Dividend Decisions

Question 1

Cum-dividend

Answer 1

It trades as cum-dividend following the announcement – the entitlement to the expected dividend is bought and sold along with the share.

Question 2

Ex-dividend (‘ex-div’) date

Answer 2

• the day on which the share ceases to be traded with entitlement to the dividend.

Question 3

Constraints on Dividend Policies

Answer 3

Dividends must be paid from accumulated profits
Dividends cannot be paid out of the company’s capital.
Additional restrictions on the company’s dividend policy may be contained in loan documentation, bond agreements and preference share terms and conditions

Question 4

Residual Theory

Answer 4

Under the residual theory, a company will maximise the wealth of its shareholders by investing in projects that have positive net present values.  Once the firm has provided this funding, the investors in the firm should be given any remaining funds.  They should be given these funds because they can use them to invest in other firms of the same risk class that can produce a return better than the one provided by this firm.  If the firm did not give this money back to the shareholders but instead spent it on projects with lower returns, then the shareholders’ returns would decrease.
 The residual theory proposes that companies should give priority to projects with positive net present values and distribute the residual funds

Question 5

CLIENTELE EFFECTS

Answer 5

A proportion of shareholders may choose to purchase shares, at least in part, because the dividend policy of that particular company suits them.

Individuals who are not interested in receiving large dividends in the near future, will prefer to invest in companies with good growth potential (i.e., companies which pay low dividends and use the retained funds to invest in projects with positive NPVs within the firm).
An example of this type of investor would be high-salaried individuals who do not rely on dividends for their consumption needs.
Another type of investor may prefer a high and steady income from shares and therefore would be attracted to companies with a high and stable dividend. An example of this type of investor would be a retired individual or a pension fund.

The clientele effect may place pressure on management to produce a stable and consistent dividend policy. Any inconsistency would result in a decrease in the share price as the shares became unpopular with investors that had originally invested because of the dividend policy of the company