Previously, I have discussed about the opportunities for companies to do an investment decision and raising finance decision. Now, I will write about examine the dividend decision in which more or less could influenced by the investment and financing decision. Traditionally, if nothing special for doing the investment, it would be better if increase the dividend and then give it to the shareholders or if it is difficult to get the finance or if it is too expensive, maybe, it would be best if just keep the money to finance the business instead of paying the dividend to the shareholders.
How do the companies pay off the dividends? The UK companies mostly pay the dividend twice a year (interim and final dividend) only from the accumulated distributed profit in order to protect the creditors who were willing to lending money to companies and thus, obviously the companies must have enough cash to pay the dividend to the shareholders. Every company probably need to have the dividend policy before they can pay the dividend (in which dividend policy is the policy that company uses to determine on how much it will pay out to shareholders in dividend) and should intend to maximise the shareholder wealth. And this is also explained in classic study by Porterfield (1965) which he argued that a dividend payment would only do so if the new share price+dividend is equal or higher than previous share price.
Even so, there is an objection from others where according to Modigliani & Millar (1961), the dividend policy is irrelevance to the share price that company is actually valued from future earning potential and not dividends that paid now thus, amount of earnings distributed are not determined the share value but the investment policy does. Additionally, a rational investor is preferred more on dividend rather than the capital gains therefore, the investors are actually indifferent between these two because of the fact that M&M think the investment policy could maximise the company's market value where investing in positive NPV projects in order to increase the positive cash flow might increase the share price thus increase the wealth of shareholders as well.
In other part, Modigliani and Millar also argue that dividends represents a residual payment which investing in all projects that can get a positive NPV and if earnings are left over, they should pay the dividend however, if no surplus after all earnings are invested, no need to pay the dividend while the market value of the company should rise to reflect the future increasing returns. Thus, they believed that dividend decision is merely a financing decision but they did not argue that paying the dividends are irrelevant to company's valuation because the company's valuation is unaffected by the timing of paying the dividend due to the same impact if pay or not paying the dividend however, if dividends are not paid, the shares of the company become not worth at all.
Even so, there are other argument that supported the relevance of dividend before Modigliani & Millar where according to Traditional View; Linter (1956) and Gordon (1959), the investors are more preferable to have the dividends than capital gains because of the uncertainty of future gains in uncertain investments. Thus, as they would prefer on dividends, the market value of the company will influence by the dividend policy for example, if a company pay low dividend to investors, they might swap to other company that pay more dividend to them and this will result on the decrease in share price of the company.
Conceptually, the investors do not have any kind of access to get any internal information of the business so, they see the dividends as the signal to have an idea about the company's performance (high dividends: good performance and low dividends: bad performance). However, the reverse may be true in reality; (where high dividends: lack of attractive investments therefore they get lower future investment returns and low dividend: attractive investments therefore they get better future prospects).
The clientele effect argued that shareholders are not indifferent to dividends versus capital gains due to the need for a regular income to meet their liabilities but however, M&M argue that they could create their own by selling shares but the best if they can consider the control implications, transaction costs, time consuming and tax position. So, investors will be attracted to company's that best suit with their need especially when the company does the best dividend policy. In other problem that might occur in dividend decision is the agency problem which the shareholders may want on high dividend payment to avoid the manager from investing in poor projects but this tend to be burden to managers as their amount of retained profit for them will be lower and they have to raise fund externally and this may be costly thus forces them to justify the spending.
As a conclusion, the dividend decision might have several choices for a company to choose whether to forces promoting a high, low, stable or fluctuating dividend payment where actually in practice, a company may tend to avoid a very low dividend to avoid from lose investor confidence, avoid very high dividend payment to have a backup for long-term future and aim for stable dividends that could give a stable growth. Like the Felda Global Ventures Holding Bhd ( FGV) which this company is situated in Malaysia, its' dividend policy is to pay a high 'good' dividend to their shareholders every year regardless of the presence of uncertain economic condition (Business Times, 2013) as this being their company's pledge which is to distribute at least 50% from its net profit as dividend to the shareholders. This is shows that this company is highly concerned for their shareholders value because they will make sure that all the shareholders will get return on their investments and this might be as the example for other company in order to maintain or create shareholders value while making profitability.
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