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DIVIDEND POLICY AS STRATEGIC TOOL OF FINANCING IN CORPORATE ORGANIZATIONS

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Project Research Pages: 64 Available Available 1-5 Chapters NGN 5,000 Abstract Available Available Instant Download
DIVIDEND POLICY AS STRATEGIC TOOL OF FINANCING IN CORPORATE ORGANIZATIONS

CHAPTER - ONE

INTRODUCTION

1.1   BACKGROUND TO THE STUDY

The topic of dividend policy continues as one of the most challenging and controversial issues in corporate finance and financial economies. Research into dividend policy has, shown not only that a general theory of dividend policy remains elusive, but also that corporate dividend varies over time between firms.

For a firm, which encounters financial difficulties, reliance is placed on retained earnings and accordingly results in lower payout ratios.

However, shareholders have been enthusiastic interest in the outcome of their investments. These outcomes are expressed in terms of earnings and capital gains.

These two ingredients are in turn affected by the quality of policies made by the management team of the enterprises. Among the most important decisions that management of an enterprise must take which has direct bearing on firm’s continuity, earning potentials, investors' satisfaction and share price gain is the decision to withhold or distribute net earnings as retained profit or dividends.

Pandey (1999), stated firmly that "Dividend policy is a decision by the financial manager whether the firm should distribute all profit or retain them or to distribute a portion and retain the balance. Payments made to stockholders from a firms earnings, whether those earning were generated in the current period or in previous periods. Dividend policy is an important aspect of corporate finance and dividends are major cash outlays for many corporations.

Garrison (1999) defined dividend policy as payments made to stockholders from a firm's earnings', whether those earnings were generated in the current period or in the previous period. Dividend could also be referred to as that part of the enterprise earning that is given to shareholders as interest on' their investment. Also, itrepresents the return to investors who put their money at risk in the company.

Company pays dividend to reward existing shareholders and encourage others that are prospective shareholders to buy new issues of the common stock at high price.

However, many seem obvious that a firm would always want to give as much as possible to its shareholders by paying dividends. It might seem equally obvious that a firm can always invest the money for its shareholders instead of paying itout. The heart of dividend policy question is should the firm payout money to its shareholders or should the firm take the money and invest it for shareholders into the enterprise business.

Valuation is considered the heart of finance, understanding what determines the value of a firm, and how to estimates that value seems to be a prerequisite for making sensible decisions (Damodaran, 2006). Company valuation is a delicateconcoction of both science and art. The former takes the shape of quantitative risk- return model, and latter, experience and judgment on the part of the appraiser - intuitive elements that belong to the artistic realm (Pereiro, 2002). In general, there are four approaches to valuation (Damodaran, 2006). Quantitatively oriented valuation techniques include the discountedcash flow based method (DCF) and the real options model. The traditional fundamental valuation technique is the discounted' cash flow (DCF) based method, which relies on the capital asset pricing (CAPM) to compute the cost of capital. And attractive technique for valuing future opportunities is the real options framework. This method is used when there is a reasonable chance of reserving the rights of exploration for the investments undertaken (Pereiro, 2002). A third model for valuation is based in relative valuation and involves computing value multiples for a representative sample of comparable companies or transactions similar to the target under appraisal

(Pereiro, 2002). Excess return models have their roots in capital budgeting and the net present value rule with its widely used variant, the Economic Value Added (EVA (R).

(EVA (R) is a registered trade mark of stem steward &co. EV A (R) is a measure of the surplus value created by an investment or a portfolio of investments. It is computed as the product of the "excess return" made on an investment(s) and the capital invested in thatinvestments) (Damodaran, 2006).

Moreover, it has been discovered that the .dividend policy of a firm always have short term or long term effect on the market price of its shares. It shall be found out in the course of this research, the actual relationship between the dividend payout and dividend policy of companiesi.e payout ratio of the firm is a percentage of dividends to earnings.

It is quite difficult to clearly identify the· effects of payout on firm's valuation. The valuation of a firm is a reflection of so many factors that the long run effect of payout is quite difficult to separate. J.S. Kehinde (2001) viewed dividend policy as "the dividend policy of a firm accounts for how a firm divides its income between retained earnings and dividends. It states the policy measure of how much dividend to the declared, in what form should the dividend be declared- either as a cash dividend or as stock dividends. By dividend .policy the corporate organization, strike a balance between current income tothe shareholders and a future income.

Income can be retained and reinvested' into available profitable investment opportunities. The retained earnings provide the cheapest source of financing. This research is to examine empirically the dividend policy of all quoted companies (banks) in Nigeria and to present evidence on what determines corporate payout policy this market. In addition, it tends to identify the impact of dividend policy on company valuation and the various approaches to dividend payment to stakeholders as against retaining it for re-investment.

 

1.2   STATEMENT OF PROBLEM

Maximization of shareholder's wealth appears to be the cardinal objective of most firms. The value of wealth to the shareholders is represented by the market price of the firm's common stock, which is tum is a reflection of the firm's investment, financing and dividend decision.

Dividend policy is thus assumed to have an influence on the value of firm's common stock and hence its value. Despite the above statement, the impact of dividend policy, especially dividend payout on the valuation of firm's common stock is still open to academic debate.

This study thus intends to empirically investigate whether the dividend pay-out ratios of firms quoted in the Nigerian Stock Exchange, influence the process at which the stocks of these firms are being sold. Also to be examined empirically is the extent to which the received theory about traditional determinants of dividend decisions of business firms serves in explaining the dividend behaviour of Nigerian companies (Van-Home, 1983).

Both Gordon and Miller-Modiglinai developed theoretical models with which they argued their respective positions. These models apart from being applicable under very restrictive conditions also lead to estimated prices which mayor may not correspond with the actual prices obtainable in the market. This study hence intend to specifically test for relationship between market prices as contrasted with estimated prices of stock quoted in the Nigerian stock exchange and the dividend payout ratios of the respective firms.

1.3   RESEARCH QUESTIONS

This research tends to investigate the following questions:

i.   To which extent can dividend policy affect price of shares?

ii.   To which extent can retained earnings, affect the growth rate of a firm?

iii. What portion of total earning should a firm distribute or retain?

1.4   OBJECTIVES OF THE STUDY

The broad objective of this study is to analyze the effects of dividend policy on the value of the firm while its specific objectives include the following:

i.      To examine the nature of the' relationship between dividend payments and the value of the firm.

ii.     To examine the long-term relationship between retained earnings and growth rate of the selected banks.

1.5   STATEMENT OF THE HYPOTHESIS

The hypothesis tested in this study is stated below:

Hypothesis 1

Ho: Payout ratio has no significant influence on the value of the firm.

Hi: Payout ratio has significant influence on the value of the firm.

Hypothesis II

Ho: Dividend policy of a firm is not determined by its long-term payout ratio.

Hi: Dividend policy of a firm is determined by its long-term payout ratio.

1.6   METHODOLOGY OF THE STUDY

The data used were gathered from secondary sources. Secondary data are reliable easy to understand and are of descriptive models. These secondary data for this essay topic includes; Journal of Central Bank of Nigeria (CBN), Economic and Financial Review (EFR) and the Nigerian Stock Exchange Facebook (NSEF).

The variable on which data was collected includes; Dividend per share, profit after tax, payout ratio and earnings per share. The earnings per share are used as a proxy for value of the firm while profit after tax captures the firm's dividend policy. Thevariables identified would be integrated into models to test the impact of dividend policy on the value of the firm. The data covered periods of 1988 to 2008.

1.7   SIGNIFICANCE OF THE STUDY

This study will be of great benefit to individuals, society, corporate organizations, government etc.

To individual, it would be of benefit in deciding' on which company to invest - either to invest in a firm where higher dividend are paid with a corresponding increase in the number of investors which tends to increase the company's value or to invest in a firm with lower dividends and returns inform of capital gain in the future.

To the society, the effect of higher dividend will influence the number of individuals who are ready to subscribe for the firm’s shares. It thus helps to increase investment in the economy and maximization of the wealth of the society.

This study will also provide empirical evidence to prove the relationship between firm values and dividend 'policy in terms of inter-dependence that exist between them also, the fundamentals and importance of dividend in maximizing shareholders’ value will be exposed.

1.8   LIMITATION AND SCOPE OF THE STUDY

This study of the effect of dividend policy on company valuation will be restricted to the listed bank in the economy. The study will focus on the relationship between dividend policies and the value of the firm.

Out of the various listed banks, two banks have been chosen in the view of limitation and resource available.

These banks were chosen from a benchmark of a minimum of 20 years quotation at the stock exchange as well as its spread across the country. The banks to be used as case study of this project are First Bank of Nigeria PIc and Union Bank of Nigeria PIc(UBN).

1.9 DEFINITION OF TERMS.

Dividend: This is defined as the payment 'made to shareholders from .firm earnings, which serve as an interest income, to their investment. Pandey, I. M. (1999).

Dividend Policy: This involves the decision to payout earnings or to retain them for re-investment in the firm. It determines whether the firms should payout dividend as current earnings or retain them as capital gains.

Dividend Pay Out Ratio: The percentage of retained earnings, payment in the form of a cash dividend.

Optimal Policy: This is the policy that strikes a perfect balance between current dividends and future growth and thereby maximizes the price of the firms cost.

Dividend Yield: The ratio of the current dividend to the current price of a share of stock. That is, the firms expected dividend payment per share dividend by its current share price.

DIVIDEND POLICY AS STRATEGIC TOOL OF FINANCING IN CORPORATE ORGANIZATIONS

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