Dividend policy is a set of procedure where a financial manager of the company along with other Board of Directors decides about the amount of profit to be distributed among shareholders in the form of dividends. This policy forms to be an important part of the corporate strategy of an organization.
In simple terms, it is the share of profitable earnings which is distributed among a company’s shareholders.
Defining Dividend Policy
Weston and Brighan have defined Dividend Policy as a determination of the division of earnings between retained earnings and payments made to shareholders.
It is a dividable profit which is spread among the members belonging to an organization as per the proportion to their shares in a way. This proportion is prescribed in that company’s Memorandum and Articles of Association. It is only the Board of Directors who has the authority to recommend and declare these dividends.
Factors influencing an organization’s Dividend Policy
Factors which affect the dividend policy to be framed by an organization are as follows-
An important factor which affects dividend policy of an organization is its age. In case it is a newly established company, the company may keep a strict dividend policy as it needs to keep a large share of the incurred profits for its own growth and development. However, in case it is an old company which has already made a name for itself, it will frame a consistent dividend policy.
Even the general economic condition of a company will have a large effect on the company’s dividend policy.
For instance, if a company is under a huge financial crisis, it will keep a huge part of its income for its own reserve to maintain a stable liquidity. In case a company enjoys a prosperous scenario, it will be liberal while framing the dividend policy.
The government’s taxation policy has an immense effect on the dividend policy of a company. At a time when the government provides tax incentives, shareholders get more dividends.
Other than this taxation policy, there are several other policies of the government which has its effect on the dividend distribution of a company. There are times when government puts limitations on the percentage of dividend distribution.
It is on such policies that a company frames its dividend policy.
If the Board of Directors feel that the state of capital market is positive towards the company, it will raise funds from various sources to declare a high rate of dividend policy in that financial year.
While framing the dividend policy of this current year, the Board of Directors refers to the rate of dividend which was declared in the previous year. Generally the rate of dividend is on an average of the earlier rate.
Large scale organizations which have made a name for themselves enjoy better accessibility to the capital market than those small or newly established companies. This accessibility gives them the ability to borrow funds from external sources when and where required. In such cases, they tend to offer high rate of dividends.
However, in case of small scale companies, the rate of dividend offered may be low as they need to maintain sufficient reserves.
At times when a company enjoys sufficient availability of cash, the rates of dividend offered tend to be on a higher side. Better the cash outflow, better is the payment of dividend of that company.
Dividends are needed to be paid to the investors on a regular basis as all investors expect regular dividend payments. This is a process how companies retain their existing shareholders.
Types of Dividend Policy
Dividend policies can be classified into the following types-
When a company maintains more or less stability in their rate of dividend, it is known as a stable dividend policy. Only when the market price of a share is on a higher side permanently, can the organization adopt and maintain a stable dividend policy.
It is a dividend distribution policy where an organization decides that it will not pay dividends even after incurring huge profits. This may be only if it is a newly established company, preparing for growth and development or if its accessibility to the capital market is very difficult.
Such a policy is adopted by an organization only when it decides to pay dividends through shares instead of cash dividends. Once the stock dividends are declared by the Board of Directors of a company, it has no effect on the liquidity of that firm. Stock dividends increase the shareholdings that a company’s shareholders have.
Organizations having irregular earnings adopt the irregular dividends policy. Such companies are liable to pay dividends only when they earn huge profits.