Question

Critically discuss the extent to which you agree with the view that the pattern of dividend can increase the wealth of shareholders. Substantiate your position by providing appropriate theories or concepts, relevant supporting examples and empirical support.

Answer 1

The current share price of a firm depends on what the future dividend from the stock will be. This future dividend can increase or decrease based on the decisions the firm takes today. This is because the firm can decide to reinvest the earnings so that the future dividend payments are worth more than what you get today as dividend payments. This can be seen in most startup investments etc today. For e.g. the stock of Amazon. Amazon has not paid its shareholders any dividend till date but still, its price has increased more than other stocks which are regularly paying dividends. This is because the decision of paying a dividend essentially depends on whether the cash flow going out as dividends can be used to expand the operations of the company so that the firm becomes more valuable than before and provides a higher dividend at a later stage.

There are also instances when the act of declaring a dividend has actually increased the stock price. This is because the investors understand that the managers operating the firm understand that the firm has no better use of the funds they have and hence can be distributed among the shareholders.