Question

Data from recent initial public offerings indicates relatively few of the firms involved pay cash dividends. Explain. Why might this be the case? How does a company decide when to start issuing dividends?

Answer 1

Relatively few of the firms from the recent IPO issues pay cash dividends because of the fact that majority of the recent IPO issues was dominated by faster growing companies in the sunrise sectors like IT (information technology), energy, logistics, pharmaceuticals etc. These companies do not pay dividends to attract investors; rather investors are attracted by their unique business models. It is only conservative investors who look for dividends. However the recent IPOs are attracting investors who are not conservative but are rather willing to take calculated risks to reap higher returns, capital appreciation and gains in the future.

A company decides on when to start paying dividends when it thinks its business model has stabilized. A company that is growing rapidly will not be able to pay dividends as it will use much of its retained earnings for the purpose of capex (capital expenditures). Once a company’s business matures it can consider start paying dividends. This usually happens when the need to invest in capex reduces (comparatively) and the company is able to generate free cash flows.