IFFM_Blog 6. Dividend Policy Gan Kian Siong ID No: 14045693
A dividend policy is a policy whereby companies use cash distribution to pay out to investors. During the general meeting, the board of directors decides how much it will pay out to its shareholders in a form of dividends by a quarterly or annually (Baker, 2009). Table 1. Illustrate the US sector allocation and dividend yields that are consistently adjusted according to the industries (IndexArb, 2016). Table 2 and appendix 1 shows the market of the average annualized dividend yields have trended down drastically due to various financial market corrections (Bohan, Josefsen, & Steen, 2012). Example, Asia financial crisis in July 1997 (Sharma, 2003), the compression of US technology dot.com bubbled in March 2000 (Hunter, et al., 2005) and the recent US sub-prime mortgage crisis in 2008 to European sovereign debt (Zestos, 2016). Table 3 World maps GDP growth rates for 2009 (note: Countries in brown were in a recession).
Table 3. Source. IMF World maps GDP growth rates for 2009 (Countries in brown were in a recession)
Comparison Global 10-Year’s Treasury bond yields vs. S&P 500 Dividend Yield: According to CNBC reports dated July 15, 2016. Many commentators have noted that since in the early 60s, bond yields rose sharply above dividend yields, by 1982, 10 years’ treasury bond was nearly 10% higher than the dividend yield the S&P’s dividend payout (16% bond yield - 6% dividend yield). Table 4. In contrast, according to Bloomberg news on world bank reports, besides S&P bond yield has fallen, the global yield on 10 years’ government bonds
drop to nearly 0%, these has been demonstrated in the classic case of Japan and Germany (World Bank, 2015). Appendix 2. compare US 30 years yield vs. S&P 500 Dividend yields 2015 ~ 2016. Table 5. According to Bloomberg report, the global dividend yields have surpassed bond yields were largely due to the fact of substantial declined in bond yields. 
Table 4. Source: Bloomberg July 15, 2015. 10 Years Bond yield vs. S&P 500 Dividend yield
Generally, there are three types of dividend policies: a stable dividend policy, a constant dividend policy and a residual dividend policy (Arnold, 2013). Most companies consider these dividend principles as an integral part of the corporate strategy for pay-out.
Stable Dividend Policy
Stability or regularity dividends is considered as a desirable policy by the management of most companies. The aim of this policy is for a long term growth of steady and predictable dividend payouts year on year, in avoidance of quarterly earnings volatility. Table 6 shows two examples found in Verizon and AT&T companies applies stable dividend policy approach, allows the shareholder to have more certainty and desire for a timing of the dividend payout which is irrelevant to the company’s annual net income earnings performance (Ehrhardt & Brigham, 2016).
Constant Dividend Policy
The primary drawback of the stable dividend policy is when in bullish years, investors may not see a dividend increase. By contrast, under the constant dividend policy, a percentage of the company's earnings are paid every year. Therefore, investors would experience the full volatility of company earnings (Bohan, Josefsen, & Steen, 2012). If earnings are up, investors get a larger dividend; if earnings are down, investors may not receive a dividend. The primary drawback to the method is the volatility of earnings and dividends (Baker, 2009). It is difficult to determine dividend income when it is highly volatile as businesses are subjected to global financial market conditions.
Residual Dividend Policy
A residual dividend policy is also highly volatile, but for some investors, it is the only acceptable dividend policy that a company should have. In a residual dividend policy, the company pays out what's are left after it pays for capital expenditures and working capital needs (Arnold, 2013). However, it could be more logical in business operations perspective. Table 7 illustrate GE investors do want to invest in a company that justifies its need to pay dividends returns despite how the company's manage its radical net income earnings.
In the journal of banking and finance article in shareholder conflicts and dividend policy described that dividend policy may be irrelevant (Bohan, Josefsen, & Steen, 2012). Nevertheless, company's dividend policy is an essential consideration for some investors and some fundamentalists often reply on dividend as a major factor in relation to the rate of return and source of income for investment decision, especially for those pension fund investors.
Amid company use dividends as a form of income earnings to pay out some of the profits directly to the shareholders, even the company leaders are often the largest shareholders and have the most to gain from a generous dividend policy. Management will decide the dividend amount, timing and other various factors that influence dividend payments over time (Ehrhardt & Brigham, 2016) . Annual dividend payout can be increasing or decrease yearly according to the company capital structure, share price movement, and financial performance. Table 8 illustrate two companies (non-related industries) show the dividend payout are not equal to the EPS. However, dividend yields trend have moved along constantly with the share price.
Share buyback or Company repurchase shares
On the flip side, when the share is undervaluing, the company will activate the share repurchase or buyback shares directly from the secondly market, it is common for the company to make an offer to its shareholder at a fixed price based on NPV or existing trading price. Table 9 and 10 illustrates that most of the corporate management used this strategy as company share repurchase reduces the number of shares outstanding, it will then push up the EPS and lift up the market value of the remaining shares (The Wall Street Journal, 2014). The company could hold it at treasury share until next fundraising is required to allocate the capital outlay for the new project pipelines or use the large capital amount for the M&A exercise. Appendix 7. Illustrate the big impact for share repurchase has surged up as cash-rich companies seek to reward shareholders.
Table 9. Source: Lombardi Publishing Corp, Fact-Set Fundamental 2015
Appendices
Appendix 1. DJIA 30 stocks categories with Dividend Yield (%)
Appendix 1. Source: Bloomberg and Index-Arb July 15, 2016, Dividend Yield for stock in DJIA
Appendix 4. GE Financial Performance
Appendix 6. Microsoft and GE Stock price vs Dividend pay out
Appendix 7. Source from The Wall Street Journal, Biriyani Associates 2014
References
1. Arnold, G. (2013). Corporate Financial Management. Person.
2. Baker, H. (2009). Dividends and Dividend Policy. WILEY.
3. Bohan, O., Josefsen, M., & Steen, P. (2012, July 01). Shareholder Conflicts and dividend policy. Journal of Banking and Finance.
4. Ehrhardt, M., & Brigham, E. (2016). Corporate Finance: A Focused Approach. Cengage Learning.
5. Hunter, W., Kaufman, G., & Pomerleano, M. (2005). Asset Price Bubbles. MIT Press.
6. IndexArb. (2016, July 15). Dividend yields for stocks in the Dow Jones Industrial Average. 1 and 2.
7. Mnyanda, L., & Mogi, C. (2016, June 10). Bond yields around the world fall to records on the growth outlook. Bloomberg.
8. PWC. (2013). Correcting the course of capital projects.
9. Sharma, S. (2003). The Asian financial Crisis, Crisis, reform and recovery. Manchester University Press.
10. The Wall Street Journal. (2014, Sept 15). Companies' Stock Buybacks Helps Buoy the Market. 1.
11. Zestos, G. (2016). The Global Crisis - From US subprime mortgages to European Sovereign Debt. Routledge.
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