Dividend Policy and Stock Prices
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Dividends are the proportion of a company’s profits that is distributed among the shareholders. Dividend policy is a term referring to the decision as to which magnitude of the proportion of the earnings is to be paid out to the shareholders of a company. It is an integral part of the operations of a firm, portraying its economic stability and has important implications on its share prices.
Purpose of a Dividend Policy
The dividend policy of a company can serve as the basis for financing and investment besides creating an admirable corporate image and influencing the share prices of the company. A firm may decide to alter its dividend payout ratio in order to retain profits to raise extra capital to finance expansion. The corporate image comes in due the fact that a high dividend ratio signals investors, creating confidence on the financial status of the company. It is directed towards pulling investors to a company- the so called “clientele effect”, and has effect on the market value of the company’s stock.
Factors influencing the direction of a Dividend Policy
One of either two directions can be taken with regard to a company dividend policy; a high or a low payout to the shareholders. This is influenced by several factors but the main ones are: the need for additional capital, government policies/legal requirements and the policy of control. Additional capital may be required to meet increasing working capital requirements or for expansion purposes. A company lacking many alternatives of funding will need to declare low rates of dividends and retain big portion of the profits.
The government of the day determines the economic policies existing in terms of fiscal, labor and control policies. The taxation policy pursued by the government also affects the earning capacity of a given company. This in turn has a direct effect on the profits accrued by the company and as such the dividend payout to the shareholders.
Another important factor affecting the direction of dividend policy in a company is its policy of control. In case the directors of the company desire to keep control of the company to themselves, they will have low rates of dividend payout to discourage new shareholders. When the issue of control and power in a company are not of importance the company may pursue high dividend rates.
Effect of the Dividend Policy on Stock Prices
A company reputed to have a history of a high dividend payout rate attracts more potential investors interested in buying the company’s stocks rather than selling in comparison to one with a low dividend rate. In accordance with the laws of demand and supply, the share prices tend to rise with time.
Recommendations
Axetem International, Inc. is hoping to develop a dividend policy that will attract potential investors in order to raise capital to finance major expansion. In essence, we are trying to develop a strong “clientele effect”. This is achievable through influencing the investors to hold onto stocks by making a dividend policy that suits their needs. Their confidence needs to be built so that they prefer the certainty of these dividends over prospective capital gains. A considerably high dividend rate is therefore recommended so as to attract potential investors, and most importantly, the company needs to assure them that this dividend policy is stable enough to last into the future.
Conclusion
The dividend policy of a company is its decision regarding the percentage of net profits to be distributed to its shareholders. Its main purpose is to signal potential investors in the process developing clientele effect, besides serving as a means to raise capital for the company. Several factors are considered when determining the payout ratio, with the most important ones being the need for capital, government policy and the company’s control policy. The dividend policy pursued by a company has an important bearing on its stock values, with a high payout increasing the stock value and a low payout having the opposite effect. Since Axetem International, Inc. seeks to expand, the best approach to dividend policy will be a considerably high payout coupled with assurance that this is sustainable into the future with the aim of attracting clientele effect.
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