Download dividend policy, signal information for the capital market

The USV Annals
of Economics and
Public Administration
Volume 15,
Special Issue,
2015
DIVIDEND POLICY, SIGNAL INFORMATION FOR
THE CAPITAL MARKET
LecturerPhDAngelaNicoletaCOZORICI
'StefancelMare'UniversityofSuceava,Romania
[email protected]
Abstract:
Accumulated profits represent one of the most important sources of financing for companies and dividends
represent cash flows due to holders of shares. The decision on the distribution of dividends to the shareholders,
although it seems very simple at first sight, affect both the investment decision, as well as the financing policy of the
firm because it is a question of choose between dividend distribution and reinvesting a big part of profits, by the
company in question.
The dividend policy of firms is influenced by rules, customs, beliefs, public opinion, general economic conditions and
other factors who are in permanent change with a different impact on the companies. In these circumstances, it can not
be mathematically and uniform modeled for all companies and for all the moments. Thus, the policy adopted by a
company must be in accordance with the degree of shareholders satisfaction and with firm objectives.
Key words: benefit; dividend policy; profitability; reinvestment; shares.
JEL classification: G11, G32, G35
I.
INTRODUCTION
Finances are the subject of a policy of business drivers, which is the expression of behavior,
of an election, a tactical or strategic decision to help, in the best measure, the objective to maximize
the value. According to Stancu (1997), financial policy of the company represents a ”set of
decisions, fundamental options for the most efficient allocation of capital”. In relation with the
special notes on financial activity of the enterprise we can identify three financial policies, which
shall be regarded, at the beginning, as independend, which is an integral part of the economic policy
of the business.
Figure no. 1 - Financial policies at enterprise level
Investment policy, as part of the company's financial policy, address the issue of capital
allocation for physical or financial assets, and between these, the central place returns fixed assets
acquired as a result of the capital investments.
The funding policy is considering decisions on capital formation, including financial funds
of the enterprise. It directly targeting options on using different formation sources of capital and
financial structure of the company.
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Dividend policy is synthetic materialized through enterprise options between partial or full
reinvestment of net profit, including establishment of other funds or reserves at its disposal and/or
distribution of this profit as dividends to shareholders.
Financial policy cannot be determined once, it grows, changes, is improving and
continuously adapts to the requirements and problems that arise, considering both financial
instruments as well as the aims pursued.
II.
EPISTEMOLOGICAL FRAMEWORK OF DIVIDEND POLICY
The profit distribution policy refers to the decision of the general meeting of shareholders to
distribute dividends resulting at the end of the financial year and/or to reinvest in the company's
development.
If we consider an economic environment characterized by a relative simplicity, the dividend policy
defines the distribution of net profit by destination (for dividends or reinvestment), but with the
development of the economic environment, there were new options so that financial management
must respond to new questions about the decision to distribute cash dividends or buying back
shares, ordinary or special dividend distribution, which is more important: increases in market price
or paid as dividends or how to harmonize views belonging to different classes of investors.
Distribution of dividends complete the image of a profitable company, and constant distribution of
dividends lead to the increase public confidence towards the company, to an increase of market
value of the firm.
Reinvestment of net profits lead to increased self-financing capacity and improve the financial
structure of capital company.
In these circumstances, the company will have a higher financial potential to support their own
development (self-financing and capacity to appeal to new loans), all these factors constituting the
increase of the company.
The alternative to reinvest all or part of the net profit in financing investment projects of the
company is part of the funding policy and for this reason we can say that dividend policy is part of
the funding policy.
Numerous studies on dividend policy requires an epistemological analysis of it. Thus, in the
scientific literature were outlined two models on this concept: one that is based on a set of limiting
assumptions providing a standard in the distribution of dividends and one which emphasizes the
need for distribution of dividends because this is the actual reward
of shareholders. The first type of models belongs to the authors as Miller, Modigliani,
Walter and Bhattacharya, and for the second category we remember on Graham and Dodd.
In the paper Dividend policy, growth, and the valuation of shares, Miller and Modigliani
(1961) proves that in the perfect market conditions, a rational investor will be indifferent between
receiving dividends and reinvesting profits. On the other hand, Brennan (1970) takes into account
the tax differential between reinvested profits and dividends and proposes that the last ones should
not be ever distributed.
Modern theories focuses on informational content of dividends (Bhattacharya, 1979), as
well as on their importance in monitoring the activity of managers by shareholders (Rozeff, 1982;
Easterbrook, 1984).
Dividend policy has a significant influence on the risk of the bankruptcy of a company
because there is a decrease of availabilities which may cover loans when they should be
reimbursed.
Kalay (1982) believes that a decision which is based on the dividend decrease may be a
premise to keep under control a possible decision to increase the indebtedness of the company.
Thus, those companies that have high level of loans will be characterized by a low rate of dividend.
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III.
Volume 15, Special Issue, 2015
DETERMINANTS OF DIVIDEND POLICY
The dividend policy of firms constitute a cultural phenomenon, influenced by a variety of
factors in a permanent change, with a different impact on firms. In these circumstances, it cannot be
mathematically and uniform modeled to all firms and for all the moments.
Figure no. 2 - Determinants of dividend policy
Some theories are trying to identify exactly determinants of dividend policy actually applied
on the firms. In this category includes models developed by Lintner (1956) and by the researchers
who developed its theory. They do not attempt to provide the answer to the question "How should it
happen?", but also tries to offer an answer to the question” why it happens as it actually happens?”.
These theories propose to explain these phenomena not only in mathematical considerations, but
also psychological. Some of the arguments which may be taken into account by such a vision are
given by issues of convenience (investors collect dividends without any effort on their part), by
control of the company (power to vote at general meetings of shareholders) or simply by fashion or
mood (Shiller, 1989).
IV.
THEORIES ON DIVIDEND POLICY
In the specialized literature there are a diversity of opinions on the reason why companies
distribute a part of their earnings as dividends. These explanations, which are based on assumptions
more or less restrictive, are trying to create some standard models underlying the dividend policy
and to solve the inherent paradox linked to shareholders remuneration.
In this sense, Graham and Dodd (1951) developed the first theory addressing the
shareholders perception on the distribution of dividends according to which shareholders do not
want higher receipts in the future but effective receipts at present. Thus, they claim the need for
dividends and obtaining receipts at present in the detriment of reinvest the profits which will bring
higher receipts in the future.
Classical theories of dividend policy failed to provide an final and unquestionable
explanation of it, reminding among them neutrality theory of the dividend policy on the company,
necessity theory of dividend distribution and necessity theory of profit reinvestment.
Miller and Modigliani (1961) argues, as we mentioned a little earlier, that dividend policy
would be irrelevant, while Walter (1956) recommends first to achieve attractive investment and the
rest of the profit shall be distributed to shareholders as dividends. In this regard shall be fixed part
of the profit required for investment, and the difference should be distributed as dividend, this
showing us a different approach to dividend, namely residual variable.
Gordon and Shapiro (1956) argue that to maintain the attractiveness of the shares of a
company is required a policy based on constant growth rate of dividends. According to the authors,
share value is given by the relation:
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The USV Annals of Economics and Public Administration
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Where:
Po = value of shares
D1 = amount of dividends received
Kc = required rate of return
g = dividend growth rate
The main disadvantage of this model refers to the fact that the dividend represents the only
indicator that determines the share value, and the evaluation of a company can be wrong determined
if it is not correctly approximated. In the paper Dividend Policy, the author Victor Dragotă argues
that from a historic point of view, the first theories on dividends arise in connection with the most
obvious pragmatic role of their distribution to shareholders. Thus, we must not forget that, through
dividend, shareholders may recover the capital invested most easily once with the share acquiring.
The need for dividends distribution is explained by three theories, namely:
Figure no. 3 - Theories on dividends distribution necessity
Signal theory is addressed to large companies and argues that through dividend can
anticipate more correctly the company perspectives, therefore it has exclusively an informational
role. A company has the ability to distribute dividends to a certain level only if it has sufficient
financial resources and managers estimates the persistence of these resources in the future. Thus,
large companies should distribute larger amounts as dividends towards smaller companies, to
communicate better performance in the future. Otherwise, the public will have a feeling of
insecurity externalized by reducing demand for the company's shares and, therefore, by decreasing
the stock market course.
The agent theory claims that dividend role is to monitor the activities of managers or
shareholders. Since they have the power of decision as regards financial resources, they will be able
to orient them not only in the sense of maximizing the market value of the company, but also for the
purpose of personal interests. The decision to distribute dividends makes such managers to give up
of a part of these projects less attractive to the firm, what is constituted as a means of monitoring.
Behavioural theory. Various researchers revealed that market investors may manifest
differently at certain times towards the rational behavior defined by financial theory dictates.
Dividend is acting in this respect as a mean of monitoring the consumption.
If investors would be indifferent toward the two possible ways of remuneration (an increase
in stock market course or dividends), they will find that perfectly substitutable receipts from
dividends and those from the sale of shares. Thus, they may be tempted at certain times to consume
more, by selling shares on the market.
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The USV Annals of Economics and Public Administration
In this sense, the dividend acts as a mean of self control for shareholders, limiting their
consumption at the level of amounts received as dividends.
V.
THE DIVIDEND POLICY OF FINANCIAL INVESTMENT COMPANIES
The five investment companies were established in 1992 under Law no. 58/1991, as Private
Ownership Funds (FPP). At the time of creation, each company has received in the portfolio 6%
(30% in total) of the shares of all companies in Romania, including that of commercial banks. The
difference of 70% was passed in the administration of the State Property Fund - FPS. In 1996, the
five FPPs were transformed into Financial Investment Companies (SIF), according to Law
133/1996.
The initial share capital of each company has been set up as a result of subscriptions carried
out by Romanian citizens entitled (all citizens who, at that time, they had reached the age of 18) of
ownership certificates and privatization coupons.
Following this process, called ”The Great Privatization”, millions of Romanians, so-called
”cuponari” - have became shareholders at five SIFs, by subscribing famous carnets with ownership
certificates. At establishment, all 5 SIFs were forced by law, as if the shareholders do not raise
dividends, they will automatically receive a number of shares corresponding with the value of
dividends. The situation of dividends offered by the five financial investment companies (SIF)
during the period 2005-2013 is shown in the following table:
Table no. 1. Dividends granted by the 5 SIFs during the period 2005-2013
The
company
(symbol)
SIF Banat
Crisana
SIF1
SIF
Moldova
SIF2
SIF
Transilvania
SIF3
SIF
Muntenia
SIF4
SIF
Oltenia
SIF5
2005
0.0500
0,0670
0,0500
0,0600
0.0600
2006
0.0600
0,0630
-
0,0700
0.0700
2007
0.0700
0,0500
0,0375
0,0700
0.0780
2008
0.0300
0,0450
0,0300
0,0400
0.0600
2009
0.0500
0,0600
0,0300
0,0400
0.1600
2010
0.1030
0,0900
0,0300
0,0810
0.0750
2011
0.1000
0,2200
0,1712
0,0810
0.1300
2012
-
0,2400
0,1750
0,1340
0.1300
2013
-
0,0660
-
-
0.1600
Dividend
Source: carried out by the author according to data taken from the http://www.bvb.ro/ and http://www.tradeville.eu/
The first financial investment company that has adopted a ”zero” dividend policy was SIF1
in 2012. Thus, after a long time in which all five SIFs have granted dividends (except SIF 3 which
in 2006 has not granted dividends), in 2013, for the first time since their founding in 1996, three of
the five Financial Investment Companies have not paid dividends to shareholders, namely SIF1,
SIF3 and SIF4. The decision not to grant dividends taken by the 3 SIFs at general meetings of
shareholders held in April 2014 led to a decline in the price of shares on the stock exchange.
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Figure no. 4 – Shares evolution of 5 Financial Investment Companies
Thus, if we look succinctly at the evolution of share price of the 5 SIFs at Bucharest Stock
Exchange during the period in question we can notice that from March to April 2014 when they
knew already the proposals concerning not granting dividends, the share price traded at the BSE has
been in free fall, to all 5 SIFs, as shown in figure above.
Strategic intent of SIFs management for future business development has to intensify
investment effort based on a optimal ratio between investment policy and dividend policy, aiming
the shareholders satisfaction and ensuring future higher yields of company's, increasing
attractiveness and liquidity of the shares.
VI.
CONCLUSIONS
Enouncement of rational arguments in terms of business practices on dividend policy raised
over time many questions and caused a permanent concern in this respect.
Financial theory considers the dividend policy as an interesting field of study due to
problematic incitements which they provide to scientific research. In conditions of an economic
environment characterized by a relative simplicity, by this term was defined the distribution by
destination of net profit, for dividends or reinvestment.
Together with the development of the economic environment, appears financial
management which aims to answer at new questions about the decision mode; what type of
dividends should be distributed; whether to count more on exchange rate increases than on
dividends payments or how to harmonize different viewpoints of investors.
It can be concluded by the fact that the dividend policy of a company can target the
following purposes:
- retention of shareholders who does not intend to sell shares and which contribute to
strengthening and stability of the company;
- increasing confidence of third parties to the company and its creditworthiness;
- economic and social development of the firm through reinvestment of profit or a part of
it.
The evolution of studies on dividend policy has led to a better coordination of the financial
part of companies, this referring to a good correlation of dividends distribution according on what is
more important for the society.
Thus, to reach a top spot market the company has to make loyal shareholders and to keep
them in order to meet difficulties in the way to the podium.
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Dividend policy practiced by SIF aims at keeping a balance between shareholders
remuneration by dividend and the need to finance investments from reinvested profits.
VII.
ACKNOWLEDGMENT
This paper has been financially supported within the project entitled "Horizon 2020 - The doctor
and Postdoctoral Studies: Promoting the national interest through Excellence, Competitiveness
and Responsibility in the field of Romanian fundamental and Applied Scientific
Research, contract number POSDRU/ 159/ 1.5/S/140106. This project is co-financed by European
Social Fund through sectoral Operational Program for Human Resources Development 20072013. Investing in people!
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