Firms Dividend Policy Tends To Follow The Life Cycle Of The Firm

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In chapter 7, we introduced the link between a firm's place in the life cycle and its financing mix and choices. In particular, we noted five stages in the growth life cycle -start up, rapid expansion, high growth, mature growth and decline. In this section, we will examine the link between a firm's place in the life cycle and its dividend policy. Not surprisingly, firms generally adopt dividend policies that best fit where they are currently in their life cycles. For instance, high-growth firms with great investment opportunities do not usually pay dividends, whereas stable firms with larger cash flows and fewer projects tend to pay more of their earnings out as dividends. Figure 10.7 looks at the typical path that dividend payout follows over a firm's life cycle.

Figure 10.7: Life Cycle Analysis of Dividend Policy

Figure 10.7: Life Cycle Analysis of Dividend Policy

Life Cycle Dividend

This intuitive relationship between dividend policy and growth is emphasized when we look at the relationship between a firm's payout ratio and its expected growth rate. For instance, we classified firms on the New York Stock Exchange in January 2004 into six classes, based upon analyst estimates of expected growth rates in earnings per share for the next 5 years, and estimated the dividend payout ratios and dividend yields for each class; these are reported in Figure 10.8.

Source: Value Line Database

The firms with the highest expected growth rates pay the lowest dividends, both as a percent of earnings (payout ratio) and as a percent of price (dividend yield).3

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