For an enterprise, the distribution of a part of the profit or non-distribution of the profit will be reflected in the growth of the net assets and finally by a gain of value. The reinvestment of a significant proportion of the net profit will lead to an increase of the financial autonomy and to reducing of the financial risk. Consequently, the cost of own capital will be reduced accordingly to the risk reduction, representing a growth factor for the profitability and for the enterprise value. A company that distributes a small share of the profit and whose marginal cost of the equity is satisfactory will register a growth of its price of shares. Such an enterprise will select its shareholders. Instead a high dividend policy is a means to ensure the constancy of shareholders who were used to collect a certain income.
The harmonization between the two alternatives, distribution and/or reinvestment is done through a procedure of dividend distribution involving in the issue and free distribution of new shares. Thus, the cash capital for dividends remain in the company to finance its development, and shareholders incentives will be achieved by allocating free shares that in fact increase their property. The decision of net profit-sharing is taken by shareholders by the general meeting. However, the financial manager is not only a particular persuasion on a significant number of owners, but especially for European companies, he owns a significant percentage of the enterprise capital. The same situation occurs for a number of companies for which the ownership is divided among a significant number of shareholders, where the manager is the trustee of their interests. In practice there are many factors that favour the profit reinvesting [7]:
the taxes (personal and of the enterprise): when the personal income tax rate is higher than
the tax rate of the company profits, it will be stimulated to reduce the payments of dividends and vice versa;
the expected income, dividends and personal taxes: we are presenting here the effect of
personal taxes taking the extreme case that the dividends are taxed as ordinary income and the capital gains are not taxed at all. Looks like to a company that distributes a greater benefit in the form of dividends will have a low value (or a higher required return before tax) than the one whose benefit is expressed as non-taxable capital gains;
fluctuating costs: if the dividend policy is neutral, we can say that a company may sell new
shares if is necessary to pay dividends. The sale of the new shares can be very expensive. If we include the fluctuating costs in our argument, then we can conclude that the amount of shares fall when we sell new shares;
restrictions on dividends: in many cases, a company must deal with restrictions on its
ability to pay dividends. A common feature of bonds is to prohibit the payment of dividends over a certain level. Also, an enterprise can be stopped by the law to pay dividends if the dividend exceeds the amount of the retained profits.
The classical theory of Benjamin Graham, David Dodd and Sidney Cottle argued that companies generally have high dividend payments because [7]: the present value of immediate dividends exceeds the present value of dividends from remote and between two companies with the same overall power of gain and the same general position in the industry, one that pays big dividends almost always sell shares at a higher price.
There are a number of arguments to support the reinvestment of a significant proportion of the net profit, as destination of the distribution:
the recovery of the invested funds is done through depreciation, maintenance of the current position involving an investment policy more or less substantial;
when a fixed asset obsolete with a long time before its physical wear, the only solution is to sell or discarding it and buying a new machine, of course paying a higher price and with losses incurred by the company, offset by the profit-sharing policy by raising the funds for development;
the dividend tax rate is higher than those applied to the earnings from the increases of price share;
by not distributing dividends, the company has sufficient funds available, that is a favour in development of its current activity.
Although dividends are taxed higher and sometimes are not attractive to investors, they still appear as the destination for distribution, because:
do not forget that shareholders do not feed on account of hopes of future earnings due to the reinvestment of profits, but on account of actual receipts, such as those resulting from the receipt of dividends;
the dividends are a solution for the fact that the enterprise can not find a better investment; the dividends must be distributed to its informational role, of signalling;
through dividends there can provide a control on the managers' activity.
The problem of net profit distribution there isn’t a minor problem in the financial management of the company, getting more and more the character of a fundamental decision for the life company and the complexity of difficult problems of the financial policy. J.E. Walter (1956) argues that the profit sharing should be followed to achieve with priority the investment and financing policies, thereby claiming that dividend policy is not one major, but a waste one. According to this theory, the rational investors will prefer to see the company and preserving their financial resources only to receive dividends, provided that return such funds to be reinvested in higher yield one could obtain on your own, from investment of equal risk [2]. The theory starts from the premise that the enterprise value (V0) is given by [8]:
(
)
k Dv k r Dv V act act inv act+ × − = Pr 0 , where: actDv = dividend per share; inv
r = return on investment;
k = discount rate; act
Pr = Net profit per share.
In this relation, the interpretation is clear:
- if r k
inv > , the company will not distribute any dividend, because otherwise it will not get maximum value for V0;
- if r k
inv = , the firm value is independent of the rate of profit distribution as dividends;
- if r k
inv < , the company must distribute dividends, as it can not provide a satisfactory rate of return for investors.
The adoption of this theory in practice is difficult for large companies, because determines a high variability of dividends, which is generally interpreted as a negative situation on the financial market as it creates uncertainty about the future of the enterprise. It can still apply for small enterprises. Other theories claim the decreasing of the distributed dividend due to the tax differentials between reinvested profits and dividends, most often for the first destination. Many authors have shown that the neutrality of dividend policy is not achieved in practice because there is a distinction between the taxation of dividends and earnings from increases of share price.
The criticism of this current of opinion related on the first: the negative reactions to the variability of the financial markets or absence of dividends; the fact that it is possible to conduct the shareholder behaviour who becomes obsessively preoccupied by stock speculation; the uncertainty about the future, in the context of information asymmetry and that managers can use undistributed profits to the shareholders for non-viable projects and even for their own interest.
4. Conclusions
In conclusion, as it is difficult to give a simple formula to assist the management in determining of the optimal capital structure, just as it is difficult to establish the optimal dividend policy [1]. However, we can identify several important factors:
the fast-growing enterprises should promote a reduced rate of dividends payment and to reinvest the funds generated internally. This approach minimizes the costs of capital market constraints to finance the development options;
the companies with high and stable operating cash-flow and with few investment opportunities have to pay higher dividends to reduce the tendency of managers to reinvest the cash-flow available in unprofitable investments;
the companies should not worry too much on fiscal factors in determining the policy dividends. Whatever policy is chosen, they will be able to attract investors. The enterprises that opt for higher rates of dividend payment will attract the tax exempt organizations and the companies that pay low dividends, or not paid at all, will attract investors with high tax rate;
the financial agreements concluded by enterprises may have an impact on determining of the policy dividends. The enterprises will try to avoid the proximity limits to minimize the possibility of dividends reducing.
References
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