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Relevance of Dividend Policy

Generally, the firms pay dividend and view such dividend payments positively. The investors also expect and like to receive dividend income on their investments. The firm not paying dividends may be adversely rated by the investors thereby affecting the market value of the share. The basic argument of those supporting the dividend relevance is that because current cash dividends reduce investor’s uncertainty, the investors will discount the firm’s earnings at a lower rate. Ke, thereby placing a higher value on the shares. If the dividends are not paid then the uncertainty of shareholders/investors will increase, raising the required rate, ke, resulting in relatively lower market value of the share and the value of the firm. The market price of the share will increase if the firm pays dividends, otherwise it may decrease. A firm must therefore pay dividend to shareholders to fulfil the expectations of the shareholders in order to maintain or increase the market price of the share.

Two models representing this argument are discussed below:

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