Introduction
The evolution of modern organizations and companies critically depends on the investment, capital, and readiness of potential investors to use their money to support the growth and development of the firm. At the same time, the shareholders and their involvement in the company’s work and readiness to participate in various incentives should be encouraged by specific bonuses. It means that the dividend policy used by the company is one of the fundamental factors impacting its performance, evolution, and chances for successful growth. However, a company cannot establish the amount of dividends paid out without considering the factors affecting its work, the market, and the sphere in general. For this reason, an effective and working dividend policy is one of the central determinants of success that the top management should consider.
Considering the importance of the discussed theme, the main goal of the paper is to investigate the dividend policy as an essential phenomenon influencing the work of firms and the factors impacting it. The analysis will be done regarding the clientele effect, signaling and agency theories, and the aspects that might be discussed within this framework. Under these conditions, the primary objectives include:
- Define the dividend policy and discuss its importance
- Discuss factors linked to it
- Determine the clientele effect
- Determine the signaling and agency theories
- Compare theories and their impact on dividend policy
- Conclude about the correlation between the dividend policy and the discussed theories.
The structure of the answer implies the introduction with the objectives, the main body offering information about the dividend policy’s main theories, their comparison, and the conclusion. It will promote a better understanding of the issue and credible conclusions.
Dividend Policy
The practice of selling a company’s shares is one of the fundamental aspects of the business world. A share is a specific unit of equity ownership in a particular firm (Lease et al., 2000). In other words, it is a part of the company owned by an individual who invests in its further development. A person holding a share becomes a shareholder and can enjoy benefits and profits earned by the company. The percentage and the amount of money acquired due to being a shareholder depends on a firm and its current dividend policy. In such a way, the dividend policy becomes one of the central factors impacting the individual’s and investors’ desire to participate in the firm’s further rise and development.
The term can be described in various ways because of multiple perspectives on it. Thus, the most generalized one views dividend policy as the approach used by the company to structure its dividend payout that is provided to shareholders (Manos, 2008). The amount of a firm’s earnings that should be paid to individuals possessing its shares is linked to several factors, including the current state of the market, legal regulations, stability of the economic situation, demand for a certain product, and the company’s opportunities for the further development (Manos, 2008). At the same time, it is closely linked to the performance, the overall firm’s earnings, and its existing policy. It means that it is impossible to set the level of payouts in detachment from real numbers and the current state of the economy (Ghose, Baruah and Gope, 2022). Under these conditions, firms must select the most effective approaches to ensure their dividend policy is effective enough to attract new potential shareholders and ensure the old ones are interested in continuing collaboration.
Several factors evidence the critical importance of dividend policy for companies. First, it is vital to state that any firm requires a strategic policy for dividend payouts as all market participants expect to be informed about the potential income and plan their actions regarding this information. For this reason, the weak, ineffective and unregulated dividend policy will result in the growing individuals’ dissatisfaction and the impossibility of planning further financial operations (Hussain and Akbar, 2022). They might sell shares and deteriorate the company’s state and opportunities. Moreover, it might precondition the instability in the market and its collapse. For this reason, the dividend policy is an integral part of the modern markets and ensures the stable work of the business world. It is critical to consider factors impacting it and forecast possible alterations and payouts to ensure the firm continues its evolution.
Factors Affecting the Dividend Policy
The complexity of establishing an effective dividend policy is linked to the high level of modern markets’ sophistication. Numerous aspects are interconnected, and the change in one of them results in the corresponding alteration in a set of others. At the same time, some fundamental aspects should be considered when planning the returns on investment. These might include legal rules regulating the work of companies within a state, stability of earnings, and the current state of markets (Khan et al., 2022). These factors have a critical impact on the work of any firm and its dividend policy. The company cannot establish the amount of money paid to shareholders if the given elements are not considered. Furthermore, their analysis might require the understanding of theories, such as signaling and agency ones (Labhane, 2019). In such a way, it remains a complex and vital issue.
Legal rules are considered the central issue impacting the work of the firm and its dividend policy. This aspect also affects the major theories applicable to the sphere, meaning it is critical to acquire its improved understanding. Thus, the extent to which the company can pay dividends or retain earnings is regulated by legal rules (Omerhodzic, 2014). Following the existing legal field, the three major rules are critical for the dividend policy, such as the net profit rule, capital impairment rule, and insolvency rule (Omerhodzic, 2014). The first one says that dividends that past and current earnings can be used for dividends (Omerhodzic, 2014). The second one guarantees that the capital will not be used for dividend payout (Omerhodzic, 2014). Finally, the last rule says that dividends cannot be paid if their liabilities exceed their assets value (Omerhodzic, 2014). These major regulations are critical for determining the dividend policy of any firm.
At the same time, the legal aspect is considered by most theories speaking about dividends, such as the signaling and agency ones. The given factor is central for forecasting the possible changes in the strategy of payouts employed by a firm. Any organization cannot function regardless of the existing legal field as it will be considered a severe violation of the current rules and might imply specific punishment. From another perspective, shareholders are also impacted by the law, and they cannot ask for additional payments or bonuses that are not outlined by the current rules. In such a way, the given framework ensures that all parties will be satisfied by the existing policy and will acquire the chance to monitor the functioning of every party, which is critical for transparency and the absence of possible frauds or manipulations.
The companies also consider the stability of earnings by establishing their own dividend policy. It is one of the critical factors that should be taken into account by the top management as it ensures a high level of shareholders’ satisfaction and their readiness to continue cooperation with the firm. An organization with stable earnings can always perform a rough assessment of its future income (Omerhodzic, 2014). In such a way, it acquires the chance to reconsider its current dividend policy and offer a larger percentage of its earnings than the firm with an unstable income (Lofti, 2019). In case the earnings decrease, the company will have to find funds to pay shareholders, which means it is easier to introduce a lower dividend and guarantee that all money will be paid (Omerhodzic, 2014). It will help to avoid the growing dissatisfaction from investors and partners.
At the same time, the stability of a company’s earnings is linked to the degree of interest shown by the clients and potential partners. In such a way, it is possible to admit that the dividend policy is interconnected with the current state of the company, its clients, and the stability of external and internal factors. The inability to forecast the firm’s growth might become a crucial factor leading to the undesired results (Patnaik and Das, 2018). Possible restrictions on earnings and payments might worsen the firm’s image and create the basis for the radical reconsideration of its current strategy and functioning. In such a way, the stability of earnings associated with the overall company’s performance remains a critical factor that might influence dividends. The leading dividend theories also accept the importance of this factor (Saravanakumar, 2011). It should be considered when planning relations with shareholders.
Finally, access to capital markets is an important determinant of the dividend policy. The ability to use alternative sources of financing and the simplified access to capital guarantee a more effective dividend policy and contribute to the more stable position of a firm (Omerhodzic, 2014). In such a way, a specific dilemma might emerge. Big and reputable companies have easier access to these markets and can benefit from the wide range of options to select additional investments (Omerhodzic, 2014). At the same time, potential shareholders view low and middle-sized firms as riskier (Omerhodzic, 2014). It impacts the dividend policy and results in attempts to find access to alternative markets. The dividend policy might be less effective if access to capital is limited. The size of bonuses might be reduced and influence the shareholders’ satisfaction levels.
In general, the three factors mentioned above are critical for determining the dividend strategy and guaranteeing that both the firm and shareholders will benefit from the selected approach. At the same time, the given factors can be viewed as a part of a bigger external environment impacting the work of any firm. For this reason, there are specific theories that can be used to analyze the issue and determine the possible steps and actions to avoid failures. These might include the clientele effect, signaling, and agency theories. Their enhanced understanding is vital for determining the major aspects impacting dividends and the role they play in the work of a firm. For this reason, their discussion is critical for concluding about the effects described in the outlined theories and their importance for the selected topic.
Major Theories
Dividend clientele theory is one of the frameworks used to analyze the dividend strategy. It rests on the clientele effect, or the idea that a specific movement in a company’s stock price is linked to the investors’ current demands, goals, and desires (Omerhodzic, 2014). As far as the tax changes, the demand for dividends starts to alter, which means that a firm has to respond by altering the policy of working with its shares (Omerhodzic, 2014). In such a way, the dividend clientele theory rests on the idea that potential investors find various companies attractive and worth investing because of their dividend strategies (Omerhodzic, 2014). For instance, the fast rise of Indian companies might be explained by the beneficial dividend strategy offered to clients at different stages of their evolution (Dhamija and Arora, 2019). It helped to find sources for the fast rise and stable earnings generation.
Thus, the existence of the clientele effect is an essential factor for any firm to consider. Its presence means that some shares are already sold, and the company already has shareholders who find its dividend policy attractive (Wechta, 2022). Following this assumption, top management can continue using the same model as it ensures the desired level of attractiveness for investors (Karunarathne et al ,2021). At the same time, if a firm is inconsistent and fails to select an effective dividend policy, shareholders might sell shares, which will also promote a decrease in their popularity (Singh and Tandon, 2019). In its turn, it will impact share prices and the cost of capital, which serve as important determinants of the company’s health (Wechta, 2022). In such a way, the clientele effect can be viewed as an important factor influencing the dividend strategy and the work of companies in general.
Signaling theory is another broad framework that can help to explain factors affecting the dividend policy. It implies that the company’s CEOs possess an enhanced understanding of the firm’s rise (Karunarathne et al ,2021). For this reason, they also possess more relevant information about future changes than shareholders (Gupta and Aggarwal, 2018). In such a way, if the dividend policy is altered and a new and higher percentage is introduced, the top management might possess credible evidence of the outstanding company’s rise in the future (Omerhodzic, 2014). It might be interpreted as a signal that financial prospects will be better than those forecasted by external specialists or markets (Gupta and Aggarwal, 2018). Following the positive change, shareholders and potential investors might start buying more shares and offer new resources for the company (Gupta and Aggarwal, 2018). On the other hand, lowering dividends might signal problems within the company and poor earnings, which might also be considered a sign of profound changes.
The signaling theory might be used to explain the changes in the dividend policy used by the company. Planning future actions, the top management uses information about access to markets, legal regulations, and the stability of its earnings. The positive alterations of these factors might be considered a signal for making the dividend policy more attractive, which might help to generate multiple benefits for a firm. At the same time, following the given theory, the dividend policy becomes dependent on the competency of the top management and their ability to understand the current trends, interpret them, and forecast the following alterations in the market (Omerhodzic, 2014). In such a way, signaling theory becomes one of the important steps for a better understanding of how the company might determine the amount of payment and its relations with shareholders.
The peculiarities of the dividend policy and its formation can also be understood using the agency theory. It states that in numerous cases, dividends can be used as a specific control device when existing provisions are not satisfactory or unfavorable for stakeholders (Omerhodzic, 2014). The higher number of control variables gives firms a chance to succeed and introduce a more robust and attractive dividend policy (Karunarathne et al ,2021). From another perspective, agency theory assumes that firms might pay higher dividends when insiders hold specific information that might be used to create the basis for the following growth (Karunarathne et al ,2021). From another perspective, the firm can be viewed as a set of contracts and interactions between individuals who are interested in its functioning (Omerhodzic, 2014). From this perspective, dividends should be established regarding the interests of all shareholders and parties.
At the same time, the agency theory considers other factors that impact payments for shareholders. As far as firms might use it as a control device, the top management might have to consider the existing laws, stability of earnings, and access to capital to form the appropriate offering and provide it to clients (Teng and Liu, 2018). Otherwise, there is a high risk of growing dissatisfaction among shareholders and reduced attractiveness of shares in the market. In such a way, the agency theory views dividends as a result of interactions between parties possessing various priorities and interests, which results in an attempt to establish a fair price and guarantee there are no problems in the future. The lack of cooperation between all parties might promote the failure of the whole firm and its inability to continue evolution and growth.
Theories Comparison and Discussion
In general, the three discussed theories are critical for understanding how the dividend policy is formed. Along with such factors as legal regulations, access to markets, and stability of earnings, the clientele effect, and the agency and signaling theories demonstrate how the amount of money paid for each share is decided. Comparing the theories, it is possible to conclude that they focus on various aspects of dividend formation. The clientele approach emphasizes the clients’ interests and their contribution to the company’s position in the market and earnings. The signaling framework focuses on CEOs and their critical role in the formation of the strategy, while the agency theory views dividends as the control device impacted by all parties and their interests. Regardless of the difference in perspectives, all theories touch upon the relevant and essential issues that companies should consider while introducing their policy and cooperating with clients. However, from the analysis and investigation of previous factors, it is possible to admit that the clientele effect is of the most critical factors that the top management should consider.
The work of any company and its evolution depend on the level of clients’ interest. It guarantees a high level of sales, involvement, and stability of earnings. Moreover, clients might transform into potential partners because of the stable firm’s growth and its ability to generate income (Karunarathne et al., 2021). Under these conditions, individuals’ desire to buy a company’s shares regarding the existing laws is one of the key factors explaining the formation of the dividend policy. The clientele effect shows that some of the shares are already acquired, which allows the top managers to introduce a better price and increase the amount of payment for all shareholders, hoping for a future rise. In such a way, there is a certain system consisting of interconnected elements. The company’s excellent performance attracts more clients and investors, which also increases the attractiveness of shares. As a result, they are bought by shareholders, which ensures additional capital that can be used for development and growth. The examples from the Japanese and Indian markets show that companies focused on attracting new investors through their dividend policies are more successful in the long run (Dhamija and Arora, 2019; Khan et al., 2022). In such a way, the clientele effect is one of the most critical factors affecting the dividend policy.
Conclusion
Altogether, the dividend policy is one of the critical factors impacting the success of any firm and its ability to evolve. It is essential to retain shareholders and ensure they are interested in acquiring new shares. However, too high or too low payouts might be a severe problem for a firm and limit its opportunities for successful development. Under these conditions, it is vital to consider numerous factors, such as existing laws, capital markets, and earnings stability, and analyze them regarding the existing theories. The clientele one explains the establishment of the strategy regarding the clients’ interest in the company and its shares. It helps to understand the possible demand and plan future actions.
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