Dividend Policy and Shareholder Returns: A Comparison of Strategies

This essay examines the contrasting approaches of dividend-paying and growth firms in enhancing shareholder returns. Dividend-paying firms typically follow a stable, regular payout policy, often preferred by investors seeking consistent income, particularly in developed markets. These firms are usually well-established and focus on operational efficiency. Conversely, growth firms reinvest earnings into capital expenditures and expansion, aiming for higher capital gains in the future. While some investors favor the 'bird in hand' theory, preferring immediate dividends due to concerns about corporate governance and potential overinvestment by management, others are drawn to the potential for long-term value creation through growth. The essay highlights that a constant dividend payout ratio can avoid negative signaling effects and that investors should consider factors like tax implications, macroeconomic conditions, and risk assessment when evaluating investment opportunities. Ultimately, the recommendation is that investors should generally favor firms with a consistent dividend payout policy, as it indicates stability and reliable income, although the optimal choice depends on the individual investor's risk and return profile. Desklib provides access to similar essays and study resources for students.

Running head: ADVANCED FINANCIAL ACCOUNTING
Enhancing Return for Shareholders: Dividend-Paying vs. Growth Firms
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2ENHANCING RETURN FOR SHAREHOLDERS: DIVIDEND PAYING VS 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

3ENHANCING RETURN FOR SHAREHOLDERS: DIVIDEND PAYING VS GROWTH FIRMS
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).
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

4ENHANCING RETURN FOR SHAREHOLDERS: DIVIDEND PAYING VS GROWTH FIRMS
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

5ENHANCING RETURN FOR SHAREHOLDERS: DIVIDEND PAYING VS GROWTH FIRMS
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).
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).

6ENHANCING RETURN FOR SHAREHOLDERS: DIVIDEND PAYING VS GROWTH FIRMS
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