Question

c. The dividend debate is inconclusive and still on-going in the corporate world. In your view, briefly

discuss some real world factors that may support the payment of high and low dividends.

Answer 1

Discussions regarding dividend payment by the firm to the shareholders being good or bad have been happening for quite some time now. According to the principles of corporate finance, if the firm is not able to find good projects in which the money which the firm has can be invested, projects which offer a rate of return higher than what an investor can obtain on his own, then the firm should give dividends to the shareholders. There are many reasons for this apart from the return argument. The money, if not paid as dividends, lies idle with the firm and can encourage spending which might not be required. The firm may be tempted to accept projects which offer substandard returns or have higher risks than what the company usually takes.

According to the historical market behavior seen over a long time, we have observed that the dividends should not be decreased. They can be either increased or kept constant. If the dividends are decreased, it has been seen over the years that the investors generally don't take it in the right spirit and shareholders start believing that there is something wrong with the firm. Over the years, whenever any firm has decreased the dividends, generally it was when the company was in trouble and the act of reducing the dividends has caused a dip in the share prices. There are many exceptions though. During the financial crisis of 2008, when J.P. Morgan announced to reduce dividends, their price increased instead of decreasing. It was because investors had sufficient trust in the management and the situation was such that reducing the dividends seemed like the right thing to do.

Payment of high dividends should be done when the firm can't suitable projects and have cash lying idle with them. There are firms that haven't paid any dividend to date but still investors ascribe a premium to the shares. Low dividends should be because of some new potential projects that the firm is researching or when the condition of the market or the industry is bad.