Blog 10: How companies make their dividend decisions?

The traditional view of companies’ dividend decisions is high dividends indicate the company has a good performance and low dividends indicate the company has a bad performance. When companies decide to pay high dividends, investors prefer to buy the companies’ shares and the share price will go up; when companies decide to pay low dividends, investors prefer to sell the companies’ shares and the share price will go down. However, Modigliani & Millar (1961) argued that share prices were determined by future earning potential not dividends paid now. Thus share value is determined by investment policy, not the amount of earnings distributed. Some companies decide to pay low dividends or even no dividends because they want to use these funds to invest in some attractive projects and these decisions will benefit the companies in the future. Some companies decide to pay high dividends are just because they do not have value projects to invest in. Also, M&M argued that shareholders are indifferent to the companies’ dividend decisions. When companies not pay dividends and shareholders want cash, they can simply sell some shares and when companies pay dividends, shareholders can also use dividends to buy more shares to leave funds in the company. In reality, companies tend to avoid very low dividend and very high dividend level. They prefer to give stable dividends with stable growth.

There is an example in the real world of how companies make dividend decisions. Wolseley, the world’s largest distributor for heating and plumbing products, has announce that it reinstates the dividend this year and the company’s profit increase to 5%. Wolseley’s share price increase 25p/share. This example shows that many investors hold the traditional view about the companies’ dividends. Many investors prefer companies give dividends and when companies distribute dividends, there will be lots of investors attracted by companies’ decisions and buy companies’ shares and the share price go up. Although the share prices also can be affected by other things, companies’ dividend decisions in some way can influence companies share prices.

All in all, in my opinion, in principle, companies’ dividend decisions are irrelevant to companies’ performance. It is just relevant to companies’ dividend policy. However, we cannot control investors’ mind and most of them still hold the traditional view of ‘dividend decisions’. So companies need to consider all these elements to make final dividend decisions.