Distribution policy
What is meant by the term “distribution policy”? How have dividend payouts versus stock repurchases changed over time?
Distribution policy refers to the principles that define the amount of company earnings that should be distributed to the equity shareholders of a company, at the end of each financial year. The policy is also useful in helping the company strike a balance between dividend payout and retained earnings, hence addressing the future financial needs of the company. Over time, the rate of dividend payouts, as well as stock repurchases, have been declining. Taking the case of corporate America, since the end of the Great Recession, over $1.4 https://essaygroom.com/eps-methodology-valuation-approach/trillion has been used by corporations in buying back stocks, but significant benefits have been realized. The process of buying back of stocks have proved to be ineffective, considering the fact that the stocks do not outperform the S&P 500 at any given time, and bring inconveniences to the investors. Most firms have opted not to buy back their stocks, hence reduction in the purchase. In the case of dividend payout, shareholders seemed to have changed their mentality towards high dividend payments and focused more on wealth maximization. Many corporations have opted to reinvest most of their profits instead of paying our dividends. Such strategy has proved to be effective, given that it helps in minimizing tax costs, ensuring that corporations have got adequate funds to finance their operations and activities, as well as preventing ownership dissolution in firms, as no additional shares have to be issued to raise capital for the businesses.
The terms “irrelevance,” “dividend preference, or bird-in-the-hand,” and “tax effect” have been used to describe three major theories regarding the way dividend payouts affect a firm’s value. Explain what these terms mean and briefly describe each theory.
Dividend Irrelevance Theory; the policy holds that investors should not worry themselves with payment of dividends, as whenever they need cash, they can sell a portion of the equities, and raise the required funds. In other words, payment of dividends does not matter to them (it is irrelevant as the name suggests). Under this theory, actions such as declaration and payment of dividends do not have any impact on the prices of the stocks at any given time. Dividends do not add any value to the corporation’s stock prices, and therefore, irrelevant.
A bird in the hand dividend theory: the theory is based on the adage that “a bird in the hand is worth two in the bush.” As a result, investors prefer getting dividends from the stock, instead of the capital gains. The whole idea is based on uncertainty about the future, and therefore, investors are interested in having their share of the company earnings instead of reinvesting. The reinvestment may result in losses (future capital losses), hence disadvantaging the investors. Based on this dividend theory, dividend policies are formulated, requiring the company to pay certain amounts or fixed percentages of their earnings as dividends, at regular intervals. Under this theory, the declaration and payment of the dividends have got an effect on the value of the firm. The value of the firm is said to decline with an increase in dividend payout. Again, any action taken on the dividends have an impact on the stock prices.