Determinates of Dividend Policy Apple Essay Example
Determinates of Dividend Policy Apple Essay Example

Determinates of Dividend Policy Apple Essay Example

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  • Pages: 14 (3787 words)
  • Published: April 15, 2018
  • Type: Case Study
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Publicly traded business also makes similar decisions on whether to return cash back to the owners (shareholders) and how much in the form of dividend.

Lintier (1956) was the first empirical study on dividend policy, he revealed that dividend add value to the shares of a firm. The turning point in theoretical modeling of dividend was the brilliant paper of Modeling and Miller (1 961 ) of dividend Irrelevance.

Since the postulation of dividend irrelevance, financial economists have argued via two major schools of thought; those who believe dividend is relevant and those that believe dividend is not relevant. Despite the theories y academics to examine dividend policy, the dividend picture is still puzzling. The objective of this paper is to (1 ) critically review some of the factors that influences dividend policy of firms from a theoretical perspective (2


) Analyze the last five-year dividend policy of Apple Inc.

ND Dell Inc. And discuss the factors that has influenced dividend policy in these firms over the period considered. Theories and Determinants of Dividend Policy (Section 1) Tax and Clientèles Theory Clientele theory attributes diversity in dividend policy according to the preference of investor. Clientele effects as a factor that affect dividend policy eek to explain how investors are attracted to a particular corporation as a result of the corporation's dividend policy.

According to Modeling and Miller (1961) a firm tends to attract to it a clientele comprising of those who prefer its particular payout ratio. Given tax, investors will push towards forming a clientele with specific preference according to their yield preference.

Elton & Grubber (1970) supported the clientele argument using me piratical evidence

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reporting that investors in higher tax bracket show preference for capital gain by investing in firms with low dividend payout while investors in low tax racket invest in firms with high payout ratio.

This 'tax clientele' argument is also supported by Redding (1997), he modeled two types of investors; individual (small) and institutional (large) investors, claiming that individual investors are less likely to prefer dividend due to lesser capita gain tax, institutional investors often prefer dividend due to lesser dividend. Therefore it can be said that tax incentives influence the demand for dividend of a given investors. But however, Denis & Sob (2008) argues that the clientele hypothesis is implausible. In his study of six countries (US, KICK, Canada,

Germany, France, Japan), he found that aggregate dividend is concentrated among the largest and most profitable firms and 90% of market capitalization is in dividend paying stock. Therefore, it seems improbable that investors with zero preference of dividend will be able to build a well-diversified portfolio.

A variant of the clientele theory by Baker & Wriggler (2004) called 'catering hypothesis', postulate that dividend payments are in responds to investors demand. The catering hypothesis was inconsistent with Denis & Sob (2008) in their findings that dividend is concentration.

In Denis & Sob 2008) responds to the catering hypothesis, they asked 'why would the demand for dividend by investors be limited to the most profitable firms? '. The answer to this question may be explained by the free cash flow hypothesis.

Free cash flow and the Agency Theory According to Jensen (1986), Agency theory is the analysis of a relationship fraught with conflicting interest between corporate managers (Agents)

and shareholders (principal). Jensen argued that corporate managers with large cash flow tend to invest in less profitable projects.

Paying out dividend reduces the cash available to managers thereby mitigating against cash caste. Jensen (1986) explains that paying out dividend reduce the agency cost of the firm by reducing the cash available to managers and if they are to need more funds to invest, they will move towards the capital market and the capital market impose restrictions on managers not to misuse money.

This is consistent with Easternmost (1984) claims that monitoring cost and risk aversion preferences of managers are the two factors that affect agency cost.

Us pervasion of managers from following their own goals gives rise to the monitoring cost. The second factor is risk adverse nature of managers due to heir wealth tied to the business in contract with most shareholders with diversified portfolio that makes them only interested in systematic risk. Managers may reject potential high value project as a result of their more risk adverse nature. Therefore dividends are paid to shareholders to take away excess cash from managers thereby pushing managers to the capital market in order to meet investment needs.

The discipline of the capital market reduces the monitoring cost.

From the agency theory above we can say that free cash flow leads to agency problem and its positively related with the company's dividend payout ratio. According to Jensen (1896) firms with high cash flows have to pay higher dividend so as to reduce the agency conflict amongst shareholders and managers. Growth and The Lifestyle theory According to Bulla & Submarine (2009) the life cycle theory is based

on the idea that as a company grows into maturity, its capacity to generate cash flow becomes greater than its profitable investment opportunity.

According to this theory, young firms relatively have large investment opportunities but lack the ability to generate enough cash to meet all its financial obligations.

Therefore the firm will forgo dividend payment to shareholders. Over time as the firm grows, it reaches a stage in the life cycle (maturity stage) where the firms profitable investment opportunity diminishes, making the firm generate cash in excess to investment. This is the stage where the firm pays dividend to shareholders.

In other word a firm will start paying dividend when it perceive decline in the growth opportunity of the firm. An earlier study by Grunion et al. , (2002) revealed that there are changes in dividend policy as a firm go through its life cycle.

The life cycle hypothesis posit that a firm tend to increase their cash payout and reduce plough back rate as the firm move awards maturity due to diminishing investment opportunity available to the firm.

From the life cycle theory it is obvious that growth opportunity off firm is negatively related to the dividend payout ratio. Rezone (1982) supported this argument in his work where he used revenue from sales to measure growth. He also claimed that investment policy influences dividend policy due to expensive external finance. Gill et al. , (2010) used the sales growth rate and also found negative relationship between historical sales growth opportunity and dividend payout.

Firm size The firm size factor is related to the life cycle theory. According to Gamer et al. (2013) as firms

grow they become mature, less dependent on internally generated fund, easier to access the financial market. This enables them to be able to pay more dividends. Large firms are perceived to be less risky so they can raise more funds compared to smaller firms. This consistent with Lloyd et al (1998) argument that large firm should have higher dividend payout to reduce agency cost, implying they must have reached their maturity stage.

Redding (1997) also concluded that large firms are likely to pay enormous amount of dividend.

Information Asymmetry and Signaling theory Linseed (1956) reveals that changes in dividend payment affect the stock price Of a company. Also the brilliant work Of Modeling and miller (1961) made mention of informational content which is a result of dividend. Despite their dividend irrelevant theory, he claims that in a real world changes in dividend rate often affect market price. Patriarchy (1979) gives another explanation of dividend policy based on imperfect information.

He claims that shareholders agent (managers) has private information about the future project cash flow, which they signal to investors with the level of dividend, hey choose to pay.

Increases in dividend indicate high expectation of future cash flow by managers. Patriarchy (1979) argued that because outside investors have imperfect information about the future cash flow of the firm, the firm would choose to pay out dividend even when there is tax disadvantage; this is a way of sending positive signals to outside investors.

According to Baker (2009), since outside investors have insufficient information about the profit prospects of the firm and other information such as accounting data are not completely reliable, the company therefore have

o find other ways to convince investors hence, increasing dividend seem a positive sign to outside investors about the future cash flow of the company. This is consistent with Acquits & Mullions (1983) claims that dividend carry's information not available via others informational channel such as accounting data.

Baker concluded that, Thought dividend have a higher tax rate to capital gain, investors are willing to pay a higher tax rate in exchange for the positive signal of dividend.

Miller & Rock (1985) further developed the signaling hypothesis where he state that the dividend paid by firms with positive future ash flow should be large enough so that firms with negative future outlook will not be able to copy such dividend thereby sending false signal to investors because any firm is capable of paying a minute amount of dividend to its shareholders irrespective of its financial future outlook.

Despite the us port for signaling theory some researchers have found drawbacks to the theory. Black (1976) state that the role information plays in dividend payment is exaggerated claiming that there are other less expensive ways to signal information. Denis & Sob (2008) also cast doubt on the signaling theory lamming that larger, more profitable firms with positive earned equity are the dividend paying firms which are least in need of signaling their prospect compared to newly listed firms whom fail to initiate dividend.

This is supported by Tangelo et al. , (2004) argument that vast majority of dividend are paid by large corporations which enjoy significant large coverage from journalist and analyst (least in need of dividend as a financial decisions to communicate with investors).

Therefore dividend

signaling should occur in small firms if managers uses dividend to communicate with stockholders. Risk and the Bird in hand theory The bird in hand theory is an opposing view to the Modeling and Millers dividend irrelevance theory.

The theory is explained as the name goes; a bird in the hand is worth more than Ohio in the bush. The theory states that dividends are relevant and they affect the value Of the firm. This could be traced to linter (1956) where he mentioned that dividend affect the value of firms.

According to the bird in hand theory, investors are risk adverse therefore they prefer present cash in hand through dividend rather than future dividend payment or capital gain.

Risk as a factor that influences evident policy is complemented and explained by the bird in hand theory. As a result of the high uncertainty (risk) associated with capital gain and dividend paid in the future, investors are more willing to invest in stock that pays current dividend than stocks that retains earning for future dividend payment. Since forces beyond managers determine the stock prices in the market, there is higher degree of risk or uncertainty.

According to Cordon's (1962) the farther the future, the more risky capital gain and future dividends are. Given the life cycle theory, investors will be willing to invest in firms that eve gotten to their maturity stage than infant firm implying that infant firms are risky due to high uncertainty of future dividend and capital gain.

Therefore investors are willing to pay higher given a dividend-paying firm. This theory argue that investors invest in firms they perceive to be less

risky and those firms are dividend paying firms.

This is consistent with studies that reveal convincing negative relationship between risk level and the ratio of dividend payout. Rezone (1982) measured risk using beta and found that firms report lower dividend pay-out ratio have higher beta. Fruit & Gaiting (1991) assured risk using fluctuations in earnings and discovered that firms that have stable earnings over the years can easily predict their future which indicate low risk and therefore pay higher dividend.

The bird in hand theory posit that investors will invest in firms that pays dividend rather that firms with future dividend and capital gain prospect because investors tend to be risk adverse and the future of the later type of firm is uncertain (risky), while risk as a factor that affect dividend policy claim that risky firms tend to pay less dividend while less risky firms pay more dividend. We could say that risk s a determinant of dividend policy and the bird in hand theory complement each other. Kenton et al. (2007) argued against the bird in hand theory, he argues that an increase in dividend do not reduce the risk of a firm rather it increases the risk of the firm.

This is because new stock has to be issued by managers to raise the capital needed; therefore it's just a transfer of risk from the old shareholders to the new shareholders. Profitability A firm considering paying dividend must have first considered its profitability. Thus it is logical to consider profitability as a significant factor to consider evident payout ratio.

The pecking order hypothesis state that firms prefer internally generated fund over debt

financing or external equity financing due to the cost involved and debt financing over external equity financing.

According to the pecking order theory, less profitable firms will not be able to pay dividend because there will not be enough profit to plough back in the firm and also have enough to pay as dividend. From this argument we could say that profitability is positively related to dividend payout. This is consistent to the findings of Denis & Sob (2008) that dividend are concentrated amongst the most profitable firms.

Earlier studies like Amid & Abort (2006) also found positive relationship between dividend payment and profitability of the firm. However, Grunion et al (2002) argued that profitability is negatively related to dividend payout.

They revealed that increase in dividend is as a result of subsequent decrease in profitability of the firm. They explained their findings using the maturity hypothesis, during the growth process of the firm, competitors enters the market, shrink the firm's investment opportunities and slow the growth rate of the firm.

Reductions in investment opportunities educe expenditure on capital and increased cash flow. Thus dividend payment is a signal of declining growth and investment opportunity. Conclusion The life cycle theory of dividends predicts that a firm will begin paying dividends when its growth rate and profitability are expected to decline in the future. This is in sharp contrast to the signaling theory of dividends, which predicts that a firm will pay dividends to signal to the market that its growth and profitability prospects have improved (I.

E. That dividend initiations and increases convey "good news"). Given tax, an investor should prefer capital main to dividend

payment as the tax rate on the former is usually higher than the latter. But despite high tax situations Company's still pay dividend and Baker (2009) claim that investors are willing to pay higher tax rate in responds to the positive signal of dividend.

Hence it is a puzzle adjust won't fit. Analysis of Apple and Dell Dividend Policy (Section 2) Apple Inc. According to Apple annual Report (2009, 201 0, 2011) in the year 2009 to 2011 the company did not declare dividend.

The company anticipates that it will retain any earnings for use in the operation of the business. This has helped the company's share outperform the market indexes such as the DOD Jones U.

S tech oenology index that includes the stock performance of companies whose products and services are related to that Of apple. Apple Inc. Financial strategy is to retain earnings for investment purpose to preserve capital and meet the liquidity requirement of the company. The Company also had no debt for this period.

This implies that the company depends on internally generated fund to finance its project.

Instead of paying out dividend the company prefers to reinvest these funds and reward shareholders through UAPITA gains from share price (Apple Inc. 2009; 201 0; 201 1). This is consistent with the pecking order theory that states that firms prefers internally generated revenue to debt and equity financing due to the cost involved. In March 2012 the company's board of directors announced a dividend paying policy and the company to start paying $2. 65 dividend per share quarterly to kick off from the fourth quarter of that year (Apple Inc.


align="justify">The decision to pay dividend by the tech company may be seem as reaching maturity or running Out Of profitable investment as postulated by the life cycle theory as Investors were already worried on how long the company's growth streak can last, however the Chief Executive Officer (CEO) of apple claims apple still have groundbreaking products ahead (FT 2012). From this CEO comment we could consider the decision to pay dividend as signaling the future prospect of the firm. According to the life cycle theory when the firm gets to maturity stage she can generate more cash that profitable investment bringing about excess cash flow.

This is not far from the Apple Inc.

Case where she has roughly about SSL billion dollars in his cash balance as at when dividend was declared. The chief executive said that after deliberating on what to do with the cash, they have decided to payout dividend. Wall Street Journal (2012) report that investors have been requesting for dividend and hope to see more dividends paid by the company because the amount they planned to spend over the three years of dividend payment (Spoonbill) is a small percent of the company's expected cash flow for that period.

This alliance of shareholders and management desire can be explained by the catering hypothesis which state that firms pay dividend in respond to investor's request and the demand for more cash dividend can be seen as an act of ring to reduce the excess cash of the firm to avoid the firm investing in less profitable projects according to the agency theory.

According to an analyst Adam Lashing's Apple has success problem and

has ran out of ideas on how to responsibly spend her profit Fortune (2012). The change of Apples dividend policy can't also be attributed to managerial change.

Few months after Tim Cook being the Chief Executive Officer of Apple Inc. The company reviewed its dividend policy and started a dividend paying policy. According to and analyst William Baldwin Steve Jobs wouldn't have paid dividend because the share rice has been performing well under that period but would pay out loose cash through shares repurchase. And also the federal tax rate on dividend is set to triple for the coming year (Forbes 2012).

In 201 3, Apple Inc. Increased its dividend by to 3. 05 per common share.

The increase of dividend maybe not just to signal profitability of the firm but also the confidence management has on future of the firm. Following the payment of dividend in the previous year, the company in 2013 accounted for a long-term debt of $16. 9 billion.

The debt of the firm showed that the dividend policy of the firm arced the firm to the capital market for loan to finance her project. Since the capital market has measures that impose restrictions on managers to misuse fund, this will reduced any agency cost of the firm. This is in accordance to the Agency theory.

Dell Inc.

According to the Dell annual Report (2009; 2010; 201 1; 201 2) the company never declared or paid any cash dividends on shares of ordinary common stock and do not anticipate paying any cash dividends in the immediate future. For the period 2009 to 2012 the company's total cash, cash equivalents, and investments

have increased from $9. 5 billion to $18. Billion. The company's investment policy is to manage cash and investment balance so as to maintain liquidity while maximizing returns on investment portfolio by full investment of available fund.

The strategy of Dell Inc. To follow up this investment policy is acquisition of other companies. This strategy according to the company may involve new risk and uncertainty among which are insufficient new revenue to offset expenses and divergent of management attention. This strategy could be said to have also reduce the chance or possibilities of dividend payment. Therefore plough back of profit to the equines as a source of financing could be a factor that has influenced dividend policy of the firm as the firm enjoys steady increase in retained earnings of $20. Billion (2009), $22 billion (201 0), $24.

7 billion (2011 and $28 billion (2012) (Dell Inc. 2009; 2010; 201 1; 2012). AS explained bathe pecking order theory firms will prefer internally generated fund over debt and equity financing since its the cheapest source of financing. According to Dell Inc. Annual report (201 3), on June 12 2012 the company announced a dividend policy of 0. Peer quarterly dividend per shares which the company did pay or the third and fourth quarter.

The company stated that it may not pay a dividend greater than 0. 8 per share authorized under the current dividend policy as proposed merger transaction imposes restrictions to the cash use. Few months after Apple declared dividend, Dell Inc. Reconsidered its dividend policy and announced dividend-paying policy. Apple announcement to pay dividend wasn't enlightening for the market as it has accumulated enough

cash over the years that it has no choice other than to distribute the cash to shareholders. Dell has a history of corporate struggling despite her cash balance of $17.

Lion; the firm might need the cash in present of competitions and enterprise solutions (Stone Fox Capital 2012). Sterne Gage (2012) reported that Dell was applauded for its decision to pay dividend to its shareholder but however, questions are been asked if that is the best use of the company's cash given that the company is far from becoming an enterprise player. Dell decision to start paying dividend may be seen as a result of the dividend policy Of competitors like Apple, HP, Cisco System and IBM which the company not only compete with in the market but also for investors Sterne Gage (2012).

Thought the company has a good cash balance, eying dividend will exhaust the cash needed by dell for it acquisition which is part of her growth strategy and also to continue her enterprise focus shift. Also investors have been ARQ jesting for dividend from the company over the years, its decision to change her dividend policy may be seen as responding to investor's request This can be explained by the catering hypothesis which state that a firm pays dividend in responds to demand from investors.

But however the shift in its dividend policy may not be in alliance with the investors demand for dividend as there was on-going move to raising taxes n dividend but rather following the lead of their peers in the industry (Stone Fox Capital 2012). Investors With the cash balance Of $17. Billion and the company struggling

to make profitable investment (Stone Fox Capital 2012) Dell Inc. Could be said to have reached maturity stage. The life cycle theory posit that when a firm gets to maturity it is capable of generating cash compared to profitable investment as discussed in section one.

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