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Dividend Policy and Stock Prices

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Does the good news conveyed by the announcement of a dividend increase mean that a firm can increase its stock price in the long run simply by paying cash dividends?

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This posting discusses the impact of dividend policy on stock prices.

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The good news conveyed by the announcement of a dividend increase does not mean that a firm will experience an increase in its stock price in the long run by paying dividends.

The good news conveyed by the dividend announcement may not matter because the decision is between paying dividends and retaining funds to reinvest in the firm. The argument provided is that if a firm reinvests the money now, the firm will grow and can pay higher dividends in the future. Whether a firm pays dividends or not is irrelevant to the stock price. The chapter gives factors that support a low payout. These factors are taxes, cash outflow for paying dividends, and dividend restrictions. The factors that support a higher dividend are the need for current income; uncertainty if there will be higher dividends in the future, and to gain tax and legal benefits from high dividends. According to the same chapter, dividends have a signaling function. If dividend increases, it signals that management believes that higher dividend can be sustained, there is an expectation of higher dividends and an indicator that the firm is growing healthily. This signal may help increase stock prices. On the other hand, if there is a ...

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Kasim Johar, MBA
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  • BSc, University of Calcutta
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