Dividend Policy
Dividend policy is referred with taking a decision concerning paying cash dividend in the present or paying an increased dividend at a later. The company could also pay in the form of stock dividends which unlike cash dividends do not render liquidity to the investors. All the same, it ensures capital gains to the stockholders. The anticipations of dividends by shareholders assist them to decode the share value, thus, dividend policy is a important decision taken by the financial managers of a company.
Coming up with a dividend policy is thought-provoking for the directors and financial managers of a company It is because different investors have different opinions on present cash dividends and future capital gains. Another that occurs is concerning the extent of effect of dividends on the share price. Due to the disputable nature of a dividend policy it is sometimes referred as the dividend puzzle.
Several models have been developed to assist companies to evaluate the perfect dividend policy. There is no understanding between the value of the share, relationship between dividends and the wealth of the shareholders.
Investors prefer companies which pay regular dividends and such dividends affect the market price of the share. Dividends paid by the companies are considered positively both by the investors and the firms. The companies that do not pay dividends are rated in an opposite position by investors therefore affecting the share price. The people who assist relevance of dividends clearly consider that regular dividends decrease uncertainty of the shareholders i.e. the earnings of the company is discounted at a lower rate, ke and thus increasing the market value. Even so it is opposite in the case of increased uncertainty due to non-payment of dividends.
There are few considerations that affect the dividend policy of company, such as
1. Stability of Earnings:
The nature of business has an significant bearing on the dividend policy. Industrial units having stability of earnings may formulate a consistent dividend policy than companies having an uneven flow of incomes as they can anticipate easily their earnings and savings. Normally, enterprises deals with necessities suffer less from fluctuating earnings than those dealing in fancy goods and luxuries.
2. Age of Company:
Age of the company considers much in deciding the dividend policy. A newly accomplished company may require much of its earnings for expansion and plant improvement. They may choose a rigid dividend policy whereas an established company can formulate a consistent dividend policy.
3. Liquidity of Funds:
Sound financial position and availability of cash is also an significant in dividend decisions. A dividend displays a cash outflow, the higher the funds and the liquidity of the company the better the ability to pay dividend. The liquidity of a firm is based very much on the investment and financial decisions of the firm which in turn decides the rate of expansion and the manner of financing. If cash position is good, company can distribute the cash dividend and if cash position is weak, stock dividend will be distributed.
4. Extent of share Distribution:
Nature of ownership also affects the dividend decisions to certain level. A closely held company is likely to get the assent of the shareholders for the pause of dividend or for accompanying a conservative dividend policy. On contrary, a company with a good number of shareholders distributed and forming medium or low income group, would face difficulty in securing such assent as they will put stress to distribute higher dividend.
5. Needs for Additional Capital:
Companies keep back a part of their profits for strengthening their financial position. The income may be preserved for meeting the increased requirements of working capital or of future expansion. Small companies generally find difficulties in raising finance for their requirements of increased working capital for expansion pro grammes. They have no other option and use their turned back profits. Therefore, such companies retain a big part of profits and distribute dividend at low rates.
6. Trade Cycles:
Business cycles also employ effect upon dividend Policy. Dividend policy is accommodated according to the business fluctuations. For example, during the boom out, prudent management creates food reserves for contingencies followed the inflationary period. Higher rates of dividend can be utilized as a tool for marketing the securities in an otherwise depressed market. The financial solvency can be maintained and proved by the companies in dull years if the proper reserves have been geared up.
7. Government Policies
The earnings ability of the enterprise is affected to a great degree by the change in fiscal, industrial, labor, control and other government policies. Often government bounds the distribution of dividend beyond a certain percentage in a peculiar industry or in all spheres of business activity as was done in case of emergency. The dividend policy has to be formulated or modified accordingly in those enterprises.
8. Taxation Policy
High taxation decreases the earnings of the companies and consequently the rate of dividend is lowered down. Sometimes government imposes dividend-tax of distribution of dividend beyond a certain limit. It also influence the capital formation.
9. Legal Requirements
While deciding on the dividend, the directors take the legal necessities too into thoughtfulness. In order to protect the interests of creditors, the companies Act 1956 orders certain guidelines with respect to the payment and distribution of dividend. Furthermore, a company is required to render for depreciation on its fixed and tangible assets before declaring dividend on shares. It advises that in any case, dividend should not be distributed out of capital. Similarly, contractual obligation should also be fulfilled, say for instance, payment of dividend on preference shares in priority over ordinary dividend.
10. Past dividend Rates
While developing the Dividend Policy, the directors must keep in mind the dividend paid in past years. The current rate should be around the average past rate. If it has been abnormally enhanced the shares will be subjected to speculation. The company should consider the dividend policy of the competitive organization.
11. Ability to Borrow
Large and well established companies have better access to the capital market than the new companies. They may borrow funds from the external sources if there is any requirement. Such Companies may have a better dividend pay out ratio. On the other hand smaller firms have to depend on their internal sources and thus they will have to built up good reserves by deducting the dividend pay out ratio for any responsibility requiring heavy funds.
12. Policy of Control
Policy of control is also one of deciding factor as long as dividends are concerned. If the directors want to have control on company, they would not like to add new shareholders and thus, declare a dividend at low rate. This is because by adding new shareholders they fright dilution of control and diversion of policies and pro grammes of the existing management. Thus they choose to meet the needs through held back earings. If the directors do not bother about the control of affairs they will abide by a liberal dividend policy. Thus control is an affecting factor in designing the dividend policy.
13. Repayments of Loan
A company having loan liability are anticipate to a high rate of retention earnings, unless one other arrangements are made for the repurchase of debt on maturity. It will lower down the rate of dividend. On the certain occasions, the lenders put limitations on the dividend distribution. Formal loan contracts in general render a certain standard of liquidity and solvency to be maintained. Management is forced to listen such restrictions and to restrict the rate of dividend payout.
14. Time for Payment of Dividend
Payment of dividend means outpouring of cash. It is, thus, worthy to distribute dividend at a time when it is least needed by the company. Because there are peak times as well as lean periods of outlay. Management should plan the payment of dividend in such a way that there is no cash outpouring at a time when the project is already in requirement of urgent finances.
15. Regularity and stability in Dividend Payment
Dividends should be paid regularly as each investor is concerned in the regular payment of dividend. The management should, instead of regular payment of dividend, assume that the rate of dividend should be all the most same. For this reason sometimes companies maintain dividend equalization Fund.
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