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Southeastern Steel Company Case: Distribution policy

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Question a (1)
A company's distribution policy is its decision on how much of its earnings it wants to pay out to its shareholders as opposed to reinvesting such earnings into the organization.
More and more companies now are using these earnings to repurchase their own stocks rather than an outright cash distribution to owners.

Question a (2)
Dividends' irrelevance was popularized by Miller and Modigliani (MM) Theory. The theory states that an organization's dividend policy has no impact on its cost of capital or on the wealth of its shareholders - hence why create one in the first place.

Dividend preference on the other hand states that investors have varied preference as regards dividends. Some actually prefer dividends while others are averse to it.

Bird in the hand theory postulates that investors prefer a dollar of dividend now that a dollar reinvested into the company which has a potential of being more.

Question a (3)
The above theories indicate that when management is deciding on what distribution policy to adopt, it has to balance different interests from its stockholders and take into account several factors. However, at the end of the day, the policy should always support the goal of maximizing shareholder wealth.

Question a (4)
Unfortunately, empirical testing hasn't been able to identify which of the above three theories is correct. Hence, management must rely on their judgment when setting distribution policy tempered with analysis.

Question b
The signaling effect or information content of dividends pertains to the fact that a firm's board of directors uses its approved dividend policy to signal to investors how the organization is actually doing. For example, increase in dividends is usually associated to an expected higher future income. Hence, the board of directors threads carefully in setting its dividend policy lest it signals the wrong information.

Clientele effect describes the preferences of some investors to own shares that ...

Solution Summary

Southeastern Steel Company Case distirbution policy is examined.