's share price would fall.

Therefore, from my point of view, there are various factors influencing the dividend decisions and they result in four main types of dividend levels: high dividend, low dividend, fluctuating dividend and stable dividend. Except the factors which have been discussed above, the investors’ preferences are also one important reason when deciding the amount of dividends. Meanwhile, managers should take the long view in the development of companies’ profitability. It suggested that if the future profits are going down, managers often need to maintain the current level of dividends which will have a positive effect on keeping up with share prices. On the other hand, if they forecast the profit will be very high in the future stock market, they have no choice but to be cautious about dividend decision because they can not ensure that this level could be held sustainably in the future. Of course, whenever companies make any decisions, managers should think carefully before acting， based on their companies’ actual conditions. Moreover, they need adjust measures to local conditions. This is the best method to develop companies at a long-lasting and effective speed.