Question

Payout policies of the firm should be aligned with the shareholders’ wealth maximization objective. In general, name at least three reasons why some companies should be paying their earnings out in dividends; alternatively, name at least three reasons when it might be optimal for companies to reduce dividends and retain more of the earnings.

Answer 1

Companies should be paying their out in dividends due to following reasons:

1. To meet the expectations of Shareholders

2. High goodwill in the market

3. If the return on Company's investments is less than the return expected by Shareholders

Optimal for companies to reduce dividends and retain more of the earnings:

1. When the return on company's investments are higher than the expactations of Shareholders

2. Where the investors are holding shares with the objective of capital appreciation and not for short term dividends

3. When the company has new projects/expansion coming up in future