Impact of Dividend Policy on Shareholder's Wealth

Abstract

IntroductionBy dividend policy we mean that the amount of earnings distributed to the shareholders and the amount of retained earnings. So in this policy the amount of earnings of the firm are divided into two parts, dividend paid and the amount kept for future projects. Dividend policy is considered an important tool for investors to assess the company's financial position as they require return on their investment and dividend paying company will certainly attract them.In the world of corporate finance the question that whether the earnings of the firm should be distributed to shareholders or it must be reinvested in future profitable projects has great importance. To answer this question finance mangers must consider which dividend policy will increase the shareholders wealth. Share holders like the cash dividends but on the other hand they also want the growth of the company by reinvesting the funds.In ever increasing economies every company is in stress. Finance manager's prime objective is to maximize the share holder's wealth as they are principle agents of them. Share holders wealth is represented in the market price of the share which is the result of company's financing, investment and dividend policy decisions. The optimal dividend policy is that which increases the share prices of the company which in return increase the shareholder's wealth.Researchers had tried to explain that why firms pay dividends (Green 1983). Although Miller and Modigliani (1961) argued that the dividend policy has no effect on the share holder's wealth. Dividend irrelevancy is also supported by the work of (Scholes, 1974). Many researches had shown that there is dependency of dividend policy on the shareholders wealth. Linter (1956), Gordon (1963) and Richardson (1986) had stated that there is a relevancy between the dividend policy and the firm's value and the dividend policy has the positive relationship with the firm's value. Researchers also found the positive impact of dividend policy on shareholders wealth. (Fama, 1969; Petit, 1972 & Travlos, 2001)In this study the relationship between dividend policy and the share holder's wealth has been discussed in the reference of Pakistani companies that whether the dividend payouts have the impact on the shareholder's wealth, as market price of shares is used a proxy to determine the shareholders wealth.ObjectivesO The objective is to determine the relationship between shareholders wealth and dividend policy.O To determine the impact of retained earnings on the wealth of the share holders.O To analyze the impact of dividend per share on market price per share.O The objective is to find that whether retained earnings or dividends increase shareholders wealth.O To examine the impact of return of equity on shareholders wealth.Literature ReviewThe theory presented by Miller and Modigliani suggested that the shareholders wealth is not increased by the dividend policy of the firm. Shareholders wealth depends upon solely on the earning capacity of the firm. By giving dividends to shareholders the company is adding more risk as they increase the amounts of debt so the gain for shareholders is offset by the added amount of risk. (Miller & Modigliani 1961).The research indicated that the subsequent increase in the dividend payments to the shareholders has a positive effect on the shareholders wealth. This study does not include other earnings announcements. The other studies on this area reveal that there is a negative relationship between initial dividend and subsequent dividend. The results suggest that the increase in dividend payments have a unique impact on the shareholders wealth. (Asquith & D. W. Mullins 1983).This study suggested that there is a strong relevance of dividend policy with the firm's value. The results suggested that dividend announcements and stock dividend both elicit abnormal returns for the investors. …

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