Assume that you are a financial analyst attending a shareholders' meeting at PDQ plc on behalf of your employers, a large pension fund. Your entity is one of the few institutional investors in PDQ plc, which is a medium-sized listed entity.

The majority of the shareholders are small, private investors. At the shareholders' meeting you overhear a group of shareholders discussing the entity's dividend policy. Some of the comments you hear are as follows:

• 'I think the entity should increase its dividend payout to the maximum it can afford without having to borrow. That way our returns are less risky.'
• 'I don't agree. I think the entity should reduce the dividend and retain even more of its earnings for future investment.
• 'I would prefer no cash dividend at all and receive annual bonus shares. The value of my shareholding would then immediately increase.'
• 'I read somewhere that dividend policy has no effect at all on the value of the entity's shares.'

Requirements

(a)Discuss the validity or otherwise of the shareholders' comments. (15 marks)

(b)The expectations and requirements of institutional investors in respect of an entity's dividend policy may be different in a number of respects from those of private, individual shareholders.

Explain these differences and comment on the problems PDQ plc might face in trying to reconcile the requirements of the two groups of shareholders.

(10 marks)

(Total marks = 25)