A Dividend Policy of a company refers to the proposition by which a company distributes cash to its shareholders by means of either cash dividends or share repurchases.
The dividend policy of a company affects the type of arrangement through which shareholders receive the return on their investment and is also an integral decision of a company’s board of directors. Payout decisions, along with financing decisions regarding the capital structure of the company, generally involve decision making by the board of directors and senior level of management and are closely watched by investors and analysts.
It has been observed that, several factors influence the dividend policy of a company, which include favorable investment opportunities for the company, the volatility expected in its subsequent earnings, tax considerations, flotation costs, and contractual and legal restrictions.
One of the argumentation’s in finance questions the impact, if any, on common stakeholders’ wealth of a company’s payout policy.
There are three general ideologies on investor preference for dividends:
- The first is a theory by Modigliani & Miller (MM), which argues that given perfect markets dividend policy is irrelevant.
- The “Bird in hand” theory asserts that investors prefer to receive a dollar of dividends today rather than uncertain capital gains in the future.
- The third theory suggests that countries where dividends are taxed at relatively higher rates than capital gains, taxable investors will want companies to reinvest earnings in growth opportunities or repurchase shares rather than giving out dividends and receive more of the return in the form of capital gains.
The Dividend Policy of a company may provide information to current and prospective stakeholders regarding the outlook of the company. Commencing to pay dividends or increasing a dividend sends a positive signal to investors, whereas trimming or neglecting to pay a dividend typically sends a negative signal.
An investor cannot evaluate any investment, whether it’s a stock, bond, rental property, collectible or option without a return. In case of stock, dividend is a form of return to the stockholders of the company. Dividend is one of the important ways with which companies communicate its financial position and the shareholder value too. In this article, we’ll cover the types of dividends policy and factors affecting them.
Dividend policy of a company sets the guidelines to be followed while deciding the amount of dividend to be paid out to the shareholders. The company needs to adhere by the rules set out in the dividend policy while distributing dividend.
There are basically 4 types of dividend policies.
Regular Dividends Policy
Is a policy in which company pays dividend at a usual rate. Generally retired individual or weaker section of the society prefers this policy. To implement this policy company has to make sure that earnings should be stabilized first.
Stable Dividend Policy
This policy assures dividend to the stockholder if company has positive earnings. Below mentioned table summarizes the different type of stable dividend policy and their effect on investors and management.
When the company does not have regular earnings or lack of liquid funds, it pays dividends on irregular basis.
Company does not pay dividends in case it has requirement of funds for future growth.
As it quite evident that dividend policy holds a great importance in company’s growth therefore prior to framing a dividend policy, company should consider the following factors which impact the dividend policy.
To make shareholders happy and company grow, it should decide the dividend policy and timing diligently. As there is no single optimal dividend policy that fits all the firms, companies should judiciously weigh the company specific and market related factors before formulating the dividend policy. It should also weigh the advantages and the disadvantages of the dividends before framing a dividend policy.
Also Read: Importance Of Compounding In Valuation