What role is played by a financial manager in matter of dividend policy. Discuss the alternatives that he might consider and the factors which he should take into consideration before finalizing his views on dividend policy?

What  role  is  played  by  a  financial  manager  in  matter  of  dividend  policy. Discuss the alternatives that he might consider and the factors which he should take into consideration before finalizing his views on dividend policy?

A financial manager is a person who is responsible in a significant way to carry out the finance functions. In a modern organization a financial manager occupies a key position. He or she is one of the members of the top management team, and his or her role, day-by- day  is  becoming  more  pervasive,  intensive  and  significant  in  solving  complex management problems. The finance manager is responsible to shaping the fortunes of the organization and is involved in the most vital decisions of the allocation of capital. He ensures that the funds of the enterprise are utilized in the most efficient manner.

Financial managers plan, organize, direct, control and evaluate the operation of financial and accounting departments. They develop and implement the financial policies and systems of establishments. Financial managers establish performance standards and prepare various financial reports for senior management. They play a significant role in dividend decision. They are employed in financial and accounting departments in companies throughout the private sector and in government.

Example Titles

•      controller

•      director - financial services

•      director of accounting

•      finance director

•      manager, financial control

•      manager, financial planning and analysis

•      manager, internal audit services

•      treasurer

Main duties

•      Plan, organize, direct, control and evaluate the operation of an accounting, audit or other financial department

•      Develop  and  implement  the  financial  policies,  systems  and  procedures  of  an establishment

•      Prepare or co-ordinate the preparation of financial statements, summaries, and other cost-benefit analyses and financial management reports

•      Co-ordinate  the  financial  planning  and  budget  process,  and  analyze  and  correct estimates

•      Supervise the development and implementation of financial simulation models

•      Evaluate financial reporting systems, accounting procedures and investment activities and make recommendations for changes to procedures, operating systems, budgets and other financial control functions to senior managers and other department or regional managers

•      Recruit, organize, train and manage staff

•      Act as liaison between the organization and its shareholders, the investing public and external financial analysts

•      Establish profitability standards for investment activities and handle mergers and/or acquisitions

•      Notify and report to senior management concerning any trends that are critical to the organization's financial performance.

Dividend Decisions

The size and frequency of dividend payments are critical issues in company policy. Dividend policy affects the financial structure, the flow of funds, corporate liquidity, stock prices, and the morale of stockholders. The finance manager plays an important role in the dividend policy.

The objective of dividend policy is to maximize shareholder’s return so that the value of his investment is maximized. Shareholders’ return consists of two components: dividends and capital gains. Dividend policy has a direct impact on these components.

A Low payout ratio may produce higher share price because it accelerates earnings growth. Investors of growth companies will realize their return mostly in the form of capital gains. Dividend yield- dividend per share divided by the market price per share- will be low for such companies. The impact of dividend policy on future capital gains is, however, complex. Capital gains occur in distant future, and therefore, are considered uncertain. It is not certain that low payout ratio policy will necessary lead to higher prices in reality. It is quite difficult to clearly identify the effect of payout on share price.

A high payout ratio means more current dividends and less retained earnings, which may consequently result in slower growth and perhaps lower market price per share.

Paying dividends involve outflow of cash. The cash availability for the payment of dividends is affected by firm’s investment and financing decisions. Thus, investment decisions affect dividend decisions.

There are three main factors that may influence a firm's dividend decision:

•      Free-cash flow

•      Dividend clienteles

•      Information signaling

The free cash flow theory of dividends

Under this theory, the dividend decision is very simple. The firm simply pays out, as dividends, any cash that is surplus after it invests in all available positive net present value projects.

A key criticism of this theory is that it does not explain the observed dividend policies of real-world companies. Most companies pay relatively consistent dividends from one year to the next and managers tend to prefer to pay a steadily increasing dividend rather than paying a dividend that fluctuates dramatically from one year to the next. These criticisms have led to the development of other models that seek to explain the dividend decision

.

Dividend clienteles

A particular pattern of dividend payments may suit one type of stockholder more than another. A retiree may prefer to invest in a firm that provides a consistently high dividend yield, whereas a person with a high income from employment may prefer to avoid dividends due to their high marginal tax rate on income. If clienteles exist for particular

patterns of dividend payments, a firm may be able to maximize its stock price and minimize its cost of capital by catering to a particular clientele. This model may help to explain the relatively consistent dividend policies followed by most listed companies.

A key criticism of the idea of dividend clienteles is that investors do not need to rely upon the firm to provide the pattern of cash flows that they desire. An investor who would like to receive some cash from their investment always has the option of selling a portion of their holding. This argument is even more cogent in recent times, with the advent of very low-cost discount stockbrokers. It remains possible that there are taxation- based clienteles for certain types of dividend policies.

Information signaling

A model developed by Merton Miller and Kevin Rock in 1985 suggests that dividend announcements convey information to investors regarding the firm's future prospects. Many earlier studies had shown that stock prices tend to increase when an increase in dividends is announced and tend to decrease when a decrease or omission is announced. Miller  and  Rock  pointed  out  that  this  is  likely  due  to  the  information  content  of dividends.

When investors have incomplete information about the firm (perhaps due to opaque accounting practices) they will look for other information that may provide a clue as to the firm's future prospects. Managers have more information than investors about the firm, and such information may inform their dividend decisions. When managers lack confidence in the firm's ability to generate cash flows in the future they may keep dividends  constant,  or  possibly  even  reduce  the  amount  of  dividends  paid  out. Conversely, managers that have access to information that indicates very good future prospects for the firm (eg. a full order book) are more likely to increase dividends.

Investors can use this knowledge about managers' behaviour to inform their decision to buy or sell the firm's stock, bidding the price up in the case of a positive dividend surprise, or selling it down when dividends do not meet expectations. This, in turn, may influence the dividend decision as managers know that stock holders closely watch dividend announcements looking for good or bad news. As managers tend to avoid sending a negative signal to the market about the future prospects of their firm, this also tends to lead to a dividend policy of a steady, gradually increasing payment.

Example: Dividend Policy at ONGC

Dividends are declared at the Annual General Meeting of the shareholders based on the recommendation by the Board. The Board may recommend dividends, at its discretion, to be paid to our members. The Board may also declare interim dividends. Generally, the factors that may be considered by the Board before making any recommendations for the dividend include, but are not limited to, future capital expenditure plans, profits earned during the financial year, cost of raising funds from alternate sources, cash flow position and applicable taxes including tax on dividend, subject to the Government guidelines described below:

As per the guideline dated February 11, 1998 from the Government of India, all profit- making PSUs which are essentially commercial enterprises should declare the higher of a minimum dividend of 20 percent on equity or a minimum dividend payout of 20 percent of post-tax profit. The minimum dividend pay-out in respect of enterprises in the oil, petroleum, chemical and other infrastructure sectors such as us should be 30 percent of post-tax profits