Dividend policy

                This week I will talked about how a company make decision between dividends or reinvest the retained earnings to some positive NPV projects. This topic is related to the previous topic that I posted last week. Every company will have their own ways to make profit. Some companies will prefer more debt than equity or vice versa. But in order to make sure that shareholders will not stop investing your company and  a company can increase its value each year, it has to give some return back to the shareholders as well. At this point, companies will come into a tough decision of either giving dividends to its shareholders or reinvest into some other positive NPV projects. Well, either way the company will also bring benefits to the shareholders in long term. Some shareholders will look at the dividend payout ratio before they invest into that company while some will look at the retained earnings of the company and what recent projects that the company plans to invest in.

                According to Modigliani& Miller (1961) theory, it says that the share prices are determined by the future earning potential not the dividends that will be paid now. Therefore, the share value is determined by investment policy and not the amount of earnings distributed. M&M also argue that he dividend decision is mainly financing and investment decision with any money that is leftover after a company invests in all positive NPV projects. Thus, the timing of dividend is not really important and investors should look at the long term of the investment instead. In my opinion, I think that dividend will not be the main concern for me to invest my money. It is because if a company chooses to reinvest the money into some NPV projects, then the share prices will increase. By that time, if investors prefer to get return back from the company, they can just sell some of their shares away. For example, Google Inc. is a big company that does not pay dividend to its shareholders. Google choose reinvest its retained earning into different type of project which has positive NPV where it may be good to shareholders because it might have a large capital gain in long term. However, by doing so, there are disadvantages to the shareholders because the risks of reinvesting money to other projects are uncertainty. Therefore, shareholders might not feel safe and confident in investing company like Google. Besides that, a company might not choose to reinvest the profit into other projects but to do share re-purchase schemes as ways of returning cash to shareholders instead. This is also a good way for the company to increase gearing without taking more debt and incurring interest cost. By doing so, it can increase the share price due to the lesser shares in the market and it can prevent someone to take over the company.  

                On the other hand, some shareholders will prefer company that pay dividend to shareholders like Apple Inc. It is because they can know whether the company is doing well or not. If a company is doing well, it could give a better dividend back to their investors and investors can use the money to invest in other positive NPV project that they prefer. Despite that, investors will have to pay taxes when they collect dividends. In company’s perspective, paying dividends will restrict the company from having lesser opportunity in investing positive NPV projects.

                As you can see, Google Inc. and Apple Inc. are large company in the world and both companies have used different method to create shareholder’s value. Thus, there is no best way of creating value for the company as well as to the shareholder’s wealth. If you are an investor, will you prefer a company that helps you reinvest your money into other positive NPV projects or give dividends? I believe most of the investors who are not willing to take high risk will prefer a company that gives dividend regularly. Please leave a comment and let me know what you think about the dividend policy for different companies.