Dividend Policy

Every business has shareholders who invest funds. However, dividing profits between many shareholders is a difficult task due to several conflicts that arise while distributing profits among them. So, to address the issue, companies develop a dividend policy, which thoroughly discusses the procedure for distributing profits between equity members. 

A dividend policy is how corporations develop their strategy; management must decide on the earnings amount, timings, and various other factors. So, in this article, we will discuss what a dividend policy is, the different types of dividend policy, the determinants of a dividend policy, and its impact. 

What is a Dividend? 

A dividend is a distribution of a company’s earnings to its stockholders, and it is determined by the board of directors. Dividends can be paid out in cash or as additional stock. The announcement of dividend payouts directly affects the increase or reduction in a company’s value.

What is a Dividend Policy? 

A dividend policy is a method by which a company structures its dividend to the shareholders. In theory, some researchers argue that dividend policies are irrelevant because shareholders can sell a fraction of their shares or investment if they need money.

Although many people consider dividends an essential component of corporate strategy, management must decide on the dividend quantity, timing, and other factors that affect dividend payments.

Types of Dividend Policy

Stable dividend policy 

It is the most basic and widely used dividend policy. The policy goal is to pay a consistent and predictable dividend each year, which is what most shareholders want. Investors receive a dividend whether the company’s income is up or down.

The primary objective of a stable dividend policy is to align it with the company’s long-term growth rather than with quarterly profit volatility. This method provides greater certainty to the shareholder regarding the amount and timescale of the dividend.

Constant Dividend Policy

According to this dividend policy, shareholders will be paid a dividend if a company’s earnings are high, whereas they may not obtain a dividend if earnings are low. The company’s earnings percentage is distributed as a dividend every year under the company’s constant dividend policy. In this manner, investors are exposed to the entire volatility of a company’s earnings. The disadvantage of this method is the variation of earnings and dividends. When dividends are highly volatile, it isn’t easy to plan financially.

Residual Dividend Policy

Even though the residual dividend policy is extremely volatile, some investors consider it the only appropriate dividend policy. With a residual dividend policy, the company will pay out any remaining dividends after paying for capital expenditures (CapEx) and cash reserves.

In terms of business operations, this dividend policy makes the most sense. Investors are not interested in investing in a company that rationalises its increased debt by paying a dividend.

Determinants of Dividend Policy 

• Type of Industry

The type of earnings determines dividends because a company with stable earnings has a more stable dividend policy than a company with unstable earnings. In comparison to industrial concerns, public utilities, for example, are in a much better position.

• The Extent of Share Distribution

Before establishing a dividend policy, the company consults with all stakeholders. However, industries with more widely dispersed stakeholders would have a much more difficult time obtaining such consent. 

• Business Cycles 

Corporate executives have adequate reserves to deal with the post-inflationary period crisis. Higher dividend rates are used to promote securities in a down market.

• Profit Trends

When deciding on a dividend policy, the company’s profit history should be thoroughly examined to determine the company’s average earnings. When depression is on the horizon, only a conservative dividend policy can be considered prudent.

• Age of Corporation 

Making a dividend policy is difficult for a newly established company. In contrast, old companies with more accruing experience can create a clear-cut payout policy and be liberal with dividend distribution.

• Additional Capital Needs 

The amount of profit required to reinvest in the business significantly impacts dividend policy. The income could be saved to meet the increased working capital requirements or for future expansion.

• Taxation Policy 

The amount of money paid in taxes impacts the dividend policy, both directly and indirectly. After taxes, the amount of profit distributed to shareholders decreases.

• Changes in Government Policies 

The government may limit the rate of dividends proclaimed by businesses in a specific industry or in all realms of business activity at times.

• Cash balance

Cash balance is another determinant of dividend policy. If a company’s working capital is low, it cannot implement a comparatively tiny liberal dividend payment policy. The dividend must be paid in the form of share capital to members in this case rather than cash. 

Conclusion 

A dividend policy is an essential component of any business because it plays an important role in resolving conflicts. It specifies how profit shares should be distributed between equity members. Dividend policies are classified into three types: constant dividend policies, residual dividend policies, and stable dividend policies, each of which offers several methods for profit distribution. As dividend payout announcements directly impact the increase or reduction in a company’s stock price, one must be obtained for the company. So, it is advisable to understand the importance of a dividend policy and the different types and factors that influence it.