In this specific case BP is slashing it dividends due to environmental recovery operation in the Gulf of Mexico.
The originator of the theory of “Dividend Payout Policy” Miller and Modigliani had the following assumptions in the theory (Miller and Modigliani 1961). The market structure is of Perfect competition. In perfect capital market structures information is disseminated to all the members at the same time and at the same cost about the security instrument, no additional cost is charged on a transaction in the form of taxes or levies, no stake holder can influence the decision of the company to pay dividend (Miller & Modigliani, 1961). This condition was violated since the senate intervened in the decision of BP to payout dividends, where as the assumption of no government intervention is the core value of perfect competition.
Rational behavior would imply maximization of BP’s share holder wealth in the form of incremental dividend payouts, capital gains or portfolio value enhancement in absolute terms. Miller and Modigliani asumption was “investors always prefer more wealth to less and are indifferent to cash payments or an increase the value of of their shares” (Miller & Modigliani, 1961). However this was not kept in view when the senate exerted pressure on BP to not pay dividend. This reduces the stock holders’ wealth. It is a clear violation of the corner stone of corporation’s goals (Miller and Modigliani 1961).
Perfect Certainty would specify “Complete Assurance on the part of every individual investor as to the future investment program and future profit of every corporation” (Miller and Modigliani 1961, p. 412). This concept is ignored by the senators, since they are forcing the management of BP to not pay the dividend in turn reducing the probability of the assumption of perfect certainty to prevail in the capital market from BP and its stock holders’ perspective.
Dividend policy determinants include the following, explicit claims; these claims include legal contracts and financial instruments such as bonds. In case of BP are the environmental cleaning operations which are paid by the company, before paying its implicit liabilities. Such claims are legally binding and are paid. Implicit claims in BP’s case are dividend which are payable to the common stock holders, but they are forced by the government to default on the company’s common stock holders (Holder, Langrehr, and Hexter 1998).
The interest of non-investor stake holders play a major role in the financial decision making process of the business concern. The non investor stake holders play a vital role in the financial decision making of the company. The non-investor stake holders in BP’s case are the senators who have forced the management to hold its dividends payments to the common stock holders (Holder, Langrehr, and Hexter 1998).
Dividend Policy is also dependent upon past growth rate, future growth rate, and systematic risk the firm undertakes in forms of operational and strategic leverage. How ever the future growth does not have an influential effect on dividend payments. The forecast report of credit Suisse for 2011 shows free cash flow of $3 billion after all the expenses are paid. The empirical results do not show a persuasively strong relationship between dividend payout policy and future growth (Saxena 1999).
The senators have not considered the consequences of holding the dividend payment to the common stock holders. This will result in loss of investor confidence and flow of capital in the future. Other macroeconomic effects include shortage of investment in public limited companies and reduction in the overall investment in economy due to government intervention.
In case of BP, the company’s decision is based on the basis of transaction costs related to the environmental operations in the Gulf of Mexico and the profitability of the company for the first quarter; however this affected the stock prices. This decision is refuted by the Dividend Policy Theory; it proposes, if the dividend is not paid the consequences will be reduction in demand and price of BP’s common stocks prices. The goodwill of the company will tarnish in the primary and secondary financial market.
It is evident from BP’s stock prices showing a declining trend from April 2010 – July 2010. The company did not pay interim dividend for the first quarter of the fiscal year 2010 which was cancelled on 16th, June, 2010. This supports the above stated conclusion (peroleum, British, 2010) (New York Stock Exchange, 2010).
To avoid all of the above stated consequences as per the behavioural expectation of the investors the company will pay have to pay dividend in the next quarter to increase its stock prices.
List of References
Anon., 2010. New York Stock Exchange. Web.
Holder, M.E., Langrehr, F.W. & Hexter, J.L., 1998. Dividend policy determinants: An investigation of the influences of stakeholder theory. Financial Management, 27(3), pp.73-82.
Miller, M.H. & Modigliani, F., 1961. Dividend Policy, Growth, and The Valuation Of Shares. The Journal of Business, 34(6), pp. 411-33.
British Petroleum, 2010. British peroleum. Web.
Saxena, A.K., 1999. Determinants of Dividend Payout Policy:Regulated Versus Unregulated Firms. Web.