Question

Does the good news conveyed by the announcement of a dividend increase mean that a firm can increase its stock price in the long run simply by paying cash dividends? Explain.

Answer 1

Before the dividend is paid, the issuing company must first declare the dividend amount and the date when it will be paid. It also announces the last date when the shares have to be purchased to receive the dividend. This date is known as the ex-dividend date.

The declaration of the above things, drives the price of the stock up as the investors, try to buy the stock before the ex-dividend date to get the dividend amount. In general, an increase in the stock price is usually equal to the amount of the dividend to be paid.

But after the ex-dividend date, investors can drive the price of the stock down as the new investors, will not get the dividend, so they are not willing to pay the premium.

So, the company cannot increase its stock price in the long run simply by paying cash dividends.