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In every financial year of any given corporation either profits or losses are incurred. When profits are made the company, according to prevalence, can decide to re-invest back into the business for various expansions or new ventures or can decide to pay back to the investing shareholders which is in terms of dividends (Ross 2008).
Dividends are in most cases allocated to the shareholders directly proportionally to the quantity of shares they hold while others are paid in relation to the activeness of the individual members. This is classified as pre-tax expense.
Clientele effect which can be loosely referred to as investors’ effect holds that policies of companies are indeed responsible in attracting investors. Investors share holding is dictated by the policies; once there is a change in policies then adjustment in share holding takes place (Bhalla 2010).
Dividend policy refers to the strategies and policies a company adopts in deciding the amount to be paid out to the shareholders, this is in terms of dividends. Dividend policies, which in turn determine clientele effect, are affected by numerous factors. Some of the factors include earnings stability; when formulating dividend policy the nature of business must be taken into account (Stern 2003).
Companies with stable earnings have more consistent dividend policy than those with varied flow of income since they can project the future savings and earnings easily. Corporation age is also very crucial in development of dividend policies. Consistent and clearly defined dividend policies are mainly found in well established companies as opposed to new companies that might use its income for expansion and upgrading of the system.
Other factors necessary in dividend policy formulation are: financial security, this refers to the situation the company is in financially and ownership type. A company with less share holders gets assent more easily from share holders than a company whose shares are distributed to many shareholders who in most cases insist on high dividend payment (Baker 2009).
Kapil Sheeba states that dividend decisions are mainly the mandate of the board of directors in any given firm. The author also argues that when it comes to clientele effect, there are different types of investors. Since their preferences vary, they look for different firms that suit their dividend requirement. Some prefer capital gain that is high, others high current payments in dividends while there are others who look for both (Kapil 2011).
Damodoran Aswath explains that a clientele effect has important roles and consequences. Due to the effect, companies are able to acquire the desired investors; this is so as the dividend policy of a given company attracts investors who like and personally approves the policy.
Another importance of clientele effect is that it makes hard for companies to alter or change established policy as this will affect the investors. When it comes to valuation, clientele effect provides another argument for policy dividend irrelevancy. The argument projected takes the assumption that there are enough investors in each dividend clientele to allow justified and fair valuation (Damodaran 2010).
Bierman Harold highlights the various reasons for dividend to be given. He states that firms give dividends when cash generated internally exceeds more than can be reinvested profitably.
Dividends are also given to provide stable income to the investors. Unnecessarily retained earnings could result in penalty from the Internal Revenue Service prompting firms to give out dividends. Records of dividend payment are a requirement by legal authority, while at the same time dividend payment gives crucial information to the investors (Bierman 2010).
Analysis and Discussion
The analysis of the clientele effect of dividend policy is usually an important agenda for any firm’s financial manager, its association to market imperfections and taxes existence. The topical agenda for this study is to analyze the clientele effect of dividend policy and its relevance to shareholder’s tax situation. The situation is demonstrated by how the different fiscal treatment of dividends make the various investors prefer stocks of higher or smaller dividend yields or capital gains (Stoltz 2007).
Though some experts admit to the clientele effects associated to the dividend distributions, they usually state that the market is broad and diverse to facilitate enough investors in each dividend clientele.
The proponents of this theory argue that it does not matter how the dividend determinant policies are arrived at as each policy attract a certain category of investors who are assured by the diversification of dividend clientele. However, this can be contended in that every company has a certain group of investors in mind, of which they can only secure by appropriate dividend policies.
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Clientele effect has a major impact on dividend policy whether directly or indirectly. However, high or low dividend value does not tamper with nor alter the stock value of any given organization (Jain 2005). Clientele effect has a major advantage in that an investor has the ability to choose to invest in a high value dividend policy or a low dividend policy depending on the tax inceptives offered. Clientele effect also limit many companies from making changes to their dividend policies for fear of provoking investors thus creating consistency.
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Bhalla, V. K. 2010. Financial Management and Policy. Delhi, Anmol publishers
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Damodaran, A. 2010. Applied Corporate Finance. Sussex, John Wiley and Sons
Jain, K., & Khan, Y. 2005. Basic financial management. USA, Tata McGraw.
Kapil, S. 2011. Financial Management. India, Dorling Kindersley.
Ross, Westerfield, R, & Jaffe, J. 2008. Corporate Finance 8th ed. Boston, McGraw-Hill/Irwin.
Stern, M., & Chew, H. 2003. The Revolution in Corporate Finance. USA, Wiley-Blackwell
Stoltz, A. 2007. Financial Management. South Africa, Pearson