Question

Generally speaking, a company will only pay dividends if it makes a profit, and high-growth companies should give priority to expansion and investment. However, there are many strange phenomena in the capital market. Some companies will borrow money to pay dividends to shareholders. Some high-growth companies that urgently need capital have been paying dividends. Question: Do you think these phenomena are reasonable? What are the possible reasons behind them?

Answer 1

I my opinion these phenomena are not reasonable because dividend payout should be based on residual dividend model where dividends are paid based of the residual or remaining amounts after deducting the amount of retained earnings necessary to finance the firm’s optimum capital budget.

But there are the possible reasons behind the many strange phenomena like borrow money to pay dividends to shareholders or urgently need capital have been paying dividends etc. In such cases companies pay dividends because of signaling content where investors regard dividend changes as signals of management’s earnings forecasts of the firm. Investors assumes that dividend policies have information or signaling content about future earnings of the firm and increase or decrease in dividend payout ratio is based on that. So companies used to pay dividends in that situation because they do not want to give any negative signal to the market or investors.