The value of a firm keeps changing due to changes in economic activities. In academic literature, these economic activities are precisely termed as ‘corporate event’. Corporate actions/events and changes in corporate payout policies are important considerations for the finance managers while taking financial decisions. In particular, corporate actions such as cash dividend announcements have information content and are used by managers to signal the future prospects of the firm. They reduce information asymmetry between the mangers and shareholders through the private information reflected in the stock prices. The significance of dividend payment/announcement is expressed by Ezra Solomon in these words: In an uncertain world in which verbal statements can be ignored or misinterpreted, dividend action does provide a clear-cut means of ‘making a statement’ that speaks louder than a thousand words. The same has been expressed by Gordon (1963) as payment of dividends (in the hand) is worth more than retained earnings (in the bush), due to the risk of sub-optimal investment decisions by managers.
Shareholders’ wealth is represented in the market price of the company’s common stock, which, in turn, is the function of the company’s investment, financing and the dividend decisions. Dividend decisions involve the periodic determination of the proportion of a firm’s total distributable earnings that is payable to its ordinary shareholders. They are considered as the fundamental building blocks of the corporate payout policy. Historically, cash dividends have been considered as the most important form of the payout policy. They are one of the principal mechanisms by which firms distribute cash to their shareholders. These decisions typically carry informational content concerning the value of the firm and, by and large, impact the return, risk and liquidity of the shares.
The market reaction of dividends (by and large) in India supports the Lintner’s (1956) model to be the best fit explanation for dividend behavior. Announcements of corporate actions and their impact on share prices are likely to affect the value of the firm and returns to the investors. It implies that dividends serve as a ‘signaling’ mechanism implying the firm’s future promise to disburse free cash flow and positive future earnings prospects. However, apart from the instant market reaction (represented through returns), it is desirable to understand the fundamental and the psychological factors behind these decisions/announcements. The Indian stock market has huge information asymmetry existing between the managers and the shareholders. Dividend decision is amongst the major financial decisions taken by the firm, the top level finance personnel (Directors/ Vice President/Company Secretary/ Managers) are directly involved in taking these decisions. Hence, it also becomes desirable to gauge/understand the viewpoint of the Indian finance managers behind the announcement of cash dividends. In other words, what are the driving forces and the motivations/perceptions of the management announcing these decisions?.
The Indian managers companies rely both on the past dividend and current earnings in deciding the current period’s payment of dividend. These companies also place more emphasis on dividend stability, as evinced by the fact that the dividend practices of Indian companies have been found to be unaffected by the financial crisis. At the same time, dividend announcing companies are considered to have a strong outlook regarding their future earnings prospects as perceived by the investors.In India, cash dividends also serve the purpose to attract more investors. Investors have strong preference for cash dividends, thereby increasing the market value of the firm. Cash dividend provides a positive impact on the firm’s future prospects and facilitates in maintaining a stable stock price. Dividends are a definitive statement about the ability of management to achieve profitable growth on a sustainable basis among Indian investors as supported with Black’s (1986) suggestion; “I think we must assume that investors care about dividends directly”.
The reaction of the investors subsequent to these corporate announcements helps the corporates, practitioners, market analysts, institutional investors and financial system in evaluating financial decisions like payout policy, investment strategies, construction of optimum portfolios and the availability of information to the investors. They would also provide an insight to the academicians and researchers into how Indian finance managers use the assumptions, models and decision rules generated in teaching/making financial decisions. Further, these decisions are also meant to be considered by various regulatory authorities to improve the informational efficiency of the Indian stock market. Since, these corporate actions have signaling power to indicate the future prospects of the firm, it becomes vital for the managers to identify the growth and investment opportunities prior to taking such decisions. At last, the instant reaction emanating, might help understand investors and the firms to examine the wealth and enhance the value of the firm.
References
•Black, F. (1986). Noise. The Journal of Finance, 41(3), 528-543.
•Gordon, M. J. (1963). Optimal investment and financing policy. The Journal of Finance, 18(2), 264-272.
•Lintner, J. (1956). Distribution of incomes of corporations among dividends, retained earnings, and taxes. The American Economic Review, 46(2), 97-113.
