Dividend policy is crucial to the growth and protection of shareholder wealth. A
ID: 2738199 • Letter: D
Question
Dividend policy is crucial to the growth and protection of shareholder wealth. After all, why go to all the trouble of raising capital and then building and operating a business if you are not going to get any money back. This can apply to both public companies and private investments. Over the long-term stocks have returned about 10% per annum, with nearly half that return being derived from dividends.
Which of the following is true of dividends?
Select one:
a. Dividends tend to follow earnings. Companies establish a policy of what percentage of earnings they intend to pay out as dividends, change them to match expected long-term and sustainable shifts in earnings, and only increase the dividend if the Board feels they can sustain the payments.
b. Dividends are sticky. Once they are established a company typically does not change its dividend rate frequently, and usually will only cut dividends if business conditions deteriorate significantly.
c. Dividends are smoother than earnings. In a study from 1960 to 1998 it was found that dividends had a 4% standard deviation versus 14% for earnings. Put another way, the difference between dividends and earnings is that when the dividend check shows up in your mailbox you get to cash the check and spend the money, whereas earning are to some extent a judgment.
d. All of the above.
Explanation / Answer
Dividend decisions is one of the type of financial decisions. It is taken by the management based on the performance by the company. In it the management decides how much profit portion will be distributed as dividend without hampering the sustainablity and growth of the company. Dividend distribution percentage differs from company to company. Some companies give high rate of dividend because of excess funds or lack of growth oppotunities while some companies give low dividend due to low financial condition or having growth oppportunities. Growth oriented funds give less amount of dividend because funds are required for the expansion of the business. shareholders also anticipate high growth so they satisfy themselves with loww dividend in anticipation to get high returns. In Case of poor growth oriented funds give high rate of dividend in order to lure the investors to make the investment for high returns otherwise they will not be able to sustain in the market.
So option(A)is correct- Dividends tend to follow earnings. Companies establish a policy of what percentage of earnings they intend to pay out as dividends, change them to match expected long-term and sustainable shifts in earnings, and only increase the dividend if the Board feels they can sustain the payments.