Requirements or Institutional Investors Homework Help

Requirements or Institutional Investors

A third factor encouraging stable dividend policy is the requirement of institutional investors like life insurance companies, general insurance companies, mutual funds and so on, to invest in companies which have a record of continuous and stable dividend. These financial institutions owing to the large size of their investible funds, represent a significant force in the financial markets and their demand for the company’s securities can have an enhancing effect unit, price and, thereby, on the shareholder’s wealth. A stable dividend policy is a prerequisite to anract the investible funds of the institutions. One consequential impact of the purchase of shares by them is that then, may be an increase in the general demand for the company’s shares. Decreased marketability risk, coupled with decreased financial risk, will have a positive effect on the value of the firm’s shares.

According to John Lintner’s study, dividends are sticky in the sense that they are slow to change and lag behind shifts in earnings by one or more periods. Most firms, in addition to maintaining a stable rupee amount of dividend, also have target payout ratios (long-run dividend payout ratio) which they aim at. The firms may plan a high or low long-run target payout ratio regardless of their policy towards period to period dividend stability. The desire to maintain the present dividend level may conflict with strict adherence to any particular target payout ratio especially when earnings per share drop off even temporarily. To avoid the necessity of reducing the dividend because of a lean year and to maintain progress towards the target payout ratio, firms raise their dividends per share gradually, as the earnings per share rise. Thus, Lintner concludes that dividends represent the primary active decision variable in most situations. Savings or retained earnings in a given period generally are largely a by product of dividends action, taken in terms of well established practices and policies. Dividends are seldom the residual decision.

According to Lintner, dividend is a function of earnings of that year, existing dividend rate, target payout ratio and speed of adjustment. In symbolic terms.

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In summing up, it can be commended that a company should seek a stable dividend policy which avoids occasional reduction of dividends. Investors favourably react to the price of shares of such companies and there is a price enhancing effect of such a policy as it resolves the uncertainty from the minds of the investors regarding the anticipated stream of dividends. Above all, it projects the image of a stable operating environment. An increase in the dividend communicates the feeling of a firm entering a new period of prosperity.

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