Definition of Dividends - a sum of money paid regularly (typically quarterly) by a company to its

shareholders out of its profits (or reserves).

What is a Dividend Policy?

A company’s dividend policy dictates the amount of dividends paid out by the company to its
shareholders and the frequency with which the dividends are paid out. When a company makes a
profit, they need to make a decision on what to do with it. They can either retain the profits in the
company (retained earnings on the balance sheet), or they can distribute the money to
shareholders in the form of dividends.

1. Regular dividend policy

Under the regular dividend policy, the company pays out dividends to its shareholders every
year. If the company makes abnormal profits (very high profits), the excess profits will not be
distributed to the shareholders but are withheld by the company as retained earnings. If the
company makes a loss, the shareholders will still be paid a dividend under the policy.

The regular dividend policy is used by companies with a steady cash flow and stable earnings.
Companies that pay out dividends this way are considered low-risk investments because while
the dividend payments are regular, they may not be very high.

2. Stable dividend policy

Under the stable dividend policy, the percentage of profits paid out as dividends is fixed. For
example, if a company sets the payout rate at 6%, it is the percentage of profits that will be paid
out regardless of the amount of profits earned for the financial year.

Whether a company makes $1 million or $100,000, a fixed dividend will be paid out. Investing
in a company that follows such a policy is risky for investors as the amount of dividends
fluctuates with the level of profits. Shareholders face a lot of uncertainty as they are not sure of
the exact dividend they will receive.

3. Irregular dividend policy

Under the irregular dividend policy, the company is under no obligation to pay its shareholders
and the board of directors can decide what to do with the profits. If they a make an abnormal
profit in a certain year, they can decide to distribute it to the shareholders or not pay out any
dividends at all and instead keep the profits for business expansion and future projects.
The irregular dividend policy is used by companies that do not enjoy a steady cash flow or lack
liquidity. Investors who invest in a company that follows the policy face very high risks as there
is a possibility of not receiving any dividends during the financial year.

4. No dividend policy

Under the no dividend policy, the company doesn’t distribute dividends to shareholders. It is
because any profits earned is retained and reinvested into the business for future growth.
Companies that don’t give out dividends are constantly growing and expanding, and
shareholders invest in them because the value of the company stock appreciates. For the investor,
the share price appreciation is more valuable than a dividend payout.

Factors Affecting Divident Policy

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Dividend Decisions

Factors affecting Dividend Policy

A company is raising funds from different sources, it includes debentures, preference shares and
equity shares. Payment to debenture holders and to preference share holders are at a fixed rate.
No commitment is made to equity share holders in terms of return. If there is a loss then no
payment will be made to them, however if there is a profit, then the company is required to
decide whether to pay dividend or not. If dividend is to be paid, then what amount to be paid is
required to be decided. Again this decision will be taken in such a way so that it maximizes
wealth of shareholders. There are various types of dividend policies – regular, stable, constant
and irregular. In this post, we will discuss various factors affecting dividend policy.

Table of Contents [show]

Factors affecting Dividend Policy

A company needs to analyze certain factors before framing their dividend policy.

The following are the various factors/determinants that impact the dividend policy of a company:

Type of Industry
The nature of the industry to which the company belongs has an important effect on the dividend policy.
Industries, where earnings are stable, may adopt a consistent dividend policy as opposed to the
industries where earnings are uncertain and uneven. They are better off in having a conservative
approach to dividend payout.
Ownership Structure
The ownership structure of a company also impacts the policy. A company with a higher
promoter’ holdings will prefer a low dividend payout as paying out dividends may cause a
decline in the value of the stock. Whereas, a high institutional ownership

will favor a high dividend payout as it helps

them to increase the control over the management.

Age of corporation
Newly formed companies will have to retain major part of their earnings for further growth and
expansion. Thus, they have to follow a conservative policy unlike established companies, which can pay
higher dividends from their reserves.
The extent of Share Distribution

A company with a large number of shareholders will have a difficult time in getting them to
agree to a conservative policy. On the other hand, a closely held company has more chances of
succeeding to finalize conservative dividend payouts.

Different Shareholders’ Expectations

Another factor that impacts the policy is the diversity in the type of shareholders a company has.
A different group of shareholders will have different expectations. A retired shareholder will
have a different requirement vis-a-vis a wealthy investor. The company needs to clearly
understand the different expectations and formulate a successful dividend policy.
Psychologically, cash dividend will give more satisfaction to shareholder in comparison to
capital appreciation.
Leverage

A company having more leverage in their financial structure and consequently, more interest
payments may to decide for a low dividend payout, so as to increase their net worth and to make
sure that it can make payment of financial charges even in case of earning of the company is
falling. Whereas a company utilizing more of own financing will prefer high dividends.

Future Financial Requirements / Reinvestment opportunity

Dividend payout will also depend on the future requirements for the additional capital. A
company having profitable investment opportunities is justified in retaining the earnings.
However, a company with no capital requirements should opt for a higher dividend.

Home
Dividend Decisions

Factors affecting Dividend Policy

A company is raising funds from different sources, it includes debentures, preference shares and
equity shares. Payment to debenture holders and to preference share holders are at a fixed rate.
No commitment is made to equity share holders in terms of return. If there is a loss then no
payment will be made to them, however if there is a profit, then the company is required to
decide whether to pay dividend or not. If dividend is to be paid, then what amount to be paid is
required to be decided. Again this decision will be taken in such a way so that it maximizes
wealth of shareholders. There are various types of dividend policies – regular, stable, constant
and irregular. In this post, we will discuss various factors affecting dividend policy.

Table of Contents [show]

Factors affecting Dividend Policy

A company needs to analyze certain factors before framing their dividend policy.

The following are the various factors/determinants that impact the dividend policy of a company:

Type of Industry
The nature of the industry to which the company belongs has an important effect on the dividend policy.
Industries, where earnings are stable, may adopt a consistent dividend policy as opposed to the
industries where earnings are uncertain and uneven. They are better off in having a conservative
approach to dividend payout.
Ownership Structure
The ownership structure of a company also impacts the policy. A company with a higher
promoter’ holdings will prefer a low dividend payout as paying out dividends may cause a
decline in the value of the stock. Whereas, a high institutional ownership
 will favor a high dividend payout as it helps
them to increase the control over the management.

Age of corporation
Newly formed companies will have to retain major part of their earnings for further growth and
expansion. Thus, they have to follow a conservative policy unlike established companies, which can pay
higher dividends from their reserves.
The extent of Share Distribution

A company with a large number of shareholders will have a difficult time in getting them to
agree to a conservative policy. On the other hand, a closely held company has more chances of
succeeding to finalize conservative dividend payouts.

Different Shareholders’ Expectations

Another factor that impacts the policy is the diversity in the type of shareholders a company has.
A different group of shareholders will have different expectations. A retired shareholder will
have a different requirement vis-a-vis a wealthy investor. The company needs to clearly
understand the different expectations and formulate a successful dividend policy.
Psychologically, cash dividend will give more satisfaction to shareholder in comparison to
capital appreciation.

Leverage

A company having more leverage in their financial structure and consequently, more interest
payments may to decide for a low dividend payout, so as to increase their net worth and to make
sure that it can make payment of financial charges even in case of earning of the company is
falling. Whereas a company utilizing more of own financing will prefer high dividends.
Future Financial Requirements / Reinvestment opportunity

Dividend payout will also depend on the future requirements for the additional capital. A
company having profitable investment opportunities is justified in retaining the earnings.
However, a company with no capital requirements should opt for a higher dividend.

Business Cycles
When the company experiences a boom, it is prudent to save up and make reserves for dips. Such
reserves will help a company to maintain dividend even in depressing markets to retain and attract more
shareholders.
Changes in Government Policies

There could be the change in the dividend policy of a company due to the imposed changes by
the government.

Profitability

The profitability of a firm is reflected in net profit ratio and ratio of profit to total assets. A
highly profitable company have a capacity to pays higher dividends and a company with less
profits will adopt a conservative dividend policy.

Taxation Policy

The corporate taxes will affect dividend policy, either directly or indirectly. The taxes directly
reduce the residual earnings after tax available for the shareholders. If dividend income is taxable
in the hands of investor and capital gain is exempt, then company may retain its earning so as to
increase price per share, which ultimately gives higher return to investors’ and vice versa.
Further if it is possible that bifurcate all shareholders into high tax bracket or low tax bracket,
accordingly dividend policy can be framed. Finally, objective is to give maximum return to
shareholders.

Trends of Profits

Even if the company has been profitable over the years, the trend should be properly analyzed to
find the average earnings of the company. This average number should be then studied in
relation to the general economic conditions. This will help in opting for a conservative policy if a
depression is approaching.

Liquidity

Liquidity has a direct relation with the dividend policy. Many a times, company having high
profit, may have majority of profit blocked in working capital or it may acquired assets. In that
case its liquidity is poor. In that case company should pay less dividend. High dividend payment
is possible only if company has good earning and sound liquidity.
Legal Rules

There are certain legal restrictions on the companies for dividend payments. It is legal to pay a
dividend only if the capital is not reduced post payment. These rules are in place to protect
creditors’ interest. Most importantly providing depreciation is mandatory before making
payment of dividend. Depreciation is to be provided at minimum rates provided. Providing
depreciation is very important because with that company is able to retain an amount of profit for
replacement of fixed assets in future.

Inflation

Inflationary environments compel companies to retain major part of their earnings and indulge in
lower dividends. As the prices rise, the companies need to increase their capital reserves for their
purchases of fixed assets. In case of inflationary situation, same quantity of closing stock will
have more valuation, so payment of tax also increase.

Control Objectives

The firms aiming for more control in the hands of current shareholders prefer a conservative
dividend payout policy. It is imperative to pay fewer dividends to retain more control and the
earnings in the company.

In a nutshell, the management of a company is completely free to frame the required dividend
policy. There are no obligations to be adhered to. So, the company needs to judiciously weight
all the above-mentioned factors and formulate a balanced dividend policy. A dividend policy can
also be revised in the wake of changes in any of the factors.