Relevance of the Decision to Pay Dividends - Coursework Example

Is the decision to pay dividends relevant for such a firm under these circumstances The signaling theories of dividend argue that dividends act as forecast signaling tool since managers own asymmetric information with regards to company’s future financial performance. As a result, the association between the change in dividend and the firm’s future financial performance is a vital theoretical issue. The change in dividend is considered a signal to the current and expected future company’s prospect (Chen, 2008). Miller and Modigliani (1961) provided an argument of the what influence firm dividend policy, inclusive of the signaling property of dividend. Miller and Modigliani argued that investors depict the justification for the interpretation of the change in dividend as a sign of the change in management perception with regards to firm’s future prospect. Dividend signaling model implies that the growth in dividend convey a managerial hopefulness with regards to firms’ future performance whilst a decline in dividend would suggest that managers are anticipating the poor performance of the business in the future. The research by Leftwich and Zmijewski (1994), pointed out that dividend signaling means a stern long-term worsening in firm’s future performance because of the decline in dividend payment. The dividend signaling model tries to capture information passed by an increase as well as a decrease in dividend within the similar model that fail to distinguish the exclusive situation that surrounds the change in dividend payments. An increase in dividend would imply that the firm is improving (Jensen, 2009). In pecking order model, companies will consider using the internally generated finance to get rid of under-investment linked with risky debt as well as asymmetry in the information involving the manager and the security market. If the company does have enough internally created finance to fund its business operations, they will issue debt to fund their financial deficit. Only to a rare situation, the company will fund their finance deficit with external equity capital. The company that shifts to pecking order model in funding their operation will seek to get rid of raising external capital by capitalizing on the amount of internally created finance existing to fund their operations (Shapiro, 2008). One apparent approach to pecking order model in funding their operation this might account for the decline in the propensity of the company paying the dividend as depicted in the Fama and French. A theoretically testable effect of the pecking order model is that if the company is reducing their dividend payment as per the theory then the company must as cut the amount of debt funding they are using to find its business operation A recent research depicts that many of the firms that pay dividend had reduced immensely for the last decades. Fama and French identified that almost 50% of the reduction in the portion of companies paying dividend might be as result of a big number of small, unsuccessful firms that have gone public in recent years. They as well conclude that the other 50% of the decline in companies paying the dividend was an s result of the decline in the propensity of viable companies paying the dividend. The biggest problem is that what are the main factors that lead to a decline in the propensity of companies to paying the dividend. One likely justification is that big companies commenced on funding their business operation as per the pecking order model. Payout policy is relevant because this policy can be used by managers as a signaling device to convey their intentions and expectations to markets. Concerning the insider holding, John and Lang (1991) pointed out that dividend might be important if combined with other market signals like the level of insider trading that leads to much signal cash flow signaling theorem. Under this hypothesis (signaling theorem), dividend initiation does not normally signal good news, because another signal might change the information content of the dividend announcement. In reality, John and Lang (1991 provide proof that announcement of the dividend is deemed as either good news or bad news based on the size and signal of insider dealing. According to cash flow signaling theorem of dividend, managers depict more information, unlike the outsiders. If the private information comprises of goods news, they have the incentive to signify it to the investors explicitly. Hence, for a company with superior venture opportunity, managers might signify this by growing dividend payout as well as an investor might react optimistically to increase in dividend even though it means a growth in capital. In reality, theory forests a same stock price response to any management verdict. The key weakness of this theorem is that it is not in line with observed non-uniformity of stock price response to a certain change in the dividend. Dividend announcement might entail information with regards to prospect performance of the firm, they might be important in many signaling tools to convey information to the market. The theory is that the dividend is one of the tools employed for signaling information. Notably, this theory impacts the area of funding structures of the business, the flow of finance, the liquidity, as well as investor’s contentment. Not just do managers depict an extra concern in the r payout verdict, pore specifically changes and to division omission (Chen, 2008). A dividend verdict might have information signaling impact that company will deem in the formulation of its policies. This term is derived from the economics in which signaling is the notion that an agent passes the information concerning itself to another party via an action. An information asymmetry exists where the company’s manager understand more about the company and its prospect, unlike the investor. A firms’ dividend verdict might signal what management consider being the prospect of the company and the price of its stocks. A model created by miller rock in the year 1985 recommends that announcement of the dividend will convey information to stakeholders with regards to company’s future business operations (Brav, 2004). Many research depicts that the price of stocks depict the tendency of growing when an increase in dividend is announced and depict the tendency of declining when there is a decline or omission. Miller and Rock explained that this is probably due to the information content of dividend. When an investor has partial information with regards to the company, they will look for other information in action like the company’s dividend policy. For example, when managers lack trust in the company’s capacity to create more cash flows in the prospect they will ensure that the dividend is fixed or even reduce the dividend paid to shareholders (Brio, 2009). On the contrary, executives with the right of entry to information that points a good signal of company future business operations are susceptible to growth in the dividend. An investor might use the skills with regards to manager’s attitude to inform their verdict to purchase or dispose of the stock, bid the price up because of growth in the dividend, or dispose of it when the dividend does not meet the target. this, as a result, might impact the dividend verdicts managers understand stakeholders closely supervision tend to get rid of sending a negative signal to the market with regards to prospect business operations of the company, this depicts the tendency of leading to the dividend policy of steady, steadily growing payment. Modigliani and Miller (1961) explain that dividend might depict a signaling effect. The managers of the company depict information with regards to the business plan of the company and might as well predict the prospect earning of the firm. As a result, workers if the company have more information as other investors and the market in entirety. Hence, this leads to the problem of anticipated profits for the firm (Karim, 2004). Nevertheless, even though managers use the dividend to convey information, dividend change might not be the correct signal. As per the Easterbrook (1994), dividend growth might be vague signal unless the market might differentiate between the improving company and disinvesting companies. Dividend signal theory or the information content assumption depicts much testable effect. First, if the dividend verdict is a function of the manager. Own information concerning the current as well as prospect earning, dividend growth or decline must be linked to subsequent growth or decline in earning realization. Secondly, if investors recognize the Earning latest depicted in dividend announcement, the change in dividend must be acknowledged by the change in price in the similar direction. The investor must update their anticipation concerning prospect earning subsequent to dividend change announcement. The influential dividend irrelevance of Modigliani and, Miler (1961) assume that managers and external stakeholders depict similar information with regards to venture policy and the worth of the future cash flows (Mueller, 2013). Nevertheless, dissimilarities in information involving the insider’s as well as stakeholders are probably to be common in the financial market. Miller and Modigliani explained that change in dividend level would be interpreted by investors as depicting a change in manager’s perception of the firm’s prospect growth. They recommend that this is a means to merging the practical price reaction to change in dividend with their irrelevance proposition. As explained by Modigliani and miller (1961), the content of information might rise mainly via the source and use of cash. If the company venture policies are understood or anecdotal by investors, then the dividend, net of capital raised, permits investors to back out the earning. Many types of research have been undertaken to analyze the nation, that dividend might entail some information concerning the prospect performance of the business. Under the hypothesis that managers depict insider information concerning the firm’s prospect performance, they might sue many signaling tools to convey information to the market. The theorem is that dividend is employed for signaling information (Jones, 1991). As a result, the biggest question is if the managers employ the dividend, as a device to convey information to the market. As much as many research have been undertaken, examiners Still find the different outcome, which is as well the reason for the interest to undertake an assessment of whether managers uses dividend signaling to convey information to the market.   References Brav, A. (2004). Payout policy in the 21st century. London: Pearson Education. Brigham, E. (2016). Financial Management: Theory & Practice - Page 576. New York: Cengage Learning . Brio, E. D. (2009). Dividends and Market Signalling: Analysis of Corporate Insider Trading. London: Cengage Learning. Chen, A.-S. (2008). Do firms use dividend changes to signal future profitability? London: Cengage Learning. Jamali, D. (2016). Comparative Perspectives on Global Corporate Social Responsibility. London: Cengage Learning . Jensen, G. R. (2009). What do dividend reductions signal? Journal of Finance , 60115-2854. Jones, C. (1991). The Dividend Puzzle and Tax. New York: Cengage Learning. Mueller, C. (2013). Confirming Dividend Changes and the Non-Monotonic Investor Revision. London : Cengage Learning . Peterson, P. (1999). Analysis of Financial Statements. London : Pearson Education . Shapiro, D. (2008). Dividends as a signaling device and the. Journal of Economics and Business , 28223-0001. Tracy, A. (2012). Ratio Analysis Fundamentals: How 17 Financial Ratios. London : Pearson Education . Walton, P. (2006). Global Financial Accounting and Reporting: Principles and Analysis. New York : John Wiley & Son's. Warren, C. (2006). Financial & Managerial Accounting - Page 531. London : John Wiley & Son's. Read More