Dividend & Determinants of Dividend Policy
Dividend refers to the corporate net profits allotted among shareholders. Dividends can be both of them, equity dividends and preference dividends. Preference dividends are constant dividends compensated as a portion or percentage every year to the preference shareholders if net income are positive. After the payment of preference dividends, the remaining net profits are compensated or retained or both relying on the decision taken by the management.
Determinants of Dividend Policy
The primary determinants of dividend policy of a business firm can be categorized into:
1. Dividend payout ratio
2. Dividend's stability
3. Contractual, legal and internal constraints and restrictions
4. Owner's considerations
5. Conditions of Capital market
6. Inflation.
Dividend payout ratio:
Dividend payout ratio brings up to the percentage share of the net net income allotted to the shareholders as dividends. Dividend policy requires the decision to pay out net income or to retain them for reinvestment in the firm. The retained net income constitute a source of finance. The optimum dividend policy should strike a balance among current dividends and future growth which make as large as possible the price of the business firm's shares. The dividend payout ratio of a business firm should be determined with reference to two basic objectives: make as large as possible the wealth of the business firm's owners and rendering sufficient funds to finance growth. These goals are interrelated.
Stability of dividends
Dividend stability brings up to the payment of a certain minimum amount of dividend regularly. The stability of dividends can assume any of the following three forms:
ñ Constant dividend per share
ñ Constant dividend payout ratio or
ñ Constant dividend per share in addition to extra dividend
ñ Legal, contractual and internal constraints and restrictions
Legal stipulations do not require a dividend declaration but they define the conditions under which dividends must be paid. Such conditions have to do with to net profits, capital impairment and insolvency. Significant contractual restrictions may be accepted by the company regarding payment of dividends when the company obtains external funds. These restrictions may cause the business firm to restrict the payment of cash dividends until a certain level of net income has been accomplished or fix the amount of dividends paid to a certain amount or percentage of earnings. Internal constraints are unique to a business firm and include liquid assets, growth prospects, financial requirements, availability of funds, net income stability and control.
The dividend policy is also likely to be influenced by the proprietor's considerations of the tax position of the stakeholders, their chances of investment and the weakening of ownership.
The extent to which the business firm has access to the capital markets, also affects the dividend policy. In case the business firm has easy access to the capital market, it can follow a liberal dividend policy. If the business firm has only limited access to capital markets, it is likely to adopt a low dividend payout ratio. Such companies rely on retained net income as a major source of financing for future growth.
Inflation
With rising prices due to inflation, the funds brought forth from depreciation may not be sufficient to replace obsolete equipments and machinery. So, they may have to rely upon retained net income as a source of fund to replace those assets. therefore, inflation affects dividend payout ratio in the negative side.
Bonus shares and stock splits
Bonus share is concerned to as stock dividend. They require payment to existing owners of dividend in the form of shares. It is an inherent part of dividend policy of a business firm to employ bonus shares and stock splits. A stock split is a method commonly employed to lower the market price of shares by raising the number of shares belonging to each shareholder. Bonus shares may be published to fulfill the existing shareholders in a situation where cash position has to be maintained.
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