The paper "Relevance of the Decision to Pay Dividends " is a great example of finance and accounting coursework. The signaling theories of dividend argue that dividends act as forecast signaling tool since managers own asymmetric information with regards to the company’ s future financial performance. As a result, the association between the change in dividend and the firm’ s future financial performance is a vital theoretical issue. The change in dividend is considered a signal to the current and expected future company’ s prospect (Chen, 2008). Miller and Modigliani (1961) provided an argument of what influence firm dividend policy, inclusive of the signaling property of dividend.
Miller and Modigliani argued that investors depict the justification for the interpretation of the change in dividend as a sign of the change in management perception with regards to the firm’ s future prospect. Dividend signaling model implies that the growth in dividend convey a managerial hopefulness with regards to firms’ future performance whilst a decline in dividend would suggest that managers are anticipating the poor performance of the business in the future. The research by Leftwich and Zmijewski (1994), pointed out that dividend signaling means a stern long-term worsening in a firm’ s future performance because of the decline in dividend payment.
The dividend signaling model tries to capture information passed by an increase as well as a decrease in dividend within a similar model that fails to distinguish the exclusive situation that surrounds the change in dividend payments. An increase in dividend would imply that the firm is improving (Jensen, 2009). In the pecking order model, companies will consider using the internally generated finance to get rid of under-investment linked with risky debt as well as asymmetry in the information involving the manager and the security market.
If the company does have enough internally created finance to fund its business operations, it will issue debt to fund its fiscal deficit. Only to a rare situation, the company will fund its fiscal deficit with external equity capital. The company that shifts to pecking order model in funding their operation will seek to get rid of raising external capital by capitalizing on the amount of internally created finance existing to fund their operations (Shapiro, 2008).
One apparent approach to pecking order model in funding their operation this might account for the decline in the propensity of the company paying the dividend as depicted in the Fama and French. A theoretically testable effect of the pecking order model is that if the company is reducing their dividend payment as per the theory then the company must as cut the amount of debt funding they are using to find its business operation Recent research depicts that many of the firms that pay dividend had reduced immensely for the last decades.
Fama and French identified that almost 50% of the reduction in the portion of companies paying dividend might be as a result of a big number of small, unsuccessful firms that have gone public in recent years. They as well conclude that the other 50% of the decline in companies paying the dividend was an s result of the decline in the propensity of viable companies paying the dividend. The biggest problem is that what are the main factors that lead to a decline in the propensity of companies to paying the dividend.
One likely justification is that big companies commenced on funding their business operation as per the pecking order model.