Understanding Dividend Policies: Factors, Models, and Strategies

DIVIDEND POLICY

Factors Influencing Dividend Decisions

Rate of Asset Expansion

Companies planning significant expansion may retain earnings to finance growth, avoiding the cost and time involved in raising new capital.

Profit Rate

A company's profitability directly impacts its ability to pay dividends. Higher profits lead to more available cash for distribution to shareholders.

Earnings Stability

Companies with stable earnings are more likely to consistently pay dividends compared to those with volatile earnings.

Access to Capital Markets

Easy access to capital markets allows companies to raise funds for expansion without retaining earnings, providing flexibility in dividend policy.

Control and Ownership

Management may retain earnings to maintain control by avoiding the dilution of ownership that comes with issuing new shares.

Gordon Dividend Policy

The Gordon dividend policy model values shares based on expected future dividends, assuming a constant dividend per share and a constant growth rate. The share value is calculated as the present value of all future dividends using the formula:

P = D / (r - g)

Limitations of the Gordon Model

• Assumes a constant dividend growth rate, which may not be realistic.
• Does not consider company-specific risks.
• Does not account for potential changes in dividend policy.

Walter Dividend Policy

The Walter dividend policy model determines the optimal dividend payout ratio for a company, considering various investment opportunities and their returns. The model aims to maximize company value using the formula:

D/E = r/k

The Walter model is more complex than the Gordon model, incorporating a wider range of factors but requiring more sophisticated application.