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Exploring the inuencing factors of dividend
policy--A Literature review of corporate governance
in company’s dividend policy
Abstract
This paper is a literature review which summarize the points of view
from different researchers, trying to find out the correlations
between dividends payouts and different factors. The literatures
select for this paper contain detailed empirical studies and
examples to analyze the concepts of ‘dividend policy through
multiple aspects’ and this paper use ‘corporate governance’ as a
starting point to organize the knowledge of dividend policy. After
analyzing and criticizing different papers academically, the author of
this paper find out that corporate governance is a fundamental
factor which not only protect the rights of shareholders, but also
make the dividend policy more effective and e"cient. The
in#uencing factors of dividend policy include the size of the firms,
tax, profitability, capital structure and so on. Besides, Miller and
Modigliani’s (1958) theory provide discussions about dividend
irrelevance in the perfect market. This paper use other supportive
literature to show that MM is not functional as it stands in an
imperfect market. It can be seen that corporate governance plays a
greater role in current financial market.
Introduction
In large companies, there are complex and fragmented groups of
shareholders and the board of directors are often in control of the
business of the company. The separation of ownership and
management have raised some issues such as agency problems.
Managers may focus on pursuing goals for their own benefits
without concerning the benefits of shareholders and the company.
The regulations of corporate governance comes out in order to limit
the powers of both owners and managers and to protect the
shareholders. The dividend policy is one of the area that corporate
governance can have great impacts on. Dividend policy is the
company’s determination of the portion of profits paying to its
shareholders. The key issue raised during the execution of dividend
policy is that how company select the payout methods such as
repurchasing and paying dividends and how the company use
corporate governance to balance the profits of company and
shareholders. From some investors’ perspectives, firms are
supposed to make regular dividend payout and to continuously do
so. The board of directors have the power to suggest the dividend
level and shareholders hold the right to make the final decision
about whether such a level of dividend should be paid.
When the dividend should be increased as the earnings of the
company increase. Unless the company is suffering significantly, the
dividend will not be cut largely. Baker(1985) states that managers
are less inclined to raise dividend only if they feel confident that the
company will retain its dividend in a constant level. In another
words, if the managers is going to increase the dividend, they
should get enough evidence to make optimistic forecast of
company’s future earnings. To shareholders, increasing dividends is
favorable , because in spite of the direct benefit from the company,
they can also predict that the company is confident to its current
business activities and to its future business.
Miller and Modigliani’s theory contains assumptions which relate to
the dividend irrelevance. They proposed that the share price of the
firm have no direct connections to the dividend policy if following
conditions are met, including 1, no taxes to the companies, 2, no
transaction cost existed. 3. investors in the market can borrow or
lend money with same interest rate. 4. investors in the market can
all get relevant information without paying money. 5. Capital gains
and dividends make no difference to investors. If all these conditions
are satisfied, then dividend is irrelevant. MM proposition points out
that some firms have high positive NPV, they pay all they benefits
as dividends. The reason for this is that the company believe
shareholder’s wealth will not be decreased in the perfect market
because the profits paid out can be taken place when issuing new
shares and investors are willing to buy shares because they can get
relevant information.
In order to explore the relationship between corporate governance
and dividend policy, finding out different academic views regarding
to the dividend policy, this paper is going to review some literature
which use empirical studies to analyze the dividend policy in the
company and lots of in#uencing factors. This paper is not only a
literature review to summarize and compare different ideas
academically, but also a paper that contain the writer’s own
thoughts and suggestions about how company can analyze and use
its dividend policy e"ciently.
Dividends as conveyors of information
Knowing the function of dividends is beneficial for people to
understand the role of dividends in the business world and to
understand the requirements from corporate governance. The
dividends policy of the company can be a fundamental intermediate
to convey the information to the public. For example, if the dividend
of the company is changing dramatically at a time, the investors
may estimate the potential of the company in a different way. In
general, low dividends payment can be regarded as a sign of great
prospect of companies.
Signaling
The signaling theory points out that dividend policy is developed to
reffect manager’s private information which relate to the future
earnings of the company. (Miller and Rock 1985) Zeckhauser and
Pound (1990) states that there is negative relationship between
dividends payout and the amount of shareholders. There are
different ways that shareholders will perform as signals of future
potentials of the company. The first way is that institutional
shareholders can signal to the market to show that the agency cost
is decreased, because those shareholders may take responsibility to
monitor the business activities of the firms. Nevertheless, such
supervision from institutional shareholders are not as e"cient as it
is supposed to be. The reason is that free rider may existed in this
situation, thus the monitor weak as it stands. The second situation is
that the market may regard the existing shareholders of a company
as a good signal relating to company’s potential, because
shareholders can have more participation to the management of the
