To answer the question, we need to understand the different schools of thought:

• Traditionally, we have the “ bird-in-the-hand view” that shareholders would like companies to pay high dividend. It augur well the thinking that “immediate” dividends over less certain and more distant capital gain;
• Another school takes the opposite stance whereby shareholders prefer capital gains over dividends and hence low payout ratios, because capital gains are taxed at a lower/zero rate than dividend;
• The third school of thought maintains that a company’s stock market value is relatively insensitive to its choice of dividend policy. Accordingly, as dividend is a passive decision, hence management should first determine its capital investment program and then pay out as dividends whatever cash is left over. [ Merton Miller & Franco Modigliani’s theory];

There is really no correct answer however, there is a strong trend to believe that dividend policy or changes plays a very important role as it is able to signal to the existing or potential investors regarding changes in management’s expectations as to the company’s future earnings.

We do see more listed companies are establishing higher dividend payout ratio to satisfy its existing and potential investors.Hence, the Board/Management need to carefully review the following:
the range of feasible target payout ratios together with the range of customary payout ratio and
any special shareholder mix consideration.

Shareholders need to be confident with the company they invest in to show the correct rationale when doing cash distribution/dividend. They must perceived that the Board/Management have done systematic research to determine an appropriate dividend policy.

On the part of the company, Management needs to embark on the following steps:

(a)Estimating Future Residual Funds
Determine an appropriate target payout ratio
Setting the dividend rate

(b)Estimating future residual funds
Logically, this is the starting point as we need to establish a cash flow projection over a reasonable time horizon typically 5 years. The projected level of capital expenditures and operating cash flows are the most important factors to take into account. Simply, a company should pay out that portion of its cash flow which it is unable to reinvest profitability. From the economic value added concept (considering the cost of capital), whereby the investment cannot further add value to its shareholder equity, the money which are from the shareholders should be returned to them.
In the five years cash flow projections, different scenario of the timing and quantum of capital expenditure needs to be included relative to the changes in business decisions, etc. Therefore, future operating cash flow is not entirely predictable hence the cash flow projections should reflects the different range of distributable amounts which results in the different range of feasible target payout ratio.

(c)Determine an appropriate target payout ratio
To do this, we need to analyse the payout ratio of comparable companies in the same industry. Comparable would mean that it should resemble wherever possible the company in terms of its size, product mix, operating characteristics and others.
The average industry standard should also be considered.
Finally, the range of feasible target payout ratios from the aforesaid cash flow coupled with the range of customary payout ratios be considered further with the shareholder mix to finally get the long-term target payout ratio.

(d)Setting the dividend rate
It is quite crucial not to send a wrong message to both the existing or potential investors hence the need to consider the appropriate dividend rate. What it means is that the rates should preferably not be erratic which can send a wrong message to the investors. Given its target payout ratio and its earning projections, the quarterly or interim dividend rate should be established at the highest comfortably sustainable level which should prudently be below the expected maximum rate earlier set up in the cash flow projection.

The above steps/approaches showed that to set a dividend policy decision, it will need many painstaking homework and top management review/decision. The ultimate objective perhaps is to use this dividend decision as a tool to further win the heart of the existing and potential investors.Really, in a good market, where the shareholders have confident of bright company’s prospect coupled with growing trend and consistency of dividend payout, it might not be wrong to say that shareholder value can be enhanced by the share price going up.

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