Other Arguments Supporting the Relevance of Dividend Policy.
Activity As a potential investor, how would you react to the following questions a. Would you prefer cash dividends now, against the promise of future, perhaps uncertain, dividends b. Would you prefer a stable, growing dividend to one that fluctuates in sympathy with company s investment needs c. If a company, in whose shares you invest, increases or decreases its dividend, would it change your personal investment policy In answer in question a you probably opted for cash now rather than cash you may never see. The future is uncertain and most people take much convincing that it is in their interests to postpone income.
Although the equity shareholder by definition is the risk-bearer, he is also entitled to a reasonable resolution of dividend prospects to compensate for the additional risk he carries. An investor will almost certainty pay higher price for earlier rather than later dividends. In question b, in definition, a fluctuating dividend is more risky than a stable dividend.
Investors will pay more for stability, especially if it is linked with steady growth. Research has shown that, in general, dividends follow a pattern of stability with growth. Maintenance of the previous year s dividend is the first consideration, with growth added when directors feel that a higher plateau of profitability has been consolidated. As regards question c, you would no doubt be very happy about an increase, and might even be prompted to buy more shares thus helping to put the market price up. Conversely a decreased dividend would cause to review your investment, perhaps even to sell your shares to take advantage of better investment opportunities elsewhere. Investors tend to believe that dividend changes provide information regarding a company s futures prospects, and they react accordingly. 4.