Dividends are the distribution of company profits to investors based on the number of shares they own. Dividend policy is an important financial decision of the company to determine whether profits will be distributed to shareholders or kept as retained earnings. This policy can affect a company's financial performance and is a significant factor in sourcing and investing. Dividends are also related to operating cash flow and its impact on investment opportunities. If the company increases its dividend policy, it can increase the value of the company and attract investors to invest.
Dividend policy is related to the process of paying dividends by the company, which includes determining the amount of dividends to be distributed as well as the amount of profit to be kept as company reserves. The higher the profitability of the company, the more likely the company is to produce higher dividends. The provision of large dividends to shareholders is expected to increase the value of the company (Widanaputra, 2010). However, companies may not want to pay high dividends to shareholders as this may reduce the funds available for management purposes. Dividend policy often leads to conflicts between company management and shareholders because they have different interests (Sugiarto, 2011). Management tends to want to use company profits for operational needs. Shareholders are of the view that the profits earned by the company should be distributed to them as dividends. The disagreement between management and shareholders can hinder the achievement of one of the company's goals, namely increasing company value (Sukirni, 2012).
Dividends distributed are often measured using the Dividend Payout Ratio (DPR), which determines the amount of dividends per share. Dividend Payout Ratio is the ratio between dividends paid and net income earned by the company. Investors who are interested in investing must consider the rate of return or profit that can be obtained from their investment, including capital gains and dividends which are part of the profits given to shareholders. In this context, managers must make a decision whether the profits earned by the company during a certain period will be distributed as dividends to shareholders or kept as retained earnings. Massive dividend distribution tends to be influenced by investor preferences that prefer high dividends, causing retained earnings to be low (Sari, 2013). In a situation of information imbalance (Asymmetric Information), managers can adopt strategies in dividend policy to address issues that the company does not want in the future (Haruman, 2008).
In a climate of intense competition among companies, managers are encouraged to manage the company with high efficiency and effectiveness. To maintain its operations, the company needs funds, which are usually obtained from investors. Investors generally invest their funds with the aim of seeking income or return on investment, either through dividend income (dividend yield) or profit from the difference between the selling price and the purchase price of shares (capital gain). The lack of protection for minority shareholders has caused investors to lose confidence, especially foreign investors, to maintain share ownership of public companies in Indonesia. It is hoped that the implementation of good corporate governance principles can overcome the problems faced by minority shareholders in safeguarding their rights as shareholders.
Theoretical Framework for Dividend Policy
The Board of Directors has the authority to make decisions regarding dividend distributions, which are influenced by various factors. The main factors affecting the determination of dividend distribution include the company's financial condition, future plans, and investors' wishes. The amount of dividend distribution is an important concern for companies and investors. Therefore, there are several factors that can influence dividend policy:
- Legal Legislation, Legal Law: distinct countries have distinct laws and regulations that impact profit distribution policies. These laws and regulations are often based on four primary rules: the net profit rule, the insolvency rule, the tax penalty rule, and the weak capital rule. When establishing the foundation for dividend policy, these regulations are regarded as obligatory guidelines for institutions.
- Profitable Investment Opportunities, if an institution does not find a profitable investment opportunity, it will distribute profits to its shareholders. However, if the institution finds a profitable investment opportunity, it will use the profits to fund the opportunity.
- Current Shareholders' Needs (Preferences), the current preferences of shareholders are considered to be one of the most important determinants of dividend policy. In institutions owned by a small number of individuals, there is a clear tendency to draw high profits and distribute only a small portion to shareholders, as current shareholders prefer to meet the financing needs of the company through profits received (retained earnings) rather than through issuing new shares. Issuing new shares means an influx of new shareholders, and existing shareholders do not want to lose control or borrow money to the extent that they have to pay interest on the loan.
- Availability of Cash Liquidity, this is considered an important clue as profit distributions reflect external cash flows. Therefore, the stronger the liquidity of an institution, the greater its ability to issue dividends.
- Growth and Expansion Projects, financial resources must be available to support growth initiatives for an institution going through a growth stage. It may be preferable to rely on internal financing sources rather than borrowing from outside sources. In order to avoid the interest costs associated with borrowing, institutions must keep their profits.
- Factors Relating to Owners and Capital Markets, the demands and desires of the owners influence dividend policy. It is also impacted by the capital markets since a low dividend payout ratio has been adopted.
Theories Explaining the Dividend Policy
The choice of dividend policy is seen as a crucial strategic financial decision that is influenced by a number of factors. Many ideas exist that attempt to explain how investors behave in relation to the dividend policy, these theories range from supportive to neutral with regard to the policy's effect on the financial success of the firm. Of the hypotheses put forth to try to explain distribution policy, the following are the most significant:
- Bird in The Hand Theory
This theory was developed by Gordon and Litner. Myrton Gordon and John Lintner have attempted to prove with scientific arguments that shareholders do not ignore dividend payments, the value of shares fluctuates along with the level of distribution evolution. Bird in the hand theory states that investors are more interested in companies that pay dividends (Wiagustini, 2010: 262). This theory indicates that dividend policy has a direct effect on the market value of the company by affecting the stock price, as the expected rate of return on capital decreases with the increase in dividend distribution.
- Tax Preference Theory
This theory states that if capital gains from the sale of shares are not taxed, or if the tax imposed is less than the tax rate on cash dividends distributed, investors tend to want the company not to distribute cash dividends but to retain the profits in the form of undistributed profits. By reducing the percentage of cash dividends distributed, while retaining undistributed profits, shareholder wealth will increase, with other factors remaining constant. Therefore, investors will encourage companies to pay out large amounts of cash dividends with larger profits than they receive from other companies. This means that the company distributes cash dividends in lieu of the amount of tax that investors would have paid.
- Clientele Effect Theory
