Dividend Policy

What Is Dividend Policy?

Dividend policy is the policy a company uses to structure its dividend payout to shareholders.
Some researchers suggest that dividend policy may be irrelevant, in theory, because
investors can sell a portion of their shares or portfolio if they need fund
Types of dividend policy:
There are three types of dividend policies: a stable dividend policy, a constant dividend policy,
and a residual dividend policy.
Stable Dividend Policy:
Stable dividend policy is the easiest and most commonly used. The goal of the policy is steady
and predictable dividend payouts each year, which is what most investors seek. Whether
earnings are up or down, investors receive a dividend. The goal is to align the dividend policy
with the long-term growth of the company rather than with quarterly earnings volatility. This
approach gives the shareholder more certainty concerning the amount and timing of the dividend.
Constant Dividend Policy:
The primary drawback of the stable dividend policy is that investors may not see a dividend
increase in boom years. Under the constant dividend policy, a company pays a percentage of its
earnings as dividends every year. In this way, investors experience the full volatility of company
earnings.
If earnings are up, investors get a larger dividend; if earnings are down, investors may not
receive a dividend. The primary drawback to the method is the volatility of earnings and
dividends. It is difficult to plan financially when dividend income is highly volatile.
Residual Dividend Policy:
Residual dividend policy is also highly volatile, but some investors see it as the only acceptable
dividend policy. With a residual dividend policy, the company pays out what dividends
remain after the company has paid for capital expenditures and working capital. This approach is
volatile, but it makes the most sense in terms of business operations. Investors do not want to
invest in a company that justifies its increased debt with the need to pay dividends.
FACTORS AFFECTING DIVIDEND POLICY

1.Stability of Earnings:

 More stable incomes, consistent dividend policy

 Often seen with firms dealing in necessities

2.Age of Corporation:

 A newly established corporation will require more money for expansion and may not a

rigid policy

3.Liquidity of funds:

 Greater the liquidity, greater company’s ability to pay dividend

4.Extend of Share Distribution:

 A closely held business (shareholders known each other) will make it easy for the

company to have a flexible policy

 A widely held company (large, diverse shareholders) will demand higher and frequent

dividends
5.Need for Additional Capital:

 Greater the need for additional capital, less likely for the company to have a rigid policy

6.Trade Cycles:

 Dividend policy is adjusted to market oscillations

 During boom, a company may hold a part of profit as a reserve for contingencies

 Higher rate of dividend may be used to attract investments during off periods

7.Government Policies:

 Government might restrict the distribution of dividends

 8.Taxation Policy:

 Higher the tax rates, lower the dividends

 Dividend-tax may be levied for distribution of dividend beyond a certain limit

 In Pakistan dividend tax is 15%

9.Legal Requirements:

 Company is required to provide for depreciation on its fixed and tangible assets before

declaring dividend on shares.

 Dividend should not be distributed out of capital

 Contractual liabilities should be fulfilled, like, payment of dividend on preference shares

in priority over ordinary dividend

10. Past dividend Rate:

 Current rate should be around average past rate

 Abnormally low or high rates will arouse speculation

11.Ability to Borrow:

 Greater the ability to borrow (established firms), better would be the dividend policy
12.Policy of Control:

 If greater control is desired, dividends will be declared at low rates to keep out investors

13.Repayments of loan:

 Loan indebtedness usually means low or now dividends

 Sometimes lenders may demand restricted dividend distribution till the repayments

14.Time:

 Dividend declaration should be at the time when cash outflow is at the minimum

15.Regularity and Stability

 Greater the regularity and stability of dividend payment, more investors will be attracted.