MBA Finance Essay (Term Paper Sample)

EXECUTIVE SUMMARY
Dividend policy has been an issue of interest in financial literature since Joint Stock Companies came into existence. Dividend policy connotes to the payout policy, which managers pursue in deciding the size and pattern of cash distribution to shareholders over time. The area of corporate dividend policy has attracted attention of financial management scholars and economists culminating into theoretical modeling and empirical examination. The reason why shareholders like dividends and why they reward managers who pay regular increasing dividends need to be answered.
The cash dividends policy will not affect the returns on capital required. As a result, the company's share price which has a low cash dividend and high return earnings for future capital gains will be less than the share price which has high cash dividends. "Bird in hand theory" proposes that capital gains are more risky than cash dividends and that investors prefer companies that distribute cash dividends more than the companies that hold the profits to convert them into capital gains. The results that can be drawn from this theory are, the companies that distribute low cash dividends are often high-risk investment companies. Due to high investment risks, investors would discount future cash flows of low cash dividends companies with high risks with a larger discount rate when they evaluate these companies' shares prices. In addition dividends paid to the shareholders are reinvested by the shareholder further, to get higher returns.
According to Clientele Effect Theory, some investors would prefer companies with high cash dividends whereas others prefer companies with low cash dividends or without any cash dividends but retention for investment. Since the company chooses its customers through the cash dividends policy. If the company reduces cash dividends rate, the investors who want a higher dividend rate will sell their shares and turn to another company. As per Signaling Effect Theory, the managers use the change in cash dividends distributed rates as a means to deliver information to investors about the company (Denis, Denis et al. 1994). The supporters of the Signaling Effect theory believe that cash dividends is the ideal means to deliver specific information about the company to investors.
There are a number of benefits to invest in dividend paying stocks whether your portfolio is income generating or dividend focused, they includes; it is a signal of financial health, a source of total return to shareholders, dividend are relatively lower volatile, dividend provide higher returns despite changes to interest rates and inflation and it play a part of downside protection during various market cycles. Other benefits are; first dividends tend to la...