Group Assignment 4
Dividend Policy at FPL Group, Inc. 1. Why do firms pay dividend? What, in general, are the advantages and disadvantages of paying cash dividends?
The sole purpose of dividends per se is to return wealth back to the shareholders of a company. Shareholders take risk and invest in company and the dividends are rewards for commitment, trust and risk-taking. Dividends transfer economic value from the company to the shareholders instead of the company using the money for operations. Often in case of more established and mature companies that are growing more slowly they are not “hungry” for cash and to reward the shareholders by sharing the wealth those companies pay dividends. Similarly paying dividends often is a sign of sound business model and stability of company at large. Both paying and not paying dividends and cash dividends have their own respective pros and cons as presented below:
Advantages:
1. Dividends may appeal to investors who desire stable cash flow but do not want to incur the transaction costs from periodically selling shares of stock.
2. Behavioral finance argues that investors with limited self-control can meet current consumption needs with high dividend stocks while adhering to the policy of never dipping into principal.
3. Managers, acting on behalf of stockholders, can pay dividends in order to keep cash from bondholders.
4. The board of directors, acting on behalf of stockholders, can use dividends to reduce the cash available to spendthrift managers.
5. Managers may increase dividends to signal their optimism concerning future cash flow.
Disadvantages:
1. Dividends have been traditionally taxed as ordinary income.
2. Dividends can reduce internal sources of financing. Dividends may force the firm to forgo positive NPV projects or to rely on costly external equity financing.
3. Once established, dividend cuts