Dividend policy of the firm is irrelevant to the rational investor Essay

Dividend policy of the firm is irrelevant to the rational investor - Essay Example These factors lead to fluctuation in the share prices and valuation of the companies. The relevance of dividend policy to a rational investor has been discussed in the subsequent sections (Gross, 2007, p.14). Rational for dividend payments The objective of investments is aimed at capital appreciation of the assets or securities over the period of holding. So, there is a definite reason for the companies to pay dividends which actually reduces the long term capital appreciation due to liquid payments in the form of dividend. The dividend payments are clear cut statements by the companies to showcase their abilities to manage their assets and performance to achieve financial profits and growth. The payment of dividends by the companies assures majority of the investors of sound financial performance in future and builds confidence for investment in stocks (Xu and  Wang, 1997, p.19). The companies decide through their dividend policy on the proportion of dividend payout and the percen tage to be kept for retained earnings. The dividend payment allocations are very delicate as the company also has to focus on increasing the financial wealth in future and reduce their dependency on leverage. The interest and tax rates also play an important role in the dividend policy of the companies. A reduction in the tax rates on long term and short term capital gains would urge the companies to cut down their dividend payments and invest more retained earning for long term capital gains (Funke, 2007, p.11). Empirical theories: Irrelevance of Dividend Policy The aspect of irrelevance of dividend policy to a rational investor can be explained by considering the empirical theories of dividend policy. Residual... The companies give topmost priority to finance their needs of investment looking at the target growth rates to be achieved in the short-term as well as long run. Only after meeting the needs of finances, the companies decide to distribute the residual profits to the shareholders in the form of dividend payments. Thus the shareholders would not be concerned of the dividend policy as capital gains for future from the investments done by the company lies at the core of maximization of their wealth. The rational investors are also knowledgeable that there is no dividend policy that could referred to as an optimal dividend policy. The dividend policies are an outcome of the fund requirement of the companies for financing the investment projects. For this reason, the dividends are declared by the companies which lead to restoration of confidence among the shareholders. Thus the shareholders are attracted more towards the investment in the company stocks as a result of which the price of th e share rises and the valuation of the companies are increased.