Dividend policy –
dividend irrelevance & dividend relevance discussion
Theory introduction
The question for the effect of dividends on share prices has
been a controversial one for many years. There are two contradictory theories surrounding
that dividend irrelevance theory and dividend relevance theory.
Dividend irrelevance theory
This theory is originated with a paper published by Miller
and Modigliani. They argued that share valuation is a function of the level of
corporate earnings, which reflects a company’s investment policy, rather than a
function of the proportion of a company’s earnings paid out as dividends. To get those conclusions, they have set up 4
assumptions.
1.
There are no transactions costs associated with
converting shares into cash by selling them.
2.
Firms can issue shares without incurring
flotation or transactions costs.
3.
There are no taxes at either a corporate or a
personal level.
4.
Capital markets are perfectly efficient.
Dividend relevance theory
Litner and Gordon argued that dividends are preferred to
capital gains due to their certainty.
This often referred to as ‘the bird in the band’ argument and means that
an investor will prefer to receive a certain dividend payment now rather than
leaving the equivalent amount in an investment whose future value is uncertain.
Current dividends, on this analysis, represent a more reliable return than
future capital gains.
Discussion the relative correct of two theories
It is possible to criticise a number of the assumptions made
by Miller and Modigliani as being unrealistic. The reason is to refute those
four assumptions of Miller and Modigliani.
1.
Transaction costs are not zero and so there is a
price to be paid by investors who try to sell their shares to create a ‘home-made’
dividend; this means that capital gains are not a perfect substitute for
dividends in cash flow terms.
2.
Taxation does exist in the real world, at both a
corporate and a personal level, further distorting the required equivalence of
dividends and capital gains.
3.
Securities do incur issue costs.
4.
Information is not necessarily freely available:
investors will have to expend time and money in acquiring it.
Case verification
Theory based: Dividend relevant theory
Assumption: Dividend amount has positive relationship with
the share price.
Methodology:
1.
Choose 5 corporations from London Stock Exchange
FTSE 100 randomly.
2.
Comparing the dividend amount in 2012 and 2013.
3.
Analysing the share price before and after
dividend announcing date.
Finding:
1.
A.B. Food, BT GROUP, HSBC HLDGS. UK, SEVERN
TRENT, WPP have been chosen as data samples.
|
Corporation
|
Dividend 2013
|
Dividend 2012
|
Record date
|
Share price float
|
|
A.B Food
|
22.65p
|
20.0p
|
5 Nov.
|
+1.05%
|
|
BT GROUP
|
8.7
|
7.6
|
23 Dec.
|
+0.97%
|
|
HSBC HLDGS. UK
|
30.47p
|
31.32p
|
24 Dec.
|
+1.12%
|
|
SEVERN TRENT
|
45.51
|
42.06p
|
21 June
|
-3.08%
|
|
WPP
|
30.27p
|
25.94p
|
10 Nov.
|
-
|
(Resource: London
Stock Exchange, n.d.;London Stock Exchange ) (PS: The stock price of WPP on 10th Nov.
2013 does not show on London Stock Exchange)
Conclusion: The assumption is incorrect as share price does
not only effect by dividend policy.
Limitation and futher research: More rigourous assumtion and methodology should be used in futher research.
Reference:
Abf,. (n.d.). ABF plc - Investors -
Shareholder services - Dividend history. Retrieved 1 April 2014, from http://www.abf.co.uk/investorrelations/shareholder_services/dividend_history
Hsbc.com,. (n.d.). HSBC Holdings plc -
Dividend history. Retrieved 1 April 2014, from
http://www.hsbc.com/investor-relations/dividends/dividend-history
Severntrent,.
(n.d.). Dividend payment history : Dividends : Shareholder centre : Investors :
Severn Trent PLC. Retrieved 1 April 2014, from
http://www.severntrent.com/investors/shareholder-centre/dividends/dividend-payment-history
