Dividend Policies

This week’s lecture was about dividend policies and their relevance to the value of the business.

Modigliani and Miller (1961) argue that dividends do not reflect the current market value of a company when certain assumptions are made. The theory was produced in 1961 when corporations were in their infancy. The Guardian define dividend payments as

‘Shareholders count on large, traditional companies such as insurance companies to pay dividends. When these companies cut or stop a dividend, it’s a bad sign’.

This more recent definition of a dividend suggests that this theory is not widely accepted by the corporate world.

This comment lends itself to the bird in the hand explanation of dividends. Shareholders prefer a small but certain advantage.

Figures were released by Capita Registrars on 19^th April 2011 showing that UK companies paid out £15bn in dividends during the first quarter of 2011. These figures show that dividends hold and communicate financial information about the company and the economic environment. Dividends have increased by £1.4bn (10.3%) in the same quarter from the previous year.

A Telegraph article (Dividend payouts see fastest growth since 2008 20/04/2011), also commenting on the dividend payments, are more cautious in their approach to the assumption that shareholders will start experiencing increased payments in the coming months. A special dividend paid by International Power contributed to over a tenth of the £15bn paid out. They also note that although BP had cut its dividend heavily since the Horizon Deepwater incident they were still the seventh biggest payer this quarter.

An article in the Guardian (Investors buoyed by improved dividend payments 19/04/2011) quotes Charles Cryer, (CEO of Capita Registrars) who links the increase in dividend payments directly to company performance and market value. Capita work closely with the UK Government in consultancy roles, if a whisper of recession can start a recession, then is not the opposite true for investors? Capita Registrars are projecting a full year dividend payout forecast of £64.2bn and by publishing this information they (and the Government) are maybe hoping to see a confidence gain in the market causing an increase in investments.

Of the 156 companies to give dividends this quarter 126 of them increased their dividend payments. Figures showing a higher dividend payment may entice new investors or encourage current investors to re invest the dividend for more shares. This information does maximise shareholder wealth as it creates more capital for future investment opportunities.

Rentokil Initial kept their interim dividend at £2.13 per share for 3 payments (2005-2007) they also kept their final dividend steady at £5.25p per share for the same period.  This indicates a more conservative dividend as it doesn’t match their profits which decreased by 17.9% during 2005/06. This example supports M+M’s theory of market value leaving dividends unaffected. Rentokil eventually stopped all dividends in 2008. This year will be their fourth missed dividend payment. While it could be argued that the company are erring on the side of caution (that can msw) it would prevent other potential shareholders from investing and also cause the existing shareholders to sell their shares and invest in a more lucrative company if the motivation is investment income.




This is my last blog and I thought it worth mentioning that yes, I did know that opinion is spelled wrong in the blog name. This was done on purpose.....obviously......HONEST!!!