Evaluation of Firm's Dividend Policies

FACULTY OF BUSINESS AND MANAGEMENT

JANUARY 2011 SEMESTER

ASSIGNMENT TITLE: ANALYSIS AND EVALUATION ON FIRMS' DIVDEND POLICY ACROSS SECTORS

BBPW3203

FINANCIAL MANAGEMENT II

NAME : CHUO AI FEI

MATRICULATION NO : 870714605028002

IDENTITY CARD NO. : 870714605028

TELEPHONE NO. : 016 858 3381/016 968 5781

E-MAIL : chuoaifei@oum.edu.my

LEARNING CENTRE : MIRI

1.0 INTRODUCTION 2

1.1 Overview of Dividend Policy Issues 2

2.0 EFFECT OF DIVIDEND POLICY TOWARDS FIRM'S VALUE 3

2.1 The Argument for Dividend Irrelevant Theory 3

2.1.1 The Signaling Dividend Theory 3

2.1.2 The Clientele Dividend Theory 4

2.1.3 The Residual Theory of Dividends 4

2.2 The Argument against Dividend Irrelevant Theory 5

2.2.1 Bird-in-the-Hand Theory 5

3.0 ANALYSIS OF FIRMS' DIVIDEN POLICY 6

3.1 Computation of Relevant Financial Ratio for Dividend Payment 6

3.1.1 Plantation Sector 7

3.1.2 Property Development Sector 8

3.1.3 Service Sector 9

4.0 COMPARISON OF FIRM'S DIVIDEND POLICIES BY DIFFERENT SECTOR 10

4.1 Detailed Evaluation of Dividend Policies among Sectors 10

4.1.1 Plantation Sector, Property Development Sector and Service Sector 10

4.2 Factor Influencing Dividend Policy in Practice 11

4.2.1 Liquidity 11

4.2.2 Industry Life Cycle 11

5.0 CONCLUSION 12

6.0 APPENDIX 13

1.0 INTRODUCTION

1.1 Overview of Dividend Policy Issues

Dividend can be defined as the cash payments that corporation make to their common stockholder. In another word, it is the distribution of a firm's income to its shareholders. A dividend policy is a company's approach to distributing profits back to its shareholders. Meanwhile, a dividend policy helps to determine the consequences of changes of firm's value, holding capital budgeting and borrowing constant. It is also said to be a trade-off between retained earnings and distributing cash to its shareholder.

Dividend policy plays a significant role in determining stock value as well as its implication towards firm's value and investment and borrowing decisions. It is essential for a firm to have a well-planned policy because if the shareholders do not get what they expect, they often show their displeasure by selling their stock. However, it is also important for a growth firm to have certain level of retained earnings for the need of future development or investment opportunity. Generally, factors that are affecting dividend policy include the need for funds by the firm, its future financial prospects, the shareholder's preferences and firm's contractual obligation. A good dividend policy is therefore the one that suit the shareholder's need and the firm's own financing needs.

Besides, a firm may decide not to give cash dividend to its shareholder due to tight cash flow. Also, there are different groups of shareholders that favour different dividend payout policy. For example, the group of shareholder with higher margin tax rates favour capital gain instead of cash dividend, whereas the group of retiree always opted for cash dividend. Meanwhile, there exists several alternatives to cash dividend payments, such include stock dividends and stock splits and dividend reinvestment plan.

Furthermore, some researchers believe that dividends increase shareholder wealth (Gordon, 1959), others believe that dividends are irrelevant (Miller and Scholes, 1978). Thus, the firm's dividend policy will have significant implications on the firm's value.

2.0 EFFECT OF DIVIDEND POLICY TOWARDS FIRM'S VALUE

As mentioned in the previous section, there are different kinds of dividend policy as adopted by the firms nowadays. Therefore, it is essential to know the factors or the theories that are affecting their decision in determining the types of dividend policy. The next section of the report would basically cover the leading dividend theories, namely the Argument for Dividend Irrelevant Theory and Argument against Dividend Irrelevant Theory.

2.1 The Argument for Dividend Irrelevant Theory

This argument suggests that the dividend policy does not affect the firm's value or in other words the stock prices. If dividend policy has no significant impact on the firm's value, what would affect the firm's value? According to Merton Miller and Franco Modigliani (M&M), the firm value is determined by its basic earning power and its business risk and therefore investment policy of the firm is the real "matter" of the firm value instead of dividend policy.

2.1.1 The Signaling Dividend Theory

Again, it is argued by M&M that a firm's value is not going to increase with the increased dividends rather it is the dividends signal that increased the firm's future cash flow. Based on this theory, if the company declare dividend larger than the expected by the market, this will be interpreted as a signal that the firm's future financial prospect are brighter than expected. Therefore, when this signal sent out to the market, investor would feel more confident and buy more stock, which resulted in jump of stock price.

For example, a research conducted on the Dividend Policy of the Banking Industry in Greece (2007)