Dividend Policy

Why is dividend policy so attractive? One reason is deciding the amount of income to be paid, dividends are one of the main financial decisions faced by company managers. Another reason is that a proper understanding of dividend policy is critical to many other areas of financial economics. In particular, asset pricing theory, capital structure, mergers and acquisitions, and capital budgeting all rely on views of how and why dividends are paid.     

Dividends are a company's net profit, part of which is distributed to shareholders based on the proportion of share ownership they own. The amount and timing of dividend payments are based on the General Meeting of Shareholders (GMS). There are several types of dividends,  namely:  Cash Dividend (Cash Dividend), Dividends on Assets Other Than Cash (Property Dividends), Debt Dividend (Scrip Dividend), Liquidating Dividends, Stock Dividends.

According to Sundjaja and Barlin ( 2010: 382), in paying dividends there are several stages or procedures, namely: Announcement date (date of declaration), Cum-dividend date, Shareholder recording date (date of record), Dividend separation date (ex-dividend date), Payment date (date of payment).

Dividend policy is an inseparable part of a company's funding decisions. Dividend policy is a decision whether profits earned by the company will be distributed to shareholders as dividends or will be retained in the form of retained earnings to finance future investments. In determining dividend policy, it is necessary to consider the survival of a company so that profits are not only used to distribute dividends, but are also set aside to invest or pay debts. Companies that still want to live in the business world will not remain silent, but will instead utilize existing funds to invest so that the company continues to grow (Silaban & Purnawati, 2016).

Dividend policy has an impact on earnings management, namely whether paying dividends to share owners or reinvesting in the company. Retained earnings are one of the quickest and cheapest alternative sources of funds to finance company growth, on the other hand, dividends are cash flows set aside for share owners (Horne, 1998). Dividends are the distribution of profits to share owners according to the number of shares they own. This distribution will reduce retained earnings and cash available to the company, but distributing profits to owners is the main goal of a business. Some companies may have a Dividend Reinvestment Plan. This allows shareholders to use their dividends systematically to purchase small amounts of shares usually without commission. In some cases, they do not need to pay taxes on the reinvestment of these dividends, but usually need to pay a commission (Horne, 1998).

According to Sundjaja and Barlin ( 2010: 388) there are three types of dividend policies, namely: Constant Ratio Payout Dividend Policy, Regular Dividend Policy, Regular Low Dividend Policy and Added Extras.

Bringham and Houston ( 2001: 14) state that there are three theories of investor preferences, namely:

• Dividend Irrelevance Theory, This theory states that a company's dividend policy has no influence on the value of the company or its cost of capital. This theory was put forward by Merton Miller and Franco Modigliani (MM). They argue that the value of a company is not determined by the size of the Dividend Payout Ratio, but the value of the company is only determined by its basic ability to generate profits and its business risks.
• Bird In The Hand Theory (Bird In The Hand Theory), Myron Gordon and John Linther in Hadiwidjaya (2007) argue that investors actually value income in the form of dividends more than the expected income from capital gains that will be generated from retained earnings. Gordon and Linther's opinion was named by MM bird in the hand fallacy. Gordon and Linther thought that one bird in the hand was more valuable than a thousand birds in the air.
• Tax Preference Theory (Tax Preference Theory), There are three tax-related reasons to think that investors may prefer low dividend distributions to high dividend distributions, namely: 1) Capital gains are subject to lower tax rates compared to. 2) Taxes on profits are not paid until the shares are sold, so there is a time value effect. 3) Avoid capital gains tax if a person owns shares until he dies, no capital gains are payable at all.

According to Weston and Copeland (1993) in Hadiwidjaja ( 2007: 22-25) states that dividend policy is influenced by: 1. Laws 2. Liquidity Position 3. Need for Debt Repayment 4. Level of Asset Expansion 5. Profit Level 6. Profit Stability 7. Access to Capital Markets 8. Company Control.

There are two types of dividends that are often used, namely:

• Cash dividends. 

This dividend payment method is most often used as a way of distributing profits. Paid in cash and taxed according to the year of expenditure. Somewhat different from the United States where the decision to distribute dividends is in the hands of the board of directors, in Indonesia the decision to distribute dividends is basically in the hands of the General Meeting of Shareholders or GMS in accordance with Law no. 1 of 1995, article 62 paragraphs 1 and 2 (Husnan, 1996: 382).

• Stock dividend

Method of paying dividends in the form of shares to share owners. Stock dividends are actually a realignment of company capital or company recapitalization, while the ratio of company ownership does not change (Sartono, 2010: 295). This method is carried out quite often and is paid in the form of additional shares, usually by paying attention to the ratio of the number of shares owned. This dividend payment method is not subject to tax. Stock dividends also result in an increase in the number of shares but a lower price per share. For example, for every 100 shares an investor owns, the investor receives additional shares. Husnan (2010: 296) believes that the purpose of companies providing stock dividends is to save cash because there are alternative investment opportunities that are more profitable. The stock dividend policy is not permitted if the stock dividend is intended to overcome the company's financial difficulties, because the company cannot manipulate investors which will cause the share price to fall.

DIVIDEND THEORY

The current literature puts forward three main theories intended to explain dividend policy methodology, each of which centers on the idea of sending residual income to investors:

• Pure Residual Dividend Policy - states that when the return on a company's equity capital is greater then the rate of return an investor can obtain by reinvesting that capital dividends in other investments with equivalent risk, the investor prefers such dividends to a corporation acting on its behalf and reinvesting its earnings rather than issuing dividends, the Company can determine which option is more suitable to benefit investors by first identifying the company's optimal capital budget, thereby recording the level of equity capital required, and then maintaining the amount of income required to finance capital equity in the capital budget and allowing for "residual" funds (unused income from internal investments) after reinvestment that is mandated to be issued as dividends (Droms 218). Therefore, dividends are a function of income fluctuations, and this method allows for significant dividend fluctuations along with changes in income and company investment opportunities. As a result, all remaining income is paid out which leads to investment opportunities. As a result, all remaining earnings are paid out which causes the dividend payout ratio to fluctuate. This policy also results in dividends that vary from year to year, and when equity investment is greater than income, then equity financing must be initiated to create a residual (Droms, 1990).
• Smoothed Residual Dividend Policy - indicates that dividend fluctuations are kept at a minimum. Changes in dividend policy tend to lag Shapiro's earnings fluctuations, as "Dividends are set equal to the long-term residual between expected earnings and investment terms. Dividend changes, in turn, are made only when this long-term residual process is expected to change; earnings fluctuations are believed to be temporary is ignored in setting dividend payments. The obvious preference is a stable, but steadily increasing, dividend per share" (Shapiro 532-533). Thus, the dividend payout ratio fluctuates significantly with this payment method, and the dividend could potentially exceed the residual if earnings are unexpectedly low.
• Constant Remaining Payout Dividend Policy - suggests maintaining a constant dividend payout ratio, which causes dividends to fluctuate along with earnings.
• Small Quarterly Dividends with Annual Bonuses - denotes small periodic dividends and annual "bonus" dividends offered to investors if earnings exceed expectations. Companies that experience wide fluctuations in income and investment often use this policy. This option benefits management, because they have cash flexibility, and also investor flexibility because they are guaranteed a small annual dividend.

This article was written to fulfill Dr Darmawan's financial management course assignment