Dividend Policy and theory

The term dividend refers to that part of the profits of a company which is distributed amongst its shareholders According to the ICAI, dividend is a distribution to shareholders out of profits or reserves available for this purpose

Dividend policy refers to the policy concerning quantum of profits to be distributed as dividend. Dividend policy is the subject matter of the B.O.D Finance manager works in advisory capacity. Dividend decision determines the proportion of retained earnings and amount to be distributed---

Retained earnings for growth of the firm Growth of the firm and dividend distribution are in conflict. Higher dividend means lower retained earnings----which may consequently lower the growth rate and market value of shares

Dividend policy of the firm effects both long term financing and wealth of shareholders
Two views: Net earnings treated as source of finance for long term investments( in case of profitable opportunities retaining or else distributing) Shareholders view, if they prefer dividend than capital gain- payment or else retain.

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Factors affecting dividend policy (internal):

A) Desire of shareholders Capital gain Dividend Shareholders prefer dividend than capital gain for the following reasons 1. Reduction of uncertainty 2.Indication of strength 3. Need for current income

B. C. D. E.

Financial needs of the company Nature of earnings( stable / fluctuation) Desire of control Liquidity position


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External factors: General state of economy. -Uncertain economic and business conditions- retain to absorb shocks in future -Depression-retain to preserve liquidity position --Prosperity- retain for reinvestments

2.Legal restrictions 3.State of capital market 4.Contractual restrictions 5.Tax policy

Stability of dividend

The term stabilility of dividends means consistency or lack of of variability in the stream of dividend payments.
The stability dividend can be in any of the following 4 forms:-

Constant dividend per share -company pays a certain fixed amount per share as dividend without considering the fluctuations in earnings of the company 2. Constant percentage of net earnings: - paying as a fixed percentage of net earnings.Dividend will fluctuate in direct proportion to earnings
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3. Small constant dividend per share plus extra dividend: --- dividend fixed per share, but in periods of market prosperity additional dividend is paid. 4.Dividend as fixed percentage of market values: -- Dividend certain percentage of market price of shares

Significance of stability of dividend

Desire for current income Perception of stability Institutional investors requirement Raising additional finance Stability in market price of shares.