Dividend Policy or Dividend Puzzle?

In the words of Fischer Black (1976), "The harder we look at the dividend picture, the more it seems like a puzzle, with pieces that just don't fit together." Considering that it is still not decided whether dividends add to, or destroy, company value, I would say that this statement is completely true. 

The main question within dividend policy is does paying dividends maximise shareholder wealth? Surely, the very basic and simplistic answer would be yes, it does. Paying dividends out to shareholders will give the shareholder more money, thus maximising shareholder wealth. However, it is not as simple as that and, as every company is different, it would be virtually impossible to give a generic answer and solutions to dividend policy. 

The main issue that companies face with regard to dividends is do they pay out (or repurchase shares) to shareholders, or do they invest this money in positive NPV projects. Which would be more beneficial to shareholders?

A large amount of research has been carried out into the attitudes of companies towards the payment of dividends, or re-investing in the company. It was commonly found that the tendency to pay dividends was lower in smaller companies, who perhaps were not yet profitable and were looking to grow and expand. Due to being a smaller company, the investment opportunities and possibilities for growth would be fairly high. My opinion on this is that these managers would be looking at the dividend puzzle with a longer term perspective and would have the attitude that in order to maximise shareholder wealth, they would have to become more competitive and profitable. In order to do this they would have to invest in positive NPV projects and reduce, or eliminate, the payment of dividends to shareholders. 

Alternatively, larger companies have been found to be more likely to pay higher dividends, rather than reinvesting the money within the company. I think the reason for this is that they have less room for growth than new, younger companies and so the best way to keep their shareholders happy is to pay the dividends directly to them. If there is not necessarily a want or a need for investment and growth, this would evidently be the optimal use of the excess earning. 

I am of the opinion that smaller companies should adopt the Residual Dividend Policy, as in order to bring in the best returns for shareholders and increase shareholder value, they will need to develop a strong base. Investing in positive NPV value projects would still increase the market value of the company to reflect the increase in future returns, as detailed by Modigliani and Miller (1961).

For larger firms, I believe that a manged dividend approach would work best. Being a larger company, they would be more susceptible to variances in earnings each year. Sometimes they would exceed expectations by a large amount, other times they could fall short. A managed dividends policy would ensure shareholders would receive a decent dividend each year, giving them peace of mind that they chose a solid investment. However, it should be noted that any reasonable investor would expect to see slight fluctuations in their dividend, both positively and negatively, due to inevitable changes in the market or should the company's position change over a longer period of time.

I think it can be said that there is no set dividend policy that companies should adopt. Each company should determine their own policy based on what is most optimal for them and their shareholders. The policy is most likely to change and evolve alongside the company, and it is important for both the company and shareholders that the money is invested in the best way to increase value for both of them.