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Impact of Dividend on Investment Decision
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Introduction
A dividend is one of the key factors that significantly impact companies’ investment decisions. A change in dividend contributes to price changes and provides significant information concerning investment and the most critical decisions that should be made. An investment decision is viewed as one of the most critical decisions for the growth and survival of companies. However, companies can be influenced by many factors one of them being dividend policy. According to Triani and Tarmid, dividend policy can negatively impact investment decisions in organizations as a result of reduced liquidity and the distribution of a company’s internal resources among shareholders. While the influence of a firm’s dividend policy on the wealth of shareholders remains a debatable issue, this research takes a significant approach to examine the impacts of dividend policy on firms’ investment decisions.
Literature Review
Current literature reveals a significant link between dividend policy and critical investment decisions. According to a study conducted by Bataineh, dividend policy negatively impacts investment decisions because of the distribution of organizations’ internal resources among reduced liquidity and shareholders. The researchers conducted a survey on 20 companies of pharmaceuticals and technology industries in the United States between 2017 and 2020. They found that dividend policy was irrelevant to company value in a capital market.
In another research, Saens and Tigero shows that companies that controlled their dividend are forced to give more investment opportunities and are under financial pressure. Using the continuous regression model and accounting data, the researchers demonstrate that there are no substantial dissimilarities between the investment decisions made by corporations that disburse dividends and the ones that fail to pay. Studies of Ginanjar, Hasnawati and Fiska show that dividends mitigate the investment problems of managers by minimizing free cash flows available to them. Thus, dividend policy has a significant effect on companies’ cash flows and investments. According to the researchers, capital expenditure is positively and strongly linked to the level of free cash flow. This means that the higher the amount of cash flow a company has, the more investments the company is likely to engage in.
Bataineh conducted a study on 3, 800 firms and found that dividends have negative impacts on investment decisions since managers have remained reluctant in cutting dividends and they also view reaching dividends unreachable. The managers argued that they provide investment opportunities as a way of reaching dividends. The researchers also tested whether if dividend cut, increased external investment and reduced investment could provide the expected value of investment and dividend. They found that fewer companies cut their dividend. In similar research, Uzomah and Ihe found out that fewer organizations cut their dividend while many companies mitigated their investments according to their expected level. They also suggest that dividend is likely to lead to investment problems and has negative impacts on investment decisions in companies.
In another study, Agung, Hasnawati and Huzaimah found that investment expenditures by companies increased borrowings and led to positive impacts on financial performance. The researchers conducted their study on high-tech companies in China and Taiwan and their causal structures of corporate financial strategies. Even though the researchers found that investment expenditures positively impacted financial performance in Taiwan, they also found that the same financial decisions positively affected capital expenditures in China. Bataineh in his research found that high quality financial reporting mitigated the impacts of dividends on investment designs. The mitigating effect is stronger in firms that have a growth value and R&D investments.
Impacts of Dividend on Firms’ Investment Decisions
The decision-making preferences of investors are significantly affected by the dividend policies of their firms. Research shows that dividend is irrelevant to investment decisions made by company stakeholders and investors. Dividend affects cash flows and changes play a crucial role in the collection of data and dividend changes eventually lead to price changes and provide significant data about future investment and income with no effect on company value. One key explanation is that free cash flows are grounded on the reaction between investors and managers. This suggests that dividend deals with managers’ investment problems by reducing available free cash flows.
Capital expenditure is connected to the influence of free cash flow on capital expenditure since it increases as the size of the firm decreases. Furthermore, companies with a more likelihood of paying surplus dividends can significantly invest in more prospects and have more financial constrictions. Therefore, dividend policy impacts investor decisions through mandatory dividend regulation and cash flow privileges of marginal stockholders. Besides, companies tend to maximize their value by making investment decisions and this acts as a motivation to managers owning firm shares and are willing to invest in projects that contribute to their firms which is a future and long-term perspective compared to providing dividends to shareholders.
Companies have to decide where they will invest their money so that they can earn maximum returns. These decisions are referred to as investment decisions and they are significantly affected by dividend policy. Therefore, managers must implement an effective, stable, target-oriented, and well-managed dividend policy along with effective supervisory techniques to help investors make critical decisions and uplift their firm’s performance. Evidence also indicates that companies that mitigate their dividend have to provide investment opportunities and are under more financial pressure. Thus it is expected that cash dividend distribution has more negative effects on companies that have reduced their dividend. The choices made by investors serve as the starting point of every economic behavior of an enterprise. Research indicates that investors’ preference for cash dividends, the ownership ratio of insider asymmetrical information effects, and employee dividend policies are significant factors that investors pay attention to when making decisions. While they adjust dividend policy releases, investors consider their corporate profits, revers surplus, and scale.
Investment decisions are associated with the economic performance of the firm. This means that the decision-making process is impacted by dividend formulation policy. Among other factors such as impact of asymmetric information and the ratio of insider ownership, and employee dividend is considered by managers in the investment decision-making. When moderating dividends for realizing, a company will take into account reserve surplus, corporate profits and scale. It is important to note that investors do not always understand the internal aspects of the company they invest in. therefore, one of the ways investors can understand the operation circumstances of an enterprise by monitoring the decrease and increase of dividends. Corporate borrowing and dividend policies denote a company’s forecast of its operations and reveal internal information about the company. The dividend allotment of an organization acts as reflection to investors, which helps to iron the information difference between investors and insiders of the firm. Therefore, the wider the information gap between the organization and its outsider investors, the lesser the dividend allotment. Additionally, companies with weak administration are likely to pay higher dividends to attract investors.
Often, firms would prefer retaining earnings as opposed to sourcing from external financiers for investment. For this reason, the amount of dividend to be distributed contribute to the investment decisions made by internal and external investors. According to Baker, Kent, Dewasiri, Koralalage, and Azeez, organization with greater investment opportunities pay less dividends than those with lower chances of investment, which in turn allows them to reduce financial outsourcing. From pecking order theory, it can be deduced that firms that focus on reinvestment maybe shunned by investors more than those that depend on the outside financial resources. Research by Baker, Kent, Dewasiri, Koralalage, and Azeez found that there is a statistically significant and negative association between free cash flow and dividend policy. Theoretically, dividend distribution reduces free cash flow control by the manager. As such, negative relations supports free cash flow theory that differs from the life cycle dividend theory. Dividend premiums calculations determine investors’ demand for dividends. In this case, if the market of players and market of non-players are different, then the premiums should be zero. According to catering theory, positive premium values depict a preference for dividends.
Dividend payment by a firm denotes its future profitability or revenue. Notably, firms with no consistent increase in earnings have a challenge in experiencing such denotations. On the other hand, firms that incur consistent losses reflect their performance through lack of dividend payments, which means that they have a negative influence on investment decisions as well as payment of premiums. From this concept, it can be generally be concluded that the ability of an organization to pay dividends depicts its good financial performance. An appropriately performing organization pay dividends, although those that do not pay do necessary imply that they are making losses.
For instance, Microsoft’s progression through its life cycle depicts the connection between dividend and organizational growth. When the prospects of the company was about growth, dividends were not paid, but the profits were retained and reinvested to fuel the company’s progression. In the end, the 800-pound software “gorilla” reached its growth limit that it maintained for a significant amount of time. To maintain investors’ interest, Microsoft used dividends and share buybacks rather than rewarding shareholders through capital appreciation. Announced in 2004, the cash distribution plan repaid investors $75 billion worth of value.
The dividend yield is another aspect of dividend that determines investment decisions, and is calculated as an annual dividend income per share and divided by the current price per share. It determines the amount payable in form of income proportional to the price of shares. Low dividend yield in a company compared with others indicates two possibilities: the price of shares is significantly high because the market considers the company impressive in its prospects and payment of dividends is less of a concern; the company is underperforming and is not able to pay sufficient amounts of dividends. On the other hand, a firm with high dividend offers may imply that it is in trouble with depressed share prices. However, dividend yield is not very significant in determining the company’s growth.
Dividend coverage ratio is the ratio between the earnings of a company and the dividends paid to shareholders. It is used to determine the propensity for measuring sufficiency of company to pay dividends. This ratio is calculated by dividing earnings per share by dividend per share. Low coverage ratio indicate that dividends are likely to reduce, resulting in the negative organizational valuation. Notably, a coverage ratio of between 2 and 3 is the most preferred with investors. However, prospects may be perceived as risky when the coverage ratio is below 1.5. On the other hand, a ratio below 1 indicates that the company is retaining dividends from the previous year to pay dividends. When the dividend payout is higher, such as 5, investors raise concerns whether the organization is withholding excess earnings and paying insufficient cash to shareholders. Therefore, companies that increase their dividends show investors that business is likely to achieve stability in the next 12 months.
Dreaded dividend cut is an indication of impending financial trouble for a company with history of consistent payment of dividends. Although a history of consistent dividend payment or increased dividend is reassuring to investors, organizations that bank on financial outsourcing to facilitate these payments should be of concern to investors. For instance, the utility industry attracted many investors for having higher dividends and reliable earnings had to sink into greater debt levels to maintain their dividend level and facilitate expansion at the same time. The Investopedia team argues that firms with debt-to-equity ratio greater than 60% are not good for investment. Notably, higher debt ratios attract pressure from Wall Street and debt-rating agencies, and may compromise the ability of the company to pay its dividends.
Dividend initiates appropriate discipline to the organizational management decision-making. Notably, retaining profits may result in overcompensation of the executive, compromised management and misuse of resources. Notably, the more money the company withholds, the higher the probability of it overpaying acquisitions that may eventually compromise the value of the shareholders. On the other hand, companies that pay dividends have more effective management of capital than those that do not pay dividends.
Conclusion
For the growth and survival of organizations, investment decision is critical. One of the major aspects that influences investment decisions in companies is dividend decisions. Therefore, critical research on the impacts of dividend policy on investment decisions is important for understanding how organizations can implement important strategies that will help in ensuring dividend policies are effective. A review of current literature shows that dividend policy negatively impacts investment decisions due to the distribution of organizations’ internal resources. It also indicates that organizations controlled by their dividend policies are under financial pressure and are forced to provide investment opportunities. Research also shows that dividends mitigate investment issues of managers and negatively impact investment decisions since managers are reluctant to cut dividends. While a review of literature on the dividend policy impacts is important, more research is needed to enable organizations to come up with effective strategies to minimize the negative effects.
Bibliography
Agung, Ginanjar, Sri Hasnawati, and RA Fiska Huzaimah. “The Effect of Investment Decision, Financing Decision, Dividend Policy on Firm Value.” Journal of Business Management (2021): 1-12. https://doi.org/10.23960/jbm.v17i1.189
Baker, H. Kent, N. Jayantha Dewasiri, Weerakoon Banda Yatiwelle Koralalage, and Athambawa Abdul Azeez. “Dividend Policy Determinants of Sri Lankan Firms: A Triangulation Approach.” Managerial Finance 45, no. 1 (2019): 2-20. doi:10.1108/mf-03-2018-0096.
Bataineh, Hanady. “The impact of ownership structure on dividend policy of listed firms in Jordan.” Cogent Business & Management 8, no. 1 (2021): 1863175. https://doi.org/10.1080/23311975.2020.1863175
Hennessy, Emily A., Blair T. Johnson, and Ciara Keenan. “Best practice guidelines and essential methodological steps to conduct rigorous and systematic meta‐reviews.” Applied Psychology: Health and Well‐Being 11, no. 3 (2019): 353-381. https://doi.org/10.1111/aphw.12169
Saens, Rodrigo, and Tamara Tigero. “Mandatory dividend rules and the investment decision: The case of Chile.” The North American Journal of Economics and Finance 56 (2021): 101373. https://doi.org/10.1016/j.najef.2021.101373
Sheng, Tzu-Chun, Alvin Chang, Shu-Hui Lan, and Shih-Cheng Li. “Analysis of the Dividend Policy Decision-Making Mechanism of Chinese and Taiwanese Lithium Battery Industries.” Mathematics 8, no. 10 (2020): 1689. doi:10.3390/math8101689.
Sihwahjoeni, Sihwahjoeni, Edi Subiyantoro, and Maria Ringi Bili. “Analysis Effect of Investment Decision, Financing and Dividend Policy on Value Company with Variable Business Risk as Mediation.” International Journal of Research and Scientific Innovation (IJRSI) 7, no. 7 (2020): 261-269. https://www.rsisinternational.org/journals/ijrsi/d…
Tajuddin, Risal, and Kristiawati Endang. “The effect of investment decision financing decision dividend payment policy and company size.” Journal of Administrative and Business Studies 3, no. 2 (2017): 105-113. DOI: 10.20474/jabs-3.2.5
The Investopedia Team. “Why Dividends Matter to Investors.” Investopedia. June 09, 2021. Accessed November 28, 2021. https://www.investopedia.com/articles/fundamental/03/102903.asp.
Triani, Nur, and Deden Tarmidi. “Firm value: impact of investment decisions, funding decisions and dividend policies.” International Journal of Academic Research in Accounting, Finance and Management Sciences 9, no. 2 (2019): 158-163. http://dx.doi.org/10.6007/IJARAFMS/v9-i2/6107 (DOI: 10.6007/IJARAFMS/v9-i2/6107)
Uzomah, Ijeoma A., and John Ihe. “Dividend policy as determinant for investment decision.” Middle European Scientific Bulletin 12 (2021): 192-201. https://cejsr.academicjournal.io/index.php/journal/article/view/539
Presentation
What research you extend, modify, or correct (no more than a minute).
I extended research on the impact of dividends on investors’ decision-making. I researched more on the subject and found that there are theories that support the concept of dividend payment and its association with investment decisions. They include pecking order theory and catering theory.
2. What question your research addresses—the gap in knowledge or understanding (thirty seconds or less).
My research addresses the following questions:
What dividend factors of a company affect investment decision making?
This research seeks to explore what dividends indicate about an organizational performance.
3. Why your research matters—an answer to so what? (Thirty seconds).
This research provides an understanding platform to investors willing to invest in companies to earn dividends by providing an in-depth analysis of instances of dividend payment that depict company performance. For instance, this study has established that higher dividend does not necessary indicate positive performance.
4- Your claim, the answer to your research question (thirty seconds or less).
Higher dividend earnings do not necessarily indicate the company performance.
Higher dividends may mean that the company is struggling in share prices or retained earnings for company growth.
5- A forecast of the structure of your presentation (ten to twenty seconds). The most useful forecast is an oral table of contents: “First I will discuss . . .” That can seem clumsy in print, but listeners need more help than readers do. Repeat that structure as you work through the body of your talk on the spirit of research
I will be introducing this research, giving the background of the topic.
I will then take you through the literature review, in which we shall see how various authors have addressed the topic.
The next part will be topic synthesis in which I shall discuss the role of dividends in a company’s investment decision.