Some Good Reasons for Paying Dividends

While the tax disadvantages of dividends are clear, especially for individual investors, there are some good reasons why firms that are paying dividends should not suspend them. First, there are investors who like to receive dividends, either because they pay no or very low taxes, or because they need the regular cash flows. Firms that have paid dividends over long periods are likely to have accumulated investors with these characteristics, and cutting or eliminating dividends would not be viewed favorably by this group.

Second, changes in dividends allow firms to signal to financial markets how confident they feel about future cash flows. Firms that are more confident about their future are therefore more likely to raise dividends; stock prices often increase in response. Cutting dividends is viewed by markets as a negative signal about future cashflows, and stock prices often decline in response. Third, firms can use dividends as a tool for altering their financing mix and moving closer to an optimal debt ratio. Finally, the commitment to pay dividends can help reduce the conflicts between stockholders and managers, by reducing the cash flows available to managers.

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