Question

Discuss this: “In practice, companies’ payout decisions should not be made in isolation”. Larger, established companies tend to issue regular dividends as they seek to maximize shareholder wealth. However, new or start-ups and some high-growth companies rarely offer dividends. You can open your discussion by linking between the payout policy and future competition that any company could face

Answer 1

The payout policy of a company can directly be linked to the future competition that a company could face. Payout policy determines a company’s dividend yield. The dividend yield measures how much income has been received relative to the share price. A higher yield is more desirable and more attractive and makes a particular stock seem to be more competitive relative to the industry. On the other hand a lower yield will make the stock seem less competitive.

Now a company’s payout decisions cannot be made in isolation. Along with payout decisions management will also have to consider the company’s investment decisions as well as financing decisions. Payout decisions will have to consider the following –

· Is the dividend decision related to other financial decisions – For instance will paying dividends increase the need for borrowing?

· Impacts and effects of changing dividends – For instance increasing dividend payments will increase the share price.

Larger and established companies will have to be more competitive on a relative basis and hence they issue regular dividends. On the other hand new or start-ups and some high-growth companies rarely offer dividends because for such companies relative competition is not the key focus area. Start up companies and new companies are trying to establish themselves in the market and as these companies are based on new ideas they have the potential to generate large returns in the form of capital appreciation. Same is the case with some high-growth companies who are already on growth trajectory.