Dividend Policy - Nepal’s Capital Market and Corporate Finance

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CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Companies that earn profit can decide either of three ways: pay that profit out to shareholders, reinvest it in the business through expansion, debt reduction or share repurchase, or both. When a portion of the profit is paid out to the shareholders, the payment is known as dividend.

Dividend is a part of net income paid to shareholders and dividend decision is all about the appropriation of the past income. It is defined as that portion of net income of the firm, which is distributed to the shareholders either in the form of cash or stock, as per its dividend policy. Dividend policy is a firm’s decision regarding the size of dividends it will pay to its shareholders. Dividend policy involves the decision to pay out earnings versus retaining them for reinvestment in the firm. And dividend policy should be optimal which balances the opposing forces and maximizes stock price.

Nepal’s capital market and corporate finance is facing issues from the actions of dividend policy. Investors in developing countries like Nepal mostly look for profitability of the firm while purchasing equity shares from the secondary market. Since dividend paid to the shareholders is one of the best indicators of profitability, it is believed that dividend plays a crucial role in determining market price of the corporate share (Khadka, 2012). The attraction of dividend policy has increased over the last few decades. Globally, people think that dividend policy has strong impact on the firm performance. Among the four main decisions in finance, dividend policy is a key decision affecting the value of the firm’s common stock. The other decisions include financing, investing and working capital. Different companies argued that dividend decision is of great importance because it predicts the amount of funds transferred to investors and retained earnings of firm for future investment.

The area of corporate dividend policy has attracted attention of management scholars and economists reaching to apex into the theoretical modeling and empirical examination. According to the black (1976), “the harder we look at the dividend picture the more it seems like a puzzle, with pieces that just don’t fit together”. He argues that paying

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dividends can mitigate a potential over investment problem because, they reduce the amount of free cash flow.

Since the joint stock companies came into existence, dividend policy has been an issue of interest in financial literature. Dividends are generally defined as the distribution of earnings in real assets among the shareholders of the firm in proportion of their ownership (Thapa and Basnet, 2014).

1.1.1 Dividend payment procedures

The dividend payment procedures on behalf of a corporate firm can be given below:

 Declaration date

The BOD meets on this day and declares a specified amount of dividend to be paid to the shareholders as of the holders-of-record date.

 Holder-of-record date

On this date, the company closes its stock transfer book and makes up a list of the shareholders receiving the dividend. If the company is notified of sale and transfer of stock after this date, the old shareholder gets the dividend.

 Ex-dividend date:

The date when the right to the dividend leaves the stocks is ex-dividend date. It is set by the brokerage business to avoid the conflict over dividend right due to delay in notifying the sale and transfer of shares to the firm. Ex-dividend date is four business days prior to the holders of record date.

 Payment date:

On this date, the company actually mails the dividend checks to the holders of record date.

1.1.2 Forms of Dividend

 Cash Dividend

Cash dividend is the dividend which is distributed to the shareholders in cash out of the earnings of the company. When cash dividend is distributed, both total assets and net worth of the company decrease as cash and earnings decrease. The

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market price of share drops in most case by the amount of the cash dividend distributed.

 Stock Dividend

A stock dividend occurs when the board of directors authorizes a distribution of common stock to existing shareholders. It increases the number of outstanding share of the firm’s stock. Under stock dividend, shareholders receive additional shares of the company instead of cash dividend. There is no cash involved in a stock dividend.

 Stock Split Dividend

It is another form of dividend payment that increases the number of share outstanding for each shareholder but consequently reduces the par value of each share. A stock dividend of more than 20-25 percent of the number of share previously outstanding is called a large stock dividend or stock split. A stock split can be compared to a reserve stock split which reduce the number of share outstanding and increase the per share price.

1.2 Statement of the Problem

 What is the impact of dividend policy on the firm’s performance?

 Is there any significant relationship between dividend policy and firm’s profitability?

 What is the impact of dividend policy on investment?

 Is there any significant relationship between dividend policy and earning per share of the firm?

1.3 Objective of the Study

The objective of seminar mainly comprises, enhancing the conceptual as well as analytical knowledge related to current issues and practices of finance. Some of the objectives of the study are:

 To determine the relationship between firm performance and dividend policy.

 To examine the impact of dividend policy on the firm’s performance.

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 To ascertain the significant relationship between dividend policy and firms profitability.

1.4 Scope of the Study

This study tries to emphasize the dividend policy of