State law also helps to protect the company’s creditors against excessive dividend payments. For example, companies are not allowed to pay dividend out of legal capital, which is generally defined as the par value of outstanding shares. Dividends are normally paid out of cash reserves but companies could also compensate shareholders by offering them more shares instead of cash dividend payouts. Whiles some corporate managers decide the amount of dividend payout for an accounting period, others prefer some form of target payout ratios to determine the amount payable to shareholders.
According to Brealey & Myers (2003) some corporate managers, especially those of growth companies do not pay dividend at all. In their studies of corporate industries in the United
...State, Baker and Powell (1999) stated that researchers have developed many different models for explaining dividend behaviour. In Lintner’s (1956) classic study, managers perceived that shareholders were entitled to a fair share of the firm’s earnings through dividends. Although managers advocated a long-range target payout ratio, they believed that shareholders preferred a steady increase of dividends.
Managers sought to avoid making changes in their dividend rates that might have to be reversed within a year or so. Therefore, they tended to make partial adjustments toward a target payout ratio rather than dramatic changes (ibid). This behavioural model suggests that the change in dividends is a function of the target dividend payout less the last period’s dividend payout
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