Question 9.RQ.2: ‘The business’s dividend decision is really a by-product of ...
‘The business’s dividend decision is really a by-product of its capital investment decision.’ Discuss.
The residual theory of dividends states that dividends should be regarded as a residual amount arising when the business does not have enough profitable opportunities in which to invest. The argument assumes that shareholders will prefer the business to reinvest earnings rather than pay dividends, as long as the returns earned by the business exceed the returns that could be achieved by shareholders investing in similar projects. However, when all the profitable projects that meet this criterion have been taken up, any surplus remaining should be distributed to shareholders. Thus, dividends will be, in effect, a by-product of the investment decision, as stated.