Type: Economics
Pages: 9 | Words: 2432
Reading Time: 11 Minutes

One of the most popular forms of company capitalization is the issuance of shares. However, in order to make the capitalization process successful, the sales managers of the company in cooperation with other departments of the public stock company have to persevere to induce the prospective shareholders to purchase the shares of the company. In the context of the shareholders’ attraction and retention the crucial point is the dividend policy. The dividend policy of the company is the method the accrued profits of the company are calculated and turned into the regular payouts, which are subsequently distributed among the shareholders of the firm. The unanimous scholarly and business opinion in this regard is that the dividend policy is the decisive factor, which induces a person to become a shareholder of a specific business entity or to seek other alternatives for their investments.

This paper outlines the most popular theories relating to dividend payments, substantiates the nature of those theories and practically demonstrates the relevance and justification of the theories thereto.

Part I. The Theories

Dividend Irrelevance Theory

This theory has been elaborated and researched at the dawn of the conventional capitalism era. To be more exact, the main points and the postulates of this theory have been formulated by the practicing business people and by the economic and finance academic scholars with a broad recourse to the practice of the domestic, international and transnational companies. Although, it is ubiquitously disputed and challenged by the scientific and corporate scholars and business people, contemporarily both the statistics as well as the convergent academic and business opinion stipulates that this theory is the most solid and substantiated. The essence of the theory is the following: the dividends are paid to the shareholders of the company on the regular basis, after all legal and economic compulsory payments and tax deductions have been exercised by the managers of the company.

Under the postulates of this dividend theory the interests of the managers’ of the firm are in a permanent and intransigent conflict with the interests of the shareholders. The explanation of the trend is plain and simple: the shareholders are interested in receiving as much dividends as possible, whilst the managers and other executive officers of the firm always prioritize the expansion of the company and the rise of the financial instruments, which can prospectively increase the revenues accrued by the firm in general. Therefore, the conflict in question exacerbates always due to the fact that the shareholders perennially demand and claim bigger payouts, while the increase of these payments integrally necessitate the increase of the investments made to the development of the firm.

Another aspect of this dividend payment strategy is the relation between financial ambitions of the executive officers of the firm and the day-to-day managerial decisions of the managers of the company. The CEO and the managers may have big financial appetites and these interests may hypothetically collide with the interests of the stakeholders and the managers who are in charge of the development and progress of the company. In order to illustrate, similar situation occurred when the decision of BMW to launch its facilities in Belgium, this milestone opportunity was widely discussed by the shareholders and the managers with the involvement of the CEO and other executive officials of the enterprise. Finally, the managers and the executive people managed to convince the shareholders to vote for the expansion of the productive facilities, which temporarily cause the decrease in payouts.

Under the principles of this theory, the managers need to increase the dividends when the shareholders of the company indicate the trend that they are likely to sell their shares, thereby diminishing the capitalization of the company. In other words, the payouts are increased when the shareholders and the bondholders are to be either retained or attracted.

Bird in the Hand Policy

Under the postulates of this approach, the interests of the shareholders of the enterprise are at the top of the list of the firm’s priorities. This policy is often chosen by the managerial department of the firm particularly upon the crisis-related circumstances when the top objective of the company is to preserve the capitalization and to retain as much shareholders as possible. In these situations, the main objective of the company is the retention of the existing shareholders base, even when the value of the shares is steadily diminishing.

Upon the aforementioned conditions of the firm’s environment, the most successful strategy for the firm is to make the payouts stand at the same level, so that the shareholders of the firm may report confidence and satisfaction by the performance of the company. Under such business environment, usually there is no need to invest into the increase of the nominal and the operational values of the shares emitted by the enterprise.

The managers of the firm are required to increase the payouts exercised to the shareholders of the firm when the shareholders dispose of their shares be means of selling them or by the unwillingness to realize their preemptive rights to purchase the newly-emitted shares.

Agency Costs Theory

The nature of this theory is closely connected with the fiduciary duty of the management board. Before the question is elaborated, it is necessary to stress the fact that under the postulates of this theory, the agent is charged with the obligation to act in the best interests of the principles, i.e. the business entity or the individual who hired the agent to exercise those functions gives that agent full set of legal capacities. However, the point of contention in this sphere of the shareholders-management privity is the control. The shareholders are always less financially proficient than the managers and therefore they can not successfully monitor whether the financial resources of the enterprise are being utilized in accordance with the articles of incorporation and the terms of the shares emission.

The framework of this theory relating to the dividend payment purports that the agent shall act diligently and  prudently to maximize the payouts to the shareholders if so agreed by the parties. Under contemporary business law, the violation of the fiduciary duty which is integrally connected with this type of the policy is the key point thereto. The violation of this aspect is a ground to terminate the cooperation among the parties, i.e. to the dismissal of the management group.

The need to increase the payouts is usually generated when it becomes evident for the managerial staff of the company that the shareholders and the bondholders of the company become preoccupied with the performance of the managers. To be more exact,  when it becomes obvious  for the shareholders that the fiduciary duty is being violated, the increase of the payouts is the shortest way to dull the scrutiny of the most scrupulous  and watchful shareholders.

Part II.

Practical Calculations of the Share Prices and the Profits Accrued to the Balance of the Company by the Individual Share

The assumptions of the task are the following:

a)  The value of the shares in New Corp today stands at the point of $50 per share.

b)  The dividends accrued by the individual share by the end of the year is expected to be at the rate of $2,50 per share

The task of the present case study is to calculate

a)   the dividend yield;

b)   total rate of return;

c)   return from capital gains;

The calculations in question shall reflect the aforementioned points on the condition that the share value increased to $58,50  per share and then it was reduced to $45 per share.

The 2nd scenario of the given case study, the price of the shares was increased to $58,50  while the dividends either fluctuated proportionally or remained the same.

The third scenario of the present situation is the stipulation that the price of the share was reduced to $45 per share while the dividends either fluctuated proportionally or remained the same. However, in order to infer viable and legitimate values, it is important to assume that the dividends accrued by the firm at the end of the accounting year did remain the same.

a)  Calculation of the Dividend Yield

In accordance with the internationally established formula of the dividend yield calculation, this value is deduced the following way:

Dividend yield = annual dividend per share/ stock price

The Rate of Return formula is the following:

Rate of Return = ((Return – Capital)/Capital)) * 100%

Therefore, for the first scenario (the price $50 per share) the dividend yield is the following:

DY = 2,50 / 50 = 0,05.

The Rate of Return is the following

RoR = ((52,5-50)/50) * 100%= 5 %

For the second scenario (the stock price is $ 58,5 per share and the annual dividend per share remains the same) the calculations are the following:

DY%u2082 = 2,50/ 58,5 = 0,042

RoR%u2082 = ((61 -58,5)/58,5) *100% = 4 %

For the 3rd scenario the calculations and the values are the following:

DY%u2083=  2,5/45 = 0,055

RoR%u2083 = ((47,5-45)/45)) *100% = 5,5 %

The Anticipated Reaction of the Shareholders and the Managers of the firm

Having considered the scholarly and the business opinion with regard to the discussed issues, it can be recapitulated that the shareholders and the investors in their majority will react negatively towards the changes in the financial, especially in the stock section of the company.  Although the dividends accrued and paid out to the shareholders do remain the same, the willingness of the existing and the prospective shareholders to purchase new shares and of the potential investors to invest to the development of the company will be reduced accordingly.

Provided that the nominal value of the stock increases (situation 2) the investors are more likely to invest more to the development of the firm, whilst the shareholders can be expected to purchase newly emitted stock. Moreover, the new shareholders will be invited to the firm.

The actions of the managers to increase the dividends of the company

The scheme is twofold.   To be more exact, there are two major schemes of dividends increase. Under the first approach, all revenues accrued by the company are shared among the shareholders, hereby increasing their regular payouts. The long-term policy includes the cutback of the amount of existing payments, with the allocation of the newly-obtained funds to the development of the productive facilities of the company. The period when the facilities are installed and the productive tempos are achieved the dividends will be temporarily reduced, but since the full capacity is achieved the dividend payouts will be bigger than those initially received by the firm.

Part III. The Causations

In this section of the paper, it is necessary to outline the causation between the put option prices and the changes reviewed in the previous section with the accent put on the stock price increase, the extension of the option of the date, the decrease in the volatility of the stock prices and the rise of the interest rate. It is also necessary to analyze the reaction of shareholders to the previously mentioned factors.

A) The Relation With the Stock Price

The relation with the stock price of the shares under the normal business environment usually led to the increase in the dividends collected by the firm. Sometimes, especially, during the general economic downturn, the share prices may increase while the dividends accrued may be at the same level, but this situation is paradoxical rather than normal. This assumption is made on the following model: it is undisputed that the price of the share price increase when the demand on the share prices respectively increases. The demand on the shares increases only in the situations when they perform well, therefore, it is both logical and natural to assume that with the increase in the stock value the dividends accrued by the firm are increased alongside.

B) The Relation With the Extension of the Expiration Date

As far as the causation between the dividends and the extension of the expiration date of the option, it is logical to stipulate that since the deadline thereto is adjourned, generally the amount of the accrued dividends is increased proportionally, as the shareholders become more willing to purchase the shares of the company.

Providing that the volatility of the stock price falls, it is logical that the dividends collected will be diminished, due to the fact that the general market flexibility and adaptability is substantially diminished. If the risk free interest and the exercise price of the shares are reduced, the dividends collected by the firm are very likely to drop in accordance with the postulates of the contemporary international economic theory.

C) The Reaction to the Increase of the Stock Price

Based on all the above mentioned, it is necessary to analyze the reaction of shareholders and investors to the increase of the stock price. Thus, it is obvious that in case of increase of a stock value, the demand for it will also rise. The dividends will grow in proportion to the price, and, on this basis, company will become more attractive both to investors and present stakeholders. On the other hand, there are some apprehensions that the holders of shares will try to sell their part, in order to obtain an additional profit. This situation can occur when the company has its peak value and the price falling is expected. In this case, investors won’t buy the shares, being afraid of its cost lowering. The same consequences can take place in case of increasing of exercise price, because the majority of investors try to purchase the stock at a low price. Although, it must be mentioned that the reaction of investors is also depends on the marketing forecast and the prospect for further development of the company. When the growth of the company is expected, investors will be willing to buy the shares of this entity even at a rather high price.

Providing that the volatility of the stock price falls, it is logical that the dividends collected will be diminished. This may lead to the situation when the market attractiveness of such a firm will considerably be reduced. Moreover, there is an urgent need to emphasize the fact that the current showings of stock price, exercise price, expiration date of the option, volatility of the stock price, and the risk-free interest rate do not always bring to the uniqueness of solution of shareholders and investors concerning its action on the market, because there are a lot of factors that should be carefully analyzed.

D)  The Issues of the Put Option

As far as the economic reaction of the put option to the above stipulated activities of the managerial department are concerned, it shall be highlighted that the put option naturally increases with the increase of the share price and the rise of the dividends accrued and its value is respectively reduced with the decrease of the aforementioned economic parameters of the company.

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