Dividend Policy and the Value of the Firm- a Critical Literature Review

Abstract

This independent study paper examines the extent to which dividend policy influences company value. The study begins by exploring the conceptual background of dividend policy practices, theories and variables that influence the choice of dividend policy and their effect on value of the firm. The purpose of this study is to review the theoretical literature and empirical studies on dividend theories with a view of establishing the progress and the current status of on dividend policy research. The outcome of this study will help generate research gaps that will form a basis for a more detailed research study. A detailed analysis of the existing dividend theory and empirical studies have been constructed, beginning with the land mark paper by Franco Modigliani and Merton Miller 1961 dividend irrelevance proposition, the challenge to initial propositions and subsequent developments in theory and empirical tests of the theories by researchers since then. Among the theories reviewed include clientele effect theory, bird in hand theory, signaling hypothesis and agency theory. This study has established that dividend policy influences firm value and the extent by which dividend policy impacts on firm value is intervened by firm profitability, liquidity and level of Information asymmetry. Availability of growth investment opportunities, managerial ownership and leverage are key moderating variables in dividend policy and firm value relationship. Several studies have tried to analyze the impact of key managerial decisions like dividend policy, capital structure and working capital management on the value of the firm, but so far results are inconclusive. One of the important outcomes of this study is a recommendation to investigate the impact of ownership structure on the value of the firm; the outcome of key decisions like dividend policy depends on the ownership structure of individual firms and this has implication on the value of the firm. To the investors this study recommends that they should analyze the profitability and potential investment opportunities for the firm instead of focusing on the dividends paid by the firm, they should evaluate their cash needs before investing in particular stock because important managerial decisions like dividend payment for a firm, take into account the composition of investors, ownership structure, investment opportunities and liquidity of the firm.