Dividend Policy of a company means it is the policy concerning the amount of profits to be distributed as dividend. The basic concept of the dividend policy is that the company takes future action regarding the payment of dividend with the help of the company law
According to Weston and Brighan, “Dividend Policy determines the division of earnings
between payments to shareholders and retained earnings”.
Factors Affecting Dividend Policy
Number of factors affect the dividend policy of a company. The major factors are :
- General Economic Conditions. General Economic Conditions greatly affect the management decision to distribute its earnings as dividend. During the periods of economic depression, the firm holds large sums of money in reserve in order to· meet the liquidity position of the company. But in the case of prosperity, the company may not be liberal in dividend payments because of large profitable investment opportunity.
- Age of a Company. Age of a company must decide the dividend policy. A newly established company may require huge amount of its earnings for development purpose and may formulate rigid dividend policy. But in the case of older company it can frame a consistent policy regarding dividend.
- State of Capital Market. If the capital market position ofthe country is more favourable to the company, the company may raise funds from different sources without any difficulty. So the management may declare a high rate of dividend to attract the investors. But in stock market, the shareholders are not interested in making investment so the management should follow a conservative dividend policy by maintaining the low rate of dividend.
- Government Policy. Some of the policies are announced by the Government from time to time. It may affect the profit earning capacity of the organisation. Sometimes, Government restrict the distribution of dividend beyond a certain percentage in a particular industry. So the dividend policy has to be formulated accordingly.
- Taxation Policy. The tax policy announced by the Government also affect the dividends policy. High taxation reduces the earnings of the company and consequently the rate of dividend is lowered down.
- Past Year Dividend Rate. At the time of formulating the dividend policy of the company, the directors must consider the dividend paid in past years. The current dividend rate should be around the average of past rates.
- Liquidity of Funds. Payment of dividend represents actually a cash outflow. Availability of huge amount of cash and liquidity of the firm says it has better ability to pay dividend .
- Ability to Borrow. Well established and large scale companies have better access to the capital market than the new companies. And they may borrow funds from other external sources as and when necessity arises. This type of companies may have a better dividend pay out ratio. But smaller firms have to maintain adequate reserve and low dividend pay out ratio. ·
- Regularity and Stability in Dividend Payment. Dividend should be paid regularly to the investors. Because all investors expect regular payment of dividend. Through this process only, company will retain the existing shareholders on a permanent basis, and if necessary, to mobilise resources in an efficient manner.
Types of Dividend Policies
Different types of dividend policies are as· follows :
(i) Stable Dividend Policy. When the company maintains more or less the stable rate of dividend, it is known as stable dividend policy. If the company has to maintain and follow stable dividend policy, the market price of its share will be of permanently higher value.
(ii) Policy of Regular Stock Dividend. It is the policy followed by the company to pay dividend in the form of shares instead of cash. Some companies follow this as a regular practice. Whenever the stock dividends are declared by the company, it does not affect the liquidity but increases the shareholdings of the shareholder.
(iii) Policy to Pay Irregular Dividend. Generally, this policy of dividend is followed by the companies having irregular earnings or inadequate profits. Based on this policy, the company earn an higher amount of profit to pay higher dividend. If there is no profit in any particular year, the company does not declare the dividend to its shareholders.
(iv) Policy of no Immediate Dividend. It is the policy followed by the company which decides to pay no dividend even when it earns large amount of profits. Because, either it may be a new company or the firm’s access to capital market is difficult.