Dividend Decision

The financial decision relates to the disbursement of profits back to investors who supplied capital to the firm. The term dividend refers to that part of profits of a company which is distributed by it among its shareholders. It is the reward of shareholders for investments made by them in the share capital of the company. The dividend decision is concerned with the quantum of profits to be distributed among shareholders. A decision has to be taken whether all the profits are to be distributed, to retain all the profits in business or to keep a part of profits in the business and distribute others among shareholders. The higher rate of dividend may raise the market price of shares and thus, maximize the wealth of shareholders. The firm should also consider the question of dividend stability, stock dividend (bonus shares) and cash dividend.

It is crucial for the top management to determine the portion of earnings distributable as the dividend at the end of every reporting period. A company’s ultimate objective is the maximization of shareholders wealth. It must, therefore, be very vigilant about its profit-sharing policies to retain the faith of the shareholders. Dividend payout policies derive enormous importance by virtue of being a bridge between the company and shareholders for profit-sharing. Without an organized dividend policy, it would be difficult for the investors to judge the intentions of the management.

The Dividend Policy is a financial decision that refers to the proportion of the firm’s earnings to be paid out to the shareholders. Here, a firm decides on the portion of revenue that is to be distributed to the shareholders as dividends or to be ploughed back into the firm.

A few basic dividend policies which firms generally pursue are mentioned below:

• Constant Percentage of Earnings:

A firm may pay dividend at a constant rate on earnings. Since payment of dividend depends on the current earnings, the payment of dividend will rise in the year the firm is earning higher profit and the dividend payment will be lower in the year in which the profit falls. Since fluctuations in profits lead to fluctuations in dividends, the principle adversely affects the price of the shares. As a result, the firm will find it difficult to raise capital from the external source.

• Constant Rate of Dividend:

As per this policy, the firm pays a dividend at a fixed rate on the paid up share capital. If this policy is pursued, the shareholders are more or less sure on the earnings on their investment. This policy of paying dividend at a constant rate will not create any problem in those years in which the company is making steady profit. But paying dividend at a constant rate may face the trouble in the year when the company fails to earn the steady profit. Therefore, some of the experts opine that the rate of dividend should be maintained at a lower level if thus policy is followed.

• Stable Rupee Dividend plus Extra Dividend:

Under this policy, a firm pays fixed dividend to the shareholders. In the year the firm is earning higher profits it pays extra dividend over and above the regular dividend. When the normal condition returns, the firm begins to pay normal dividend by cutting down the extra dividend.

Objects of Dividend Decisions

• Evaluation of Price Sensitivity

Companies chosen by investors for its regularity of dividend must have a more stringent dividend policy than others. It becomes essential for such companies to take effective dividend decisions for maintaining stock prices.

• Cash Requirement

The financial manager must take into account the capital fund requirements while framing a dividend policy. Generous distribution of dividends in capital-intensive periods may put the company in financial distress.

• Stage of Growth

Dividend decision must be in line with the stage of the company- infancy, growth, maturity & decline. Each stage undergoes different conditions and therefore calls for different dividend decisions.

Types of Dividends

Dividends are a portion of a company’s earnings distributed to its shareholders as a return on their investment. There are various types of dividends that companies can choose to issue based on their financial condition, profitability, and strategic goals.

The type of dividend a company chooses to issue depends on various factors, including its financial condition, growth strategy, and the preferences of its shareholders. Dividends play a crucial role in attracting and retaining investors, providing them with a tangible return on their investment and influencing the overall perception of the company’s financial health and stability.

1. Cash Dividends:

Cash dividends are the most traditional form of dividends, where shareholders receive cash payments directly from the company’s profits.

• Significance: Provides shareholders with liquidity, allowing them to receive a direct monetary return on their investment.

2. Stock Dividends:

Stock dividends involve the distribution of additional shares of the company’s stock to existing shareholders, proportional to their current holdings.

• Significance: Offers a non-cash alternative for returning value to shareholders, while potentially avoiding immediate tax implications.

3. Property Dividends:

Property dividends involve the distribution of physical assets or investments to shareholders instead of cash.

• Significance: Typically occurs when a company has valuable assets that can be distributed to shareholders, providing them with ownership in those assets.

4. Scrip Dividends:

Scrip dividends allow shareholders to choose between receiving cash or additional shares of stock. Shareholders can opt for new shares rather than cash.

• Significance: Provides flexibility to shareholders in choosing their preferred form of dividend.

5. Liquidating Dividends:

Liquidating dividends occur when a company distributes a portion of its capital to shareholders, often as a result of closing down or selling a segment of the business.

• Significance: Typically signifies the end of the company’s operations or a significant change in its structure.

6. Special Dividends:

Special dividends are one-time, non-recurring payments made by a company in addition to regular dividends.

• Significance: Issued in response to exceptional profits, windfalls, or unique circumstances, providing shareholders with an extra return.

7. Interim Dividends:

Interim dividends are payments made to shareholders before the company’s final annual financial statements are prepared.

• Significance: Provides shareholders with periodic returns throughout the year, rather than waiting for the end of the fiscal year.

8. Regular Dividends:

Regular dividends are routine, recurring payments made to shareholders at predetermined intervals, often quarterly, semi-annually, or annually.

• Significance: Establishes a consistent pattern of returning value to shareholders, contributing to investor confidence.

9. Dividend Reinvestment Plans (DRIPs):

DRIPs allow shareholders to automatically reinvest their cash dividends to purchase additional shares of the company’s stock.

• Significance: Encourages the compounding of returns by reinvesting dividends directly into additional shares, often at a discount.

10. Spin-Off Dividends:

Spin-off dividends occur when a company distributes shares of a subsidiary or business segment as dividends to existing shareholders.

• Significance: Enables the separation of different business units, allowing shareholders to hold interests in both entities separately.