Complete Guide To Corporate Finance

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Dividends - Real-World Factors Affecting Dividend Payouts

Real-World Factors Affecting Low Dividend Payouts
As we mentioned earlier, some financial analysts feel that the consideration of a dividend policy is irrelevant. They contend that investors have the ability to create "homemade" dividends by adjusting their personal portfolios to reflect their own preferences. For example, investors looking for a steady stream of income are more likely to invest in bonds (in which interest payments don't change) than in a dividend-paying stock (in which value can fluctuate). Because their interest payments won't change, those who own bonds don't care about a particular company's dividend policy. The second argument claims that little to no dividend payout is more favorable for investors. Supporters of this policy point out that taxation on a dividend is higher than on a capital gain. The argument against dividends is based on the belief that a firm that reinvests funds (rather than paying them out as dividends) will increase the value of the firm as a whole and consequently increase the market value of the stock. When investors sell, they profit from a lower-taxed capital gain. According to the proponents of the no-dividend policy, investors benefit more in the long run from the company's undertaking more projects, repurchasing its own shares, acquiring new companies and profitable assets, and reinvesting in financial assets. (Keep reading about capital gains in Tax Effects On Capital Gains.)

A third argument in favor of low dividends is the high cost to a firm of issuing new stock. In other words, to avoid the need to raise money through the issuance of new stock, which is expensive, firms should retain most or all of their earnings and pay little to no dividends to investors.

Real-World Factors Affecting High Dividend Payouts
In opposition to these three arguments is the idea that a high dividend payout is important for investors because dividends provide certainty about the company's financial well-being; dividends are also attractive for investors looking to secure current income.

In addition, there are many examples of how the decrease and increase of a dividend distribution can affect the price of a security. Companies that have a long-standing history of stable dividend payouts would be negatively affected by lowering or omitting dividend distributions; on the other hand, these companies would be positively affected by increasing dividend payouts or making additional payouts of the same dividends. Furthermore, companies without a dividend history are generally viewed favorably when they declare new dividends. (For more, see Dividends Still Look Good After All These Years.)

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