DIVIDEND POLICY Essay Example | Topics and Well Written Essays - 750 words

DIVIDEND POLICY - Essay Example The management increased both the interim and final dividend throughout the four-year period. In 2007 the company paid an interim dividend of 6.5p which increased to 6.75p in 2008, 6.9p in 2009,7.6p in 2010 and finally 7.9p in 2011. For the case of the final dividend, the amount paid in 2008 was 13.5p, which was increased to 14.1p, 16.2p, 16.85p in 2009,200 and 2011 respectively (Associated British food, 2011). This is attributed to the increasing performance and profitability together with the increase in the performance of the general economy. Since the economy recovered from the recession and the inflation rates reduced, the company realized a reduction in the cost that made it post positive performance. The improving global economic performance also resulted in the increase in the sales turnover and improvement in ABF cash flows (Associated British food, 2011). Since the payments of dividends depends on the availability of cash flows, an increase in the cash inflows would result into an increase in the dividend that can be distributed to the company. Several theories have been developed o elucidate the relevance or irrelevance of dividends decision on the value of a firm (Lease, 2000). Modigliani and Millar dividend irrelevance theory asserts that dividends have no effect on the firms value in a perfect market because dividends are paid out of earnings and therefore whether distributed or not, it does not affect the firms earnings. Dividends have no effect on both equity and cost of equity (Baker, Powell & Veit, 2002). The bird in hand theory was also developed. According to this theory, dividend payments affect the value of a firm since investors are sure about the dividend earnings than the expected capital gains, which they consider as a bird in the bush (Miller & Kevin, 1985). The tax preference theory on the contrary claims that investors will prefer capital gains to the dividend because of the tax advantage associated with the capital gain. Since divi dends attract higher taxes, investors will prefer capital gain. The signaling theory further argues that dividend payment is significant in a firm’s investment decisions because it acts as a signal to the performance of the company. A company with high dividends is said to have better future prospects hence this will attract investors; the theory is based on the assumption that capital markets are imperfect and investors have different levels of knowledge (Benartzi, Roni & Thaler,1997). Before selecting a dividend policy, company managements must take into consideration the likely impact of their dividend decisions. Dividend decisions of a firm are important, as it can be use in influencing the value to the shareholders. In paying dividend, firms will considerer several factors. First, the dividend policy can be determined by the financial requirements of a firm. A firm that has several positive investment projects may decide to increase the proportion that is retained to inv est in the positive projects (Baker, Powell & Veit, 2002). Retention in this case provides the capital required to undertake the positive projects. Secondly, the dividend policy can also be determined by the nature of the company’s earnings. A company that realizes stable income in the financial performance can decide to increase the amount of dividends paid because of stability in the earnings whereas those with fluctuating incomes may reduce the amount of dividend distributed to the shareholders (Clayman, 2012). Moreover, firms’ liquidity also affects its dividend policy. A firm with better cash flows and which is liquid has the ability to make large dividend payments than that is not liquid. This is because dividends are always distributed out of cash and is therefore determined by the