INTRODUCTION

Dividends are payments made by a corporation to its shareholders or it is the portion of corporate profits paid out to stockholders. Every company follows or tries to follow a certain dividend policy. Dividend policy is the policy taken by the management of the firm to make payments to its shareholders from the firm’s profit or reserve. It is very important from the Corporate finance’s point of view to understand every aspects of dividend policy. So clear understanding of dividend policy helps management or other responsible persons to take efficient decision in this regard.

In Bangladesh practice of following a particular dividend policy is not very strong. We know that in 1956 Lintner showed that a firm basically increases its dividend after being assured that its earnings growth is sustainable. But in our country it is really very difficult to find a pattern in dividend policy of a company because most of the companies here pay dividend without following any policies that we find in the text.

To analyze the dividend policy of a company I have taken Gemini Sea Food Limited and showed its dividend policy and various effects of its dividend policy on market, firm and other investors. To do so, I have calculated many ratios and showed the impact of dividend policy followed by the company on those ratios to identify any particular pattern. I have also answered the assigned questions which explore various effects of dividend policy.

GEMINI SEA FOOD LIMITED-OVERVIEW

Events Date/DescriptionDate of incorporation 16.09.1982

Date of operation 03.08.1984

Brands ‘MEENA’ & ‘GEMINI’

Nature of business Processing, Packaging & Exporting of quality frozen Raw shrimp, Cooked shrimp and White fish.

Products Headless shell-on

Peeled & Deveined

Head-on Shell-on Semi IQF

Butterfly IQF

Ezypeel IQF

Cooked and balanced IQF

Skewer Semi IQF

Sources of raw The company processes the firm raised shrimps

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material received from the government FIQC approved sources only. All the shrimps are naturally cultured.

Machineries & Equipments

The company is equipped with state-of-the-art and world class machineries and best possible equipments

Production capacity Block: 15 tons

IQF: 10 tons

Quality control The company possesses a very well set and equipped laboratory with highly professionals capable of carrying out all essential tests and checks required to ensure best possible hygienic products conforming to the standard as per HACCP.

DEFINITION OF DIVIDEND

Dividends are payments that firms make to their shareholders.  Historically dividends were a major portion of returns to stockholders. From its business operations a company generates profit. Part of this profit is kept in the company as retained earnings and the other part is distributed as dividends to shareholders. When we state dividend in % term we basically mean dividend on par value or face value.

TYPES OF DIVIDEND

CASH DIVIDEND

Cash dividend is the money paid to stockholders, normally out of the corporation's current earnings or accumulated profits. All dividends must be declared by the board of directors and are taxable as income to the recipients. This is the most common form of dividend.

STOCK DIVIDEND

Stock dividend is a kind of dividend paid out in the form of additional stock shares of the issuing corporation. They are usually issued in proportion to shares owned. For example: Beximco limited declared 20% stock dividend for its shareholders, which means that a current shareholder of Beximco limited who owns 100 shares of the company will be entitled to receive 20 additional shares at ex dividend date.

Stock dividend is very much preferred in our country as we know that in Bangladesh it is profitable to sell shares after the record date because after the record date price of shares appreciates very quickly from the adjusted price.

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STOCK REPURCHASE

Stock repurchase (or share buyback) is the reacquisition by a company of its own stock. In some countries, including the U.S. and the UK, a corporation can repurchase its own stock by distributing cash to existing shareholders in exchange for a fraction of the company's outstanding equity; that is, cash is exchanged for a reduction in the number of shares outstanding. The company either retires the repurchased shares or keeps them as treasury stock, available for re-issuance.

Stock repurchase is an alternative to cash or stock dividend. This is not familiar in our country.

STOCK SPLIT

A stock split or stock divide increases the number of shares in a public company. The price is adjusted such that the before and after market capitalization of the company remains the same and dilution does not occur.

For example: FuWang food’s 100 shares of stock are priced at $50 per share. The market capitalization is 100 × $50, or $5000. The company splits its stock 2-for-1. There are now 200 shares of stock and each shareholder holds twice as many shares. The price of each share is adjusted to $25. The market capitalization is 200 × $25 = $5000, the same as before the split.

Well, in our market, from the recent evidence we have seen that price of a company’s stock increases unusually when it splits its stock. This happens due to increased accessibility of the company’s stock by the investors after split. Though price increases fundamentals of the company remain same after the split.

DIVIDEND POLICY

Dividend policy is the policy used by a company to decide how much it will pay out to shareholders in dividends.

TYPES OF DIVIDEND POLICY

There are mainly four types of dividend policies in practice, these are written below.

Stable dividend policy

Constant payout ratio dividend policy

Residual dividend policy

Sticky dividend policy

Stable dividend policy

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In the stable dividend policy, management of a company maintains a fixed dividend per share each year. Under this policy dividend amount per share remains same over the years even though the earning of the company increases. The impact on share pricing can be seen from the share valuation formula (DDM) below:

P0 = D1/(r-g)

Where,

P0 is the current price

D1 is the dividend in the coming years,

r is the required equity return and

g is the dividend growth rate.

Now, as there is no growth of dividend for stable dividend policy if there is no growth in dividend, g=0. Then,

P0 = D1/r.

After one year

P1 = D1/r because D1 = D2. Thus P1 = P2 and there is no growth in the share price.

EXAMPLE

Management of FuWang foods limited maintains a stable dividend policy. Suppose the company decided to pays Tk.3 cash dividend annually on par value of Tk.10 for indefinite time period. If return on equity is 15% then under Dividend discount model the value of the company’s share will be:

P0 = 3/(.15-0) = 20; which will continue for indefinite period until the company changes its current dividend policy.

Constant payout ratio dividend policy

In the constant payout ratio situation, management maintains a fixed percentage dividend payout ratio.

EXAMPLE

Management of FuWang foods limited can be said to maintains a stable dividend policy if it pays dividend to its stock holders at a payout ratio of 35% for indefinite period. Here dividend fluctuates with increased or decreased earnings. Suppose in 2008 the company’s EPS was 8 so DPS was 2.8, again in 2010 EPS was 6 so DPS became 2.1.

Sticky Dividend Policy

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Lintner (1956) found that managers hate to cut dividends (because investors see cuts as a signal that things are going poorly). Thus once the Board of Directors decides to raise dividends they want to be sure they do not need to cut them in the future. This leads to "sticky dividend policy." Sticky dividend policy refers to the idea that dividends track earnings but with a lag since management wants to be sure the earnings are sustainable.

EXAMPLE

Suppose management of FuWang foods limited follow sticky dividend policy. In 2005 EPS was 3 & DPS was 1.5, in 2006 EPS was 4 & DPS was 1.5 again and in 2007 when EPS became 5 then the company’s management was sure that earnings growth is stable so it increased its DPS to 2. Here 2005-2006 is a lag when management did not increased dividend with incremental EPS to be sure that earnings growth is stable.

Residual Dividend Policy

In a residual dividend policy, profits are used to fund new projects at first and then the residual or remaining profit is distributed as dividends.

EXAMPLE

If a company has a profit of Tk. 100 million and is going to fund a new development project costing Tk. 60 million, the remaining Tk. 40 million will be distributed as dividends.

GEMINI SEA FOOD-TYPE OF DIVIDEND POLICY

We can see a mix up in the dividend policy of Gemini sea food limited. From the graph below we can see that total dividend of the company was 25% or Taka 25 per share. So we can say that from 2005-07 company’s dividend policy was stable.

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Below we can see the EPS of the company which fluctuated highly over the years. From the graph below we can see that there is a declining trend in the company’s EPS though in 2008

and in 2010 EPS of the company bounced back and increased. In the graph we compared between EPS and Total dividend in percentage. We can see that in 2010 Gemini’s EPS increased but the company cut its dividend, again from 2005-2007 company’s dividend policy was stable though EPS decreased.

So finally we can say that for the first three years company’s dividend policy seemed to stable then from 2008 with incremental EPS but decreased total dividend the company lost its pattern of the earlier dividend policy or we can say for the last three years Gemini did not follow any particular dividend policy. We can also observe the fluctuation in EPS in the last three years.

GEMINI SEA FOOD-FACTORS AFFECTING DIVIDEND DECISION

We know that dividend decision of a company is taken by the management and there are several factors that influence this decision. Final figure of dividend of a company is determined only after considering the following factors:

Type of Business

Current Year's Earnings

Past

Dividends

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For the first 3 years Gemini Sea Food followed stable dividend policy then in the next three years the company’s

Estimate of Future

Earnings

Future Needs of Capital

Fluctuations in Business

Present Amount of

Reserves

Distribution of

Shareholders

Age of the Company

Position of Liquidity

Government Policy

Taxation

Legal Restrictions

Attitude of Management

So from Gemini Sea Food’s perspective only 6 of the above factors seems affected the dividend decision of the company.

Past dividend

Though the company was in loss in the early years of 2000 it rebounded from 2003 and since then the company paid some dividend to its shareholders though it’s accumulated retained earnings was negative. We know that past dividend generates expectation of better future dividend so the company tried to pay dividend at a stable rate to its shareholders from 2003 to 2007 then its dividend fluctuated or declined gradually. So we can say that past dividend is has been a factor that influenced the dividend decision of the company.

Estimate of Future Earnings

We have already seen that the company’s dividend declined from 2008 to 2010. This is because of Estimate of Future Earnings by the company’s management. We know that in 2008 & 2009 Sidr & Ila two tornadoes visited Bangladesh which affected the shrimp industry of our country as a result of which many shrimp processing companies closed down their operations. So the expectation of future less profitability and more sufferings may have shaped the declining dividend decision of Gemini Sea Food limited’s management.

Future Needs of Capital

This is another factor which we can say might have affected the dividend decision of the company. After suffering from two devastating natural calamities the company was in need

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The following factors affect the dividend decision of Gemini Sea Food Limited:

Past dividendEstimate of Future EarningsFuture Needs of CapitalPresent Amount of ReservesAttitude of

of immediate capital investment to smoothen its operations. So this factor may have an effect on the reduced dividend decision of the company in later years.

Present Amount of Reserves

Present amount of reserve of the company is negative. So to retire the negative reserve as early as possible the company may have reduced the dividend from 2008-2010.

Attitude of Management

Attitude of management towards investors is positive because they recommended cash dividend to the stockholders when they could have stopped paying any form of dividend as the company’s reserve was negative. From the companies act 1994 we know that a company may not to pay any dividend until its accumulated reserve or retained earnings became positive.

Position of Liquidity

From the balance sheet in the appendix we can see that most of the bank loan that company has in the form of term loan for meet up the working capital requirements. So to reduce the loan or to increase the company’s ability to meet working capital requirements its management may have revised its dividend decision in the later years.

GEMINI SEA FOOD-SIGNALING EFFECT

Signaling effect is very important issue from the perspective of literature. We know that signaling effect means that when the firm pays better or higher dividend compared to last year, its market price increases to reflect the investors belief that the company’s future cash flow generating potential has increased. After the work of Lintner in 1956, Fama and Mayers also found that increased dividend convey good news to the investors and boost their confidence which eventually is reflected in the increased share price.

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.

Although dividend signaling theory implies that dividend increases signal better prospect but recently some research works found evidence that signaling effect of dividend does not exist in market.

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Gemini’s market price increased sharply when it reduced its dividend greatly in 2009. This is contradictory to the signaling effect and proves

that there is no

So in this case, to identify whether here exists any signaling effect I have tested the market price of Gemini sea food’s per share and its total dividend per share over the period 2005 to 2010.

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From the graph above we can see that when the company’s dividend was stable its price was almost stable though it was little higher in 2006 compared to 2005 and 2007. But when the company started to reduce its dividend to a great deal from 2009 Gemini’s market price rose sharply. This is contradictory to the signaling theory. So we can say that there is no signaling effect in case of Gemini sea food limited.

GEMINI SEA FOOD-CLIENTELE EFFECT

Clientele effect represents the impact on the stock price that investors would cause in reaction to a change in policy of a company. Consequently, dividend policy won't affect the value of the stock as long as clientele exist, so when there is clientele effect dividend policy is

irrelevant.

We know that in Bangladesh individual investors pay 10% on dividend gain immediately and institutions pay 20%. So we can say that institutions like less dividend payments compared to high dividend preference by the individuals. If the company pays higher dividend people will increase their investment in the company on the other hand institutions will decrease. Here in case of Gemini Sea Food limited, there exists clientele effect

because price of the company’s shares in the market increased when the company reduced its dividend.

Basically the company paid dividend at a constant amount from 2005-2007 then it declined its dividend but this had no impact on the price of the company as the price of the company increased with the decline of dividend.

On the graph above we can see that dividend yield also declined gradually as the dividend amount decreased but market price of the company’s share increased. So there exists clientele effect of dividend for the company.

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In case of Gemini Sea Food limited, there exists clientele effect because price of the company’s shares in the market increased when the company reduced its dividend.

GEMINI SEA FOOD-STYLIZED FACTS OF DIVIDENDS

Lintner in 1956 developed a set of stylized facts about corporate dividend policies by making a series of interviews with the managers responsible for those policies. Lintner found four basic stylized facts, these are

1. Managers try to smoothing the dividend.

2. Managers use a target payout ratio to set dividends.

3. Managers change dividend only when they feel firm’s permanents earnings have changed.

4. Managers only cut dividends when they are forced to do so.

Here in case of Gemini Sea Food limited we have found managers try to smoothing the dividend by gradually decreasing dividend payout ratio to increase the growth of the form. The company’s EPS fluctuated but dividend payout ratio gradually declined o we can say that managers tried to smooth the dividend effect by gradually decreasing the dividend payout ratio and total dividend payment for increased growth rate and fluctuating EPS.

The graph below shows this stylize fact:

In Gemini Sea Food’s case two other stylized factors like “Managers use a target payout ratio to set dividends & Managers change dividend only when they feel firm’s permanents earnings have changed” are absent and I did not find any evidence for these two factors.

But for the last stylize fact I have found that managers of the company reduced the dividend when they were forced to do so in 2008-2010.

GEMINI SEA FOOD-CORPORATE GOVERNANCE

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Dividends are not only a signal about a firm's prospects under asymmetric information, but they can also act as a corporate governance device to align the management's interests with those of the shareholders. If free cash flow increases with incremental free float then we can

say that a firm practices strong corporate governance because there is less or no agency problem.

Here in case of Gemini we have seen that due to reduced dividend individuals left investing in the company. As we know that individuals have low tax bracket so they prefer high dividend compared to institutional investors. So due to less dividend payment free float of the company reduced. Again free cash flow per share fluctuated over the period so we cannot say anything strictly about the corporate governance practice of the firm.

CONCLUSION

So we can come up with the conclusion that Gemini Sea food followed stable dividend policy in the earlier years but later management of the company was forced to cut dividend to ensure firms growth by investing retained earnings in the working capital. Firms management follow two stylize facts in making dividend decisions as well as management’s intention to preserve investors rights was quite clear though I did not find any clear evidence of corporate governance. There is no signaling effect for the firm but clientele effect was there.

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