DIVIDEND POLICY

Dividend Policy

Dividend Policy

Introduction

This paper intends to examine the following statement, which is 'Changes in dividend provide a signal to the market regarding the expected future performance of the company'. Various aspects are analyzed in terms of this particular statement. In addition, several other factors are explored such as, principal predictions of the signaling model, likely impacts of dividend cuts and increase on share price and empirical evidence on those predictions.

Discussion

Dividend Policy

Types of Dividend Policies

The dividend policy of an enterprise is a plan of action to be followed whenever the contractor decides about the distribution of dividends. The policy should be considered by taking into account two basic objectives (Lease et al., 1976):

•To maximize the benefit of the owners of the company

•Provide sufficient funding

Factors of Dividend policy

The factors include legal restrictions, contractual restrictions and internal restrictions. These restrictions are related to the owners (Asquith & Mullins, 2003). They are related to the limited market alternatives available to the decision maker in establishing a dividend policy.

Legal Restrictions

The corporation is facing four basic legal restrictions regarding the payment of cash dividends, which consider the deterioration or impairment of capital, profits, insolvency and the accumulation of profits.

Impairment of capital

Most states prohibit corporations as cash dividends paid any part of the capital stock of the company governed by the value of the common shares joint. Other states require that capital includes not only the par value of the common but any capital paid in excess of the par value. Restrictions on capital impairment are usually established to protect creditors' requirements (Baskin, 2009).

Utilities

The demand for profits is similar to impairment of capital requirement that limits the amount of dividends to the sum of current and past earnings of the company. This means that the company cannot pay cash dividends more than the sum of its retained earnings recent and past.

Insolvency

If a company has liabilities due, legally insolvent or is in bankruptcy (the market value of its assets is less than its liabilities). Most states prohibit the payment of cash dividends. This restriction is intended to protect creditors by prohibiting the liquidation of a company almost bankrupt by the payment of cash dividends to owners (Rappoport, 2006). The payment of cash dividends by a company is not solvent could seriously undermine the requirements of its creditors in the event of a bankruptcy filing.

Excessive accumulation of profits

The service of income tax prohibits companies from the accumulation of profits. The owners of the company must pay tax on dividends income upon receipt, but are not taxed on capital gains in market value until the stock has been sold. An enterprise may retain much of their profits in order to provide opportunities for capital gains to owners. A company that has paid low or no dividends, retained earnings level is high and has a large amount of cash and securities business, is a possible candidate for an investigation (Born et,al 2008).

Contractual Restrictions

Often the company's ability to pay cash dividends is limited by ...