Regular Dividend Paying vs. Reinvestment in Growth Firms

Enhancing Return for Shareholders

Earnings through regular dividends or through reinvesting in the way of capital gains of the share price both act as a form of return for the investor and are different in there factors for thinking and approaching the same. The reinvestment of the dividend by the high growth firms often reinvests the dividend proceeds in the operations of the company for bringing a turnaround in the company with higher set of returns (Means 2017). The regular dividend pay-out policy is often followed by companies which are stable in nature and they are well established firms spending their resources mostly in the operating side of the company. However, the high growth firms are those, which usually invest their resources in the capital expenditure of the companies (Gitman, Juchau and Flanagan 2015). In the context of developed markets and the dividend history of these firms shows that firms have usually opted out for regular dividend instead of reinvesting and the same is dependent on the different dividend policies followed and analysed. It depends from industry to industry and the type of business the company operates which influences the dividend pay-out policy of the firm and the return created for the shareholders which is linked with the same (Floyd, Li and Skinner 2015).

The relevance theories in context to the dividend policy there are two approaches for the dividend policy from the investor choice of dividend policy. The tax aversion theory shows that assuming less amount of tax deductions and less tax gain on the same will make investor select stocks which offers high growth return rather than regular dividend paying firms or stocks. Investors approach for investment and the way the investor perceives about the particular kind and class of investments are the key factors to be taken care before analysing (Vandemaele and Vancauteren 2015). However some investor or shareholders believe that the management of the company should preferably follow the regular dividend pay-out policy rather than the reinvestment strategy and promising for higher returns which are based on the expectation of the company. Since, the same is based on forecast and if the market and current internal and external environment of the business changes then the same would not be able to create the promised return for the shareholders of the company (Yagan 2015). Most of the investor prefer that companies should pay-out the dividend and they have been investing in such companies in the developed market where such dividend policy is followed. Empirically it has been found that investor prefer the “bird in hand theory” dividend policy as given the poor corporate governance structure of the management tendency to overinvest in asset class which may or not may lead to wealth creation (Baker and Kapoor 2015). This is the main reason why investor do not prefer reinvestment of dividend which is followed by growth companies and hence are given less preference. The dividend history of firms in the developed market varies from industry and the type, nature and establishment of the companies and every company has their different perspective for creating value for the shareholders of the company.  The overall stock return for the companies following regular dividend has given a good and a stable source of return for the investors (Buchanan et al. 2017).

Relevance Theories and Investor Choice of Dividend Policy

In developed market is quite often seen that companies which pay-out regular dividends are preferred but value investors might not always prefer this as growth firms can often bring out an additive value creation for the investors in the long term. There are some of the companies in the developed market in the real estate and pharmacy sector where the growth of the firm primarily depends on the operations of the company as the company primarily invests in investing activity if the companies which take a longer period of time for bringing desired return for the investors (de Langen and van der Lugt 2017). The ‘high growth’ firms usually has a higher amount of retention ratio than pay-out ratio so as to reinvest the proceeding or the cash flows of the company in the primarily source of operations of the company. The constant dividend pay-out policy firms in the long term has been preferred by the investors. Companies which have shown increased dividend payment ratio has shown a negative signalling effect for the investor that the company is now lacking investment opportunity. Decreasing dividend pay-out policy shows that companies is having more investment opportunities and it would invest more into the operations of the company (Bliss, Cheng and Denis 2015). Thus companies should follow a constant dividend pay-out ratio as the same would not create any signalling effect by the investors. As stated growth firms in real estate sector in the developed markets take a longer period of time for creating profitability for the investors as there primarily source of operations gets blocked in real estate projects which take a longer period of time for selling (Michiels et al. 2015). These real estate projects and companies initially have a high amount of business risk associated with them and in order to reduce the financial exposure the company does not prefer external debt approaches and prefer to use the internal source of the fund such as dividends generated. These amounts are itself used by the company for reinvesting because if the companies goes for external debt then it would get the same at a much higher cost and would also increase the financial risk along with the business risk of the company (Yegon, Cheruiyot and Sang 2014). The reinvestment of dividend would be a much cheaper source of borrowing for the company and would also give the company an opportunity for saving interest cost and would also enhance the cash flow or net income of the companies that would further enhance return for the shareholders in the long term. There are generally two source of growth for the company which are organic growth or inorganic growth for the firms. Investors prefer growth companies which usually follow organic growth approach by investing more into operations, plant and machinery, equipment and technology. However, inorganic growth approach is usually accomplished by acquiring target companies which is the same line of business operations at the same, which is given a less amount of preference by the shareholders of the company. It has been empirically found that companies following the inorganic growth strategy in the form of mergers and acquisitions have resulted in destruction of wealth. Investors prefer that companies should follow organics growth approach so that the probability of achieving higher operational return and efficiency increases (Geng, Yoshikawa and Colpan 2016).

Preference for Constant Dividend Payout Ratio

Based on the research above it is recommended that shareholders should invest in companies and firms that follow regular dividend pay-out policy. The constant dividend pay-out policy firms in the long term has been preferred by the investors. It is recommended for the investors to invest in stocks that pay-out regular and constant dividends that states that the operations and the income flow for the company is stable. Investing in growth firms with the aim of earnings higher via capital gain is often considered on probability and expectation bias where the hope of earnings more in the form is capital gain is less. Growth firms, which reinvests the dividend and which have not maintained any past track record of dividend for the firm are often considered to be risky and the corresponding return for the investor can also turn out be good if the company operates well (Baker and Weigand 2015). Every investment whether in the growth firm or in the value firm should be based on the risk and return profile of the investor. There are certain fields that the investors should take into considerations before investing into particular stock or asset class such as tax considerations and the implication of taxation effect at the time of return evaluation for the asset class. Similarly the use and incorporation of macro-economic factors like inflation should also be considered for evaluating the expected return on an asset class. It is also important for the investor for proper risk assessment of the stock and the asset class and the corresponding effect on the return on the asset class. Hence a number of factors should be incorporated for the proper assessment and evaluation of investment opportunity (Huang and Paul 2017).

Reference

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Baker, H.K. and Weigand, R., 2015. Corporate dividend policy revisited. Managerial Finance, 41(2), pp.126-144.

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Buchanan, B.G., Cao, C.X., Liljeblom, E. and Weihrich, S., 2017. Uncertainty and firm dividend policy—A natural experiment. Journal of Corporate Finance, 42, pp.179-197.

de Langen, P.W. and van der Lugt, L.M., 2017. Institutional reforms of port authorities in the Netherlands; the establishment of port development companies. Research in Transportation Business & Management, 22, pp.108-113.

Floyd, E., Li, N. and Skinner, D.J., 2015. Payout policy through the financial crisis: The growth of repurchases and the resilience of dividends. Journal of Financial Economics, 118(2), pp.299-316.

Geng, X., Yoshikawa, T. and Colpan, A.M., 2016. Leveraging foreign institutional logic in the adoption of stock option pay among J apanese firms. Strategic Management Journal, 37(7), pp.1472-1492.

Gitman, L.J., Juchau, R. and Flanagan, J., 2015. Principles of managerial finance. Pearson Higher Education AU.

Huang, W. and Paul, D.L., 2017. Institutional holdings, investment opportunities and dividend policy. The Quarterly Review of Economics and Finance, 64, pp.152-161.

Means, G., 2017. The modern corporation and private property. Routledge.

Michiels, A., Voordeckers, W., Lybaert, N. and Steijvers, T., 2015. Dividends and family governance practices in private family firms. Small Business Economics, 44(2), pp.299-314.

Vandemaele, S. and Vancauteren, M., 2015. Nonfinancial goals, governance, and dividend payout in private family firms. Journal of Small Business Management, 53(1), pp.166-182.

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