ACCA Advanced Financial Management (AFM) Practice Exam

Where are payout ratios typically smaller?

1. In companies with strong corporate governance

2. In firms with week corporate governance

3. In firms experiencing rapid growth

4. In firms facing intense market competition

The correct answer is: In firms with week corporate governance

Payout ratios are typically smaller in firms experiencing rapid growth. This phenomenon occurs because companies that are growing quickly often prefer to reinvest their profits back into the business to fuel further expansion rather than distributing those profits as dividends to shareholders. These firms may prioritize funding for new projects, research and development, or capital expenditures, which are seen as beneficial for sustaining growth in the long run. In contrast, firms with weak corporate governance may distribute dividends more freely, often as a means to appease investors or as a way to redirect cash away from potentially inefficient management decisions. However, this does not manifest in lower payout ratios, as management might choose to distribute dividends despite the underlying financial health of the company. Therefore, firms experiencing rapid growth are generally characterized by lower payout ratios due to their strategic focus on allocating resources toward growth opportunities rather than returning cash to shareholders.