“DIVIDEND POLICY OF RELIANCE INDUSTRIES” Introduction The firm's dividend decision has in the last ten to fifteen years received considerable attention from financial analysts and academics.Divergent views have been expressed and it is understood that the controversy has not been resolved,although the lack of new authorship on the subject in resent times may lead one to conclude that tha debate is deadlocked. A dividend is a payment made by a company to its shareholders. A company can retain its profit for the purpose of re-investment in the business operations (known as retained earnings), or it can distribute the profit among its shareholders in the form of dividends. A dividend is not regarded as an expenditure; rather, it is considered a distribution of assets among shareholders. The majority of companies keep a component of their profits as retained earnings and distribute the rest as dividend.
The different types of dividends include: Special dividend: Normally, public companies declare their dividends on a specific schedule; however, they also have the option to declare a dividend at any time. This type of dividend is referred to as a special dividend.
Cash Dividends Firms distribute as cash dividends a certain percentage of annual earnings in payout rates. Ordance
Four dates are crucial to dividends as follows:
accounting ordance
for cash
The date of declaration It is the date a resolution to pay cash dividends to stockholders of record on a specific future date is approved by the board of directors. At that date the firm incurs a liability prompting the recognition of a short-term debt—Dividends Payable and the debit to either Retained Earnings or Cash Dividend Declared.
The ex-dividend date It is the date the stock stops selling with dividends attached. The period between the date of declaration and the ex-dividend date is used by the firm to update its stockholders’ ledger.
The date of record It is the date at which the stockholders figuring in the stockholders’ ledger are entitled to the cash dividend. No entry is required.
The date of payment It is the date at which the firm distributes the dividend checks and eliminates the dividend payable as a liability. Case Example Let’s assume that the Lie Reliance industries itd.,on March 15, 2009, declared a cash dividend of $1 per share on 2,000,000 shares payable June 1, 2009, to all stockholders of record April 15. The following journal entries are required: 1. Date of declaration, March 15, 2009 [Debit]. Retained Earnings [Cash Dividend Declared] = 2,000,000
[Credit]. Dividends Payable = 2,000,000 2. Date of record, April 15, 2009 Memorandum entry that the firm will pay a dividend to all stockholders of record as of today, the date of record. 3. Date of payment, June 1, 2009 [Debit]. Dividends Payable = 2,000,000[Credit]. Cash = 2,000,000 Note: It is appropriate to note that cash dividend declared is closed at year-end to Retained Earnings.
Property Dividends Firms may elect to declare a “property dividend” that is payable in nonmonetary assets rather than declaring a cash dividend. Because a property dividend can be classified as a “non-reciprocal nonmonetary transfer to owners”, the property distributed is restated at fair market value at the date of declaration and a gain or loss is recognized. Case Example Let’s assume that the Reliance Industries ltd. declares a property dividend, payable in bonds of Lie Dharma Company being held to maturity and costing $500,000. At the date of declaration the bonds had a market value of $600,000. The following journal entries are required: 1. Date of Declaration Investments in Lie Dharma Company
[Debit]. Bonds = 100,000[Credit]. Gain on Appreciation of Bonds = 100,000[$600,000 - $500,000] [Debit]. Retained Earnings [Property Dividend Declared] = $600,00 [Credit]. Property Dividends Payable = $600,000 2. Date of Distribution [Debit]. Property Dividends Payable = 600,000[Credit]. Investments in Lie Dharma Company Bonds = 600,000
Stock dividend: Given in the form of bonus shares or stocks of the issuing company or a subsidiary company. Normally, they are offered on the basis of a prorata allotment
(1) Regular Dividend. By dividend we mean regular dividend paid annually, proposed by the board of directors and approved by the shareholders in general meeting. It is also known as final dividend because it is usually paid after the finalization of accounts. It sis generally paid in cash as a percentage of paid up capital, say 10 % or 15 % of the capital. Sometimes, it is paid per share. No dividend is paid on calls in advance or calls in arrears. The company is, however, authorised to make provisions in the Articles prohibiting the payment of dividend on shares having calls in arrears. (2) Interim Dividend. If Articles so permit, the directors may decide to pay dividend at any time between the two Annual General Meeting before finalizing the accounts. It is generally declared and paid when company has earned heavy profits or abnormal profits during the year and directors which to pay the profits to shareholders. Such payment of dividend in
between the two Annual General meetings before finalizing the accounts is called Interim Dividend. No Interim Dividend can be declared or paid unless depreciation for the full year (not proportionately) has been provided for. It is, thus,, an extra dividend paid during the year requiring no need of approval of the Annual General Meeting. It is paid in cash. (3) Stock-Dividend: Companies, not having good cash position, generally pay dividend in the form of shares by capitalizing the profits of current year and of past years. Such shares are issued instead of paying dividend in cash and called 'Bonus Shares'. Basically there is no change in the equity of shareholders. Certain guidelines have been used by the company Law Board in respect of Bonus Shares. (4) Scrip Dividend. Scrip dividends are used when earnings justify a dividend, but the cash position of the company is temporarily weak. So, shareholders are issued shares and debentures of other companies. Such payment of dividend is called Scrip Dividend. Shareholders generally do not like such dividend because the shares or debentures, so paid are worthless for the shareholders as directors would use only such investment is which were not . Such dividend was allowed before passing of the Companies (Amendment) Act 1960, but thereafter this unhealthy practice was stopped. (5) Bond Dividends. In rare instances, dividends are paid in the form of debentures or bounds or notes for a long-term period. The effect of such dividend is the same as that of paying dividend in scrips. The shareholders become the secured creditors is the bonds has a lien on assets. (6) Property Dividend. Sometimes, dividend is paid in the form of asset instead of payment of dividend in cash. The distribution of
dividend is made whenever the asset is no longer required in the business such as investment or stock of finished good sods. But, it is, however, important to note that in India, distribution of dividend is permissible in the form of cash or bonus shares only. Distribution of dividend in any other form is not allowed.
Factors affecting divided decision or determinants of divided decision The financial management has to take a decision regarding the distribution of dividend. These are two possible ways of dealing with the distribution of profit. The profit should either be retained in the business or distributed to the shareholders. Retained profit plays an important role in the future growth and expansion of the enterprise, because these are internal sources of financing and do not involve floatation costs and legal formalities. As such the company will adopt the policy of residual or passive (lesser) distribution, so far it can profitably invest its retained earning as a source of internal financing. The term residual distribution here means the declaration of dividend out of the profit remaining left after internal financing of the company. The dividend may be declared as higher rates if the intention of the company is to increase the value of shares. The dividend decision is also affected by the preference of shareholders. Let us now discuss the factors determining divided decisions: (1)Financial requirement of the company: - If the company has profitable investment opportunities in the enterprise itself it will declare divided at lower rates. Meeting long-term financial requirement out of its own resources is always in the interest of the company, because it is cheaper due to absence of floatation costs and legal formalities. Higher divided will declared by the companies having few long-term investment opportunities. (2)Availability of funds: - The liquidity of a company or availability of cash resources is prime consideration in divided decision. The greater the liquidity of a company, the greater is its ability to pay dividend. The
liquidity of the company is strongly influenced by the firm’s investment and financing decisions. The investment decision determines the rate of asset expansion and the firm’s need for funds and the financing decision determines the way in which this need will be financed. (3)Stability of dividends: - It is always in the interest of the company, investors and shareholders to follow the policy of stable dividend, because it resolves the uncertainty in the mind of investors and satisfies their for current income. Financial institution also like companies, declaring dividend regularly at stable rates. No company would like to ignore investment by financial institutions. In these circumstances the company may adopt one of the three following policies: a.Constant dividend per share or constant dividend rate:- According to this policy dividend is declared at constant rate every year. The rate may be increased if new level of profit is earned. b. Constant pay out ratio:- Dividend at fixed percentage of earning is paid every year. As earnings go on fluctuating every year, so the dividend also fluctuates. c. Constant dividend per share plus extra dividend :Under the policy, minimum dividend per share is fixed. In case of extra earnings, extra dividend may be declared. Investors are kept satisfied with the supplementary dividend. Extra dividend may be taken as interior dividend. (4)Preferences of shareholders:- Shareholders are owners of the company, so their preferences must be given due consideration. Small, retired and salaried people prefer regular income. They are interested in stable and regular dividend. Wealthy investors are interested in capital gain. They are prepared to forego their current income over the expected higher income. (5)Capital market consideration:- Companies can raise their additional funds either by issue of shares or by retaining their profit. If the capital market is favorable the company will raise funds by issue
of shares and declare dividends at higher rates. In case the capital market is unfavorable, the company will go in for retained earnings and declare dividends at lower rates. (6)Legal restrictions:- The companies act has laid down certain restrictions regarding payment of dividend. The company can use its current profits or past profits after providing for depreciation for the payment of dividend. The company cannot pay dividend out of its paid up capital. Company will have to satisfy itself, whether it has sufficient cash to make payment of dividends. The company is future required to make payment of interest before dividends are paid. (7)Information value:- The company should be aware of the possible impact of dividend decision on valuation of its shares. Most companies look at the dividend pay out ratios of other companies in the industry, particularly those having about the same growth. Investor’s expectation also plays an important role in dividend decision. If investor’s expectation is for high dividend pay out then company should take that into account while making a dividend decision. On the other hand, if investor expects a high market value of shares then company may decide for low dividend payout for future expansion plans. (8)Borrowing capability:- The borrowing capability of a firm affects dividend decision in the sense that high dividend payout is possible with greater borrowing capability and vice-versa. This ability to borrow can be in the form of credit or a revolving credit from the bank or simply the informal willingness of a financial institution to extend credit. The large and more established a company; the better is its access to capital markets. Issue for bonus shares:- Sometimes the company can also issue bonus shares, known as stock dividend in place of making payment of dividend in cash, It increases the number of shares and the capital base of the company, it keeps investors happy, The issues of bonus shares is an integral part of dividend policy.
Announcem ent Date 26-04-10 07-10-09 21-04-08 02-03-07 27-04-06 27-04-05
Effective Date
Dividen d Type
10-05-10 16-10-09 08-05-08 21-03-07 01-06-06 12-05-05
Final Final Final Interim Final Final
Dividen Rema d (%) rks 70.00 130.00 130.00 110.00 100.00 75.00
AGM
DIVIDEND Payment of Dividend The Dividend is paid under two modes viz: (a) National Electronic Clearing Services (NECS) (b) Physical dispatch of Dividend Warrant Payment of dividend through National Electronic Clearing Service (NECS) facility NECS facility is a centralised version of ECS facility. The NECS system takes advantage of the centralised accounting system in banks. Accordingly, the account of a bank that is submitting or receiving payment instructions is debited or credited centrally at Mumbai. The branches participating in NECS can, however, be located anywhere across the length and breadth of the country. Payment of dividend through NEFT Facility and how does it operate? NEFT denotes payment of dividend electronically through RBI clearing to selected bank branches which have implemented Core Banking solutions (CBS). This extends to all over the country, and is not necessarily restricted to the 68 designated centres where payment can be handled through ECS. To facilitate payment through NEFT, theareholder is required to ensure that the bank branch where his/her account is operated, is under CBS and also records the particulars of the new bank account with the DP with whom the demat account is maintained. Dividend through Direct Credit The Company will be appointing one bank as its Dividend banker for distribution of dividend. The said banker will carry out direct credit to those investors who are maintaining accounts with the said bank, provided the bank account details are registered with the DP for dematerialised shares and / or registered with the R &TA prior to the payment of dividend for shares held in physical form.
Benefits of NECS (payment through electronic facilities) Some of the major benefits are : a. Shareholder need not make frequent visits to his bank for depositing the physical paper instruments. b. Prompt credit to the bank account of the investor through electronic clearing. c. Fraudulent encashment of warrants is avoided. d. Exposure to delays / loss in postal service avoided. e. As there can be no loss in transit of warrants, issue of duplicate warrants is avoided. NECS facility NECS has no restriction of centres or of any geographical area inside the country. Presently around 32,000 branches of 114 banks participate in NECS.
Dividend which was given to shareholder of Reliance Directors have recommended a dividend of Rs. 7/- per Equity Share (last year Rs. 13/- per Equity Share on pre bonus share capital) for the financial year ended March 31, 2010, amounting to Rs. 2,430 crore (inclusive of tax of Rs. 346 crore) one of the highest ever payout by any private sector domestic company. The dividend will be paid to members whose names appear in the Register of Members as on May 11, 2010; in respect of shares held in dematerialised form, it will be paid to members whose names are furnished by National Securities Depository Limited and Central Depository Services (India) Limited as beneficial owners. The dividend payout for the year under review has been formulated in accordance with the Company’s policy to pay sustainable dividend linked to long term performance, keeping in view the Company’s need for capital for its growth plans and the intent to finance such plans through internal accruals to the maximum.
Bonus share paid to Reliance ShareHolders Financial Year 1980-81
1983-84 1997-98 2009-10`
Ratio 3:5 6:10 1:1 1:1
Dividend paid to shareholder for the period of 10 years
Miller and Modigliani Model (MM Model) Miller and Modigliani Model assume that the dividends are irrelevant. Dividend irrelevance implies that the value of a firm is unaffected by the distribution of dividends and is determined solely by the earning power and risk of its assets. Under conditions of perfect capital markets, rational investors, absence of tax discrimination between dividend income and capital appreciation, given the firm’s investment policy, its dividend policy may have no influence on the market price of the shares, according to this model.
Assumptions of MM model Existence of perfect capital markets and all investors in it are rational. Information is available to all free of cost, there are no transactions costs, securities are infinitely divisible, no investor is large enough to influence the market price of securities and there are no floatation costs. There are no taxes. Alternatively, there are no differences in tax rates applicable to capital gains and dividends. firm has a given investment policy which does not change. It implies that the financing of new investments out of retained earnings will not change the business risk complexion of the firm and thus there would be no change in the required rate of return. Investors know for certain the future investments and profits of the firm (but this assumption has been dropped by MM later). Argument of this Model By the argument of arbitrage, MM Model asserts the irrelevance of dividends. Arbitrage implies the distribution of earnings to shareholders and raising an equal amount externally. The effect of dividend payment would be offset by the effect of raising additional funds. MM model argues that when dividends are paid to the shareholders, the market price of the shares will decrease and thus whatever is gained by the investors as a result of increased dividends will be neutralized completely by the reduction in the market value of the shares. The cost of capital is independent of leverage and the real cost of debt is the same as the real cost of equity, according to this model. That investors are indifferent between dividend and retained earnings implies that the dividend decision is irrelevant. With dividends being irrelevant, a firm’s cost of capital would be independent of its dividend-payout ratio. Arbitrage process will ensure that under conditions of uncertainty
also the dividend policy would be irrelevant.
MM Model: Market price of the share in the beginning of the period = Present value of dividends paid at the end of the period + Market price of share at the end of the period. P0 = 1/(1 + ke) x (D1 + P1) Where:
Value of the firm, nP0
P0
=
ke
=
D1
=
P1
=
=
(n + ∆ n) P1 – I+E (1 + ke)
Prevailing market price of a share cost of equity capital Dividend to be received at the end of period 1 and Market price of a share at the end of period 1.
Where:
n
=
∆n
=
I
=
E
=
number of shares outstanding at the beginning of the period change in the number of shares outstanding during the period/ additional shares issued. Total amount required for investment Earnings of the firm during the period.
Gordon's Dividend Capitalization Model Gordon's theory contends that dividends are relevant. This model is of the view that dividend policy of a firm affects its value. Assumptions of this model: The firm is an all equity firm. No external financing is used and investment programmes are financed exclusively by retained
earnings. Return on investment( r ) and Cost of equity(Ke) are constant. The firm has perpetual life. The retention ratio, once decided upon, is constant. Thus, the growth rate, (g = br) is also constant. Ke > br Arguments of this model: Dividend policy of the firm is relevant and that investors put a positive premium on current incomes/dividends. This model assumes that investors are risk averse and they put a premium on a certain return and discount uncertain returns. Investors are rational and want to avoid risk. The rational investors can reasonably be expected to prefer current dividend. They would discount future dividends. The retained earnings are evaluated by the investors as a risky promise. In case the earnings are retained, the market price of the shares would be adversely affected. In case the earnings are retained, the market price of the shares would be adversely affected. Investors would be inclined to pay a higher price for shares on which current dividends are paid and they would discount the value of shares of a firm which postpones dividends. The omission of dividends or payment of low dividends would lower the value of the shares.
Dividend Capitalization model: According to Gordon, the market value of a share is equal to the present value of the future streams of dividends. P
E(1 - b) Ke - br
=
Where: P
=
E
=
b
=
1-b
=
Ke
=
br - g
=
Price of a share Earnings per share Retention ratio Dividend payout ratio Cost of capital or the capitalization rate Growth rate (rate or return on investment of an all-equity firm)
Example: Determination of value of shares, given the following data: D/P Ratio Retention Ratio Cost of capital r
Case A 40 60 17% 12%
Case B 30 70 18% 12%
EPS
$20
P
=
P
=
$20 $20 (1 - 0 0.17 – => (0.60 x 0.12) $20 (1 0.70) 0.18 – => (0.70 x 0.12)
$81.63 (Case A)
$62.50 (Case B)
Gordon's model thus asserts that the dividend decision has a bearing on the market price of the shares and that the market price of the share is favorably affected with more dividends.
Walter's Dividend Model Walter's model supports the principle that dividends are relevant. The investment policy of a firm cannot be separated from its dividend policy and both are inter-related. The choice of an appropriate dividend policy affects the value of an enterprise. Assumptions of this model: 1) Retained earnings are the only source of finance. This means that the company does not rely upon external funds like debt or new equity capital. 2) The firm's business risk does not change with additional investments undertaken. It implies that r(internal rate of return) and k(cost of capital) are constant.
3) There is no change in the key variables, namely, beginning earnings per share(E), and dividends per share(D). The values of D and E may be changed in the model to determine results, but any given value of E and D are assumed to remain constant in determining a given value. The firm has an indefinite life.
Formula: Walter's model P Where:
=
DKe – g
P
=
D
=
Ke
=
g
=
Price of equity shares Initial dividend Cost of equity capital Growth rate expected
After accounting for retained earnings, the model would be: P Where:
=
DKe – rb
r
=
b
=
Expected rate of return on firm’s investments Retention rate (E - D)/E
Equation showing the value of a share (as present value of all dividends plus the present value of all capital gains) – Walter's model:
P
=
D + r/ke (E D) ke
Where:
D
=
E
=
Dividend per share and Earnings per share
Example: A company has the following facts: Cost of capital (ke) = 0.10 Earnings per share (E) = $10 Rate of return on investments ( r) = 8% Dividend payout ratio: Case A: 50% Case B: 25% Show the effect of the dividend policy on the market price of the shares. Solution: Case A: D/P ratio = 50% When EPS = $10 and D/P ratio is 50%, D = 10 x 50% = $5
P
=
5 + [0.08 / 0.10] [10 5]
=> $90
0.10 Case B: D/P ratio = 25% When EPS = $10 and D/P ratio is 25%, D = 10 x 25% = $2.5
P
=
2.5 + [0.08 / 0.10] [10 2.5]
=> $85
0.10
Conclusions of Walter's model: When r > ke, the value of shares is inversely related to the D/P ratio. As the D/P ratio increases, the market value of shares decline. It’s value is the highest when D/P ratio is 0. So, if the firm retains its earnings entirely, it will maximize the market value of the shares. The optimum payout ratio is zero. When r < ke, the D/P ratio and the value of shares are positively correlated. As the D/P ratio increases, the market price of the shares also increases. The optimum payout ratio is 100%. When r = ke, the market value of shares is constant irrespective of the D/P ratio. In this case, there is no optimum D/P ratio. Limitations of this model: Walter's model assumes that the firm's investments are purely financed by retained earnings. So this model would be applicable only to all-equity firms. The assumption of r as constant is not realistic. The assumption of a constant ke ignores the effect of risk on the value of the firm.
