Question

Explain the information content, or signaling of dividend policy and list a number of factors that influence dividend policy in practice. What are stock dividends, and how do they differ from cash dividends?

Answer 1

Dividend Signaling is a theory that suggests that a company announcement of an increase in Dividend payouts is an indication of positive future prospects.

The theory is directly tied to game theory, managers with good investment potential are more likely to signal.

This theory indicates that Company announcement of Dividend increases are an indication of positive future result. It suggests that companies that pay the highest dividends are, or should be more profitable those paying smaller dividend.

Factors affecting dividend policy

1. Stability of earning-If earnings are relatively stable , a firm is in better position to predict what it's future earnings will be and such companies are more likely to payout a higher percentage of its earnings in Dividend.

2. Financing policy of the company- If the company decides to meet its expenses from its earnings, then it will have to pay less Dividend to shareholders, on the other hand, if outside borrowing is cheaper than internal financing then Company may decide to pay higher rate of Dividend.

3. Liquidity of funds- Payment of dividend means , a cash outflow and hence, the greater the cash position and liquidity of the firm determined by the firm's investment and financing decision.

4. Dividend policy of competitive concern- If competitor concern is paying higher dividend the shareholder may prefer to invest their money in those concern rather than in this concern.

A stock dividend is a dividend paid to shareholders in the form of additional shares in the company rather than as cash....like stock split stock dividends dilute the share price.

Difference between stock dividend and cash dividend:

- Cash dividend is a payment that is made in cash to the shareholder of the company. It is paid out of business' s earnings based on number of shares owned by shareholder.

Stock dividend is more shares given to investors on top of those they already own.

- Cash dividend is taxable income and Company doesn't have this money to use for growth and operation.

Company' s stock price will be affected, if company declares 10% cash dividend, the shareholder will see their shares drop by a 10% value as well.

Stock dividend is not taxable until it is sold. It doesn't change the value of Company. Only the number of shares increases with the decreases in price of shares owned by shareholder.