Question

How does disbursement policy relate to shareholder value?

Answer 1

Here disbursement policy means the expected dividend pay out(D).

And shareholder value means the intrinsic value of the share (IV).

There is a a very deep relationship between dividend payout and the share value.

The Relationship is established with one of the most famous models called dividend discount model (DDM).

Let the required rate of return of equity holders be Re.

And expected dividend(D), constantly group by g% , the intrinsic value of the share (IV) as DDM is

(Here D is assumed to be paid for Infinite period from 0 period with constant growth rate of g%)

IV = D/(Re-g).

Here g contains the retention and return on equity.

g is given by formula.

g= b*r

g= sustainable growth rate.

b= retention ratio.

r= return on equity.

Until now whatever we have discussed above shows the formula which established a relationship between disbursement policy and shareholders value.

Now let us understand theoretically.

Effect of Cash Dividend on Share Price

When a company pays its investors a dividend, it cannot reinvest those funds in the business. The retained earnings, or value of the company, will decrease by the amount of cash paid out. This is reflected in the stock price. Theoretically, a company that pays a 40-cent dividend will see the intrinsic share price drop by 40 cents.

(The actual share price may increase because people buy it get dividend and sell it afterwards- So in long run it also Decreases- if company pays more than required amount of dividend)

Effect of Share Dividend on Share Price

Share dividends are paid in additional shares rather than cash. If a company gives a 0.25 share dividend, the number of shares outstanding increases, thus decreasing the value of each share.

Thank you. Hope you find it helpful.