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According to (Moyer, McGuigan, & Kertlow, 2001), dividend policy can formally defined as the approach followed by the management in regards dividend payout decision making or alternatively, the amount and pattern of dividend cash flows shareholders receive over time. In simpler terms dividend policy can be understood as how the firm manages its earnings in regards to distributing it amongst its shareholders; how much dividend at what time and to whom.
There are a number of key factors a firm like Horizon Education would have to take into consideration while settling on a proper dividend policy for the firm.
The firm has to consider whether to announce the dividend or not. An announced dividend becomes like a debt to the firm as in the firm is now legally liable to pay the amount announced to its shareholders hence the decision of whether to announce a dividend or not is huge one. Another thing to note is that whether a firm announces a dividend or not sets precedence in the market upon which investors chose to make their decisions. Furthermore, if the firm were to not pay out a dividend to shareholders, the earnings firm could retain its earnings and invest the retained earnings for future growth.
The firm must also keep in check when the dividend (if announced) has to be paid to shareholders. It is at the firm’s discretion to settle on the announcement date i.e. the date the firm will announce the dividend. The firm also settles on a record date; a date at which the dividends have to be paid to the shareholders. Another important date for any firm about to pay dividends is the ex-dividend date, a date set a few days prior to to the record date. Any share purchased before the ex-dividend date will result in dividend being paid to the new owner of the share, If the transaction takes place after the ex-dividend date, the new owner will possess a share of the firm however the firm will not pay him the dividend rather, the dividend will be distributed to the prior owner of the share. According to (Emery, 1998) the record date and ex-dividend date carry a great significance from an economic standpoint. Dividend declaration on the record date would surprise investors and the share price will be influenced based on the investors’ understanding of the situation. The importance of the ex-dividend date lies in the fact that after it has passed the share price will by the amount of dividend paid on each share.0
The firm must also realize the importance of the size of dividend they offer to shareholders. The have to keep in mind the possible business risks present in the market currently and how it would their expected revenue, expenses and the earnings left over. The firm has to also consider the fact that as a corporation, it will be subject to corporate taxes which will have a significant impact on the earnings it pays out to its shareholders. As per (Emery, 1998) most firms would more likely maintain a stable moderate dividend allowing fluctuations in the payout ratio of the firm based on the earnings the firms generate.
Importance of Dividend Policy
For a even a layman, the importance is glaringly apparent. Dividends usually are given in the form of cash, an asset preferred by both the firm and the shareholders. As per (Ross, Westerfield, & Jordan, 2012) value of the stock is determined on the basis of the present value of the firm’s dividends. This is reflected on a larger scale as the value of firm is derived from the total present value of the equity the firm possesses. Shareholders treasure cash due to its monetary value while the firm views every rupee of earnings not issued as dividend as an opportunity to reinvest the amount for the sake of growth and expansion of the firm.
There are two opposing views on the importance of dividend policy as explained by (Chambers ; Lacey, 1994). On one hand you have traditionalists who agree with the fact that dividend policy is important and that an optimum dividend policy does exist for each firm. This is based on their belief that dividends are a like wages or rewards for shareholders that certainly deserve. On the other hand are modernists who believe that a firms earnings amount to cash for shareholders regardless of if they are used to pay a dividend or if they are kept within the firm as retained earnings. In other words, for modernists, in an ideal situation dividend policy is irrelevant and holds no weight. The debate on the perceived relevance of dividend has been a long running one and there are many theories that either accept the relevance of dividend policy or chose to completely reject it.