INTRODUCTION (DIVIDEND DECISIONS)

INTRODUCTION  (DIVIDEND DECISIONS)

Financial management is the process of making financial decisions. Financial decision broadly covers three areas:

i. Financing decision

ii. Investment decision

iii. Dividend decision

Dividend decision is one of the most important areas of management decisions. It is easy to understand but difficult to implement. Let’s understand this with the help of an example, suppose a company, say X limited, which is continuously paying the dividend at a normal growth rate, earns huge profits this year. Now the management has to decide whether continue to pay dividend at normal rate or to pay at an increasing rate? Why this dilemma?

The reason is that, if the management decides to pay higher dividend, then it might be possible that next year, the company will not achieve such higher growth rate, resulting the next year’s dividend will be low as compared. However, if the company decides to stay on the normal rate of dividend then surplus amount of retained earnings would remain idle which will result in over capitalization, if no opportunity existing to utilize the funds.

Also there are more factors which will affect the dividend decision (will be discussed later) There are few theories which put light on the complexities involved in dividend decision. These theories will be discussed under two categories

Irrelevance theory: MM approach

Relevance theories: Walter model & Gordon Model