DIVIDEND POLICY

Dividend is apart of profits distributed among the shareholders. The basic question before the Board of directors is how much profits should be divided among shareholders as dividend and how much to be retained in the business as reserves to meet the future contingencies and for expansion of business. Both-future expansion and distribution of dividend are desirable but in conflict. Hence, allocation of earnings between dividends and retained earnings is an essential part of management functions; it requires a sound dividend polic to be followed b the corporation !ccording to "eston and Brigham #Dividend polic determines the division of earnings between pa ments to shareholders and retained earnings$. %n this connection, the dividend declared during previous ears ma be ta&en as a base and the same rate is followed in the coming ears. 'enerall , Board of Directors aim at maintaining the dividend rate which we ma call a #(table Dividend )olic $. *or its purpose a +dividend equali,ation fund+ is created out of profits to equali,e the profits of the coming ears. The economic soundness of a compan is generall -udged b the amount of dividend declared and paid b a compan . %t affects its goodwill among the shareholders and the prospective share holders.

Types of Dividends: Dividend ma be of different t pes. %t can be

classified according to the mode of its distribution as follows (1) Regula Dividend! B dividend we mean regular dividend paid the

annuall , proposed b

the board of directors and approved b

shareholders in general meeting. %t is also &nown as final dividend because it

is usuall paid after the finali,ation of accounts. %t sis generall paid in cash as a percentage of paid up capital, sa ./ 0 or .1 0 of the capital. (ometimes, it is paid per share. 2o dividend is paid on calls in advance or calls in arrears. The compan is, however, authorised to ma&e provisions in the !rticles prohibiting the pa ment of dividend on shares having calls in arrears. (") In#e i$ Dividend! %f !rticles so permit, the directors ma decide to pa dividend at an time between the two !nnual 'eneral 3eeting before finali,ing the accounts. %t is generall declared and paid when compan has earned heav profits or abnormal profits during the ear and directors which to pa the profits to shareholders. (uch pa ment of dividend in between the two !nnual 'eneral meetings before finali,ing the accounts is called %nterim Dividend. 2o %nterim Dividend can be declared or paid unless depreciation for the full ear 4not proportionatel 5 has been provided for. %t is, thus, an extra dividend paid during the ear requiring no need of approval of the !nnual 'eneral 3eeting. %t is paid in cash6666666666666...

(%) &#o'()Dividend! 7ompanies, not having good cash position, generall pa dividend in the form of shares b capitali,ing the profits of current ear and of past ears. (uch shares are issued instead of pa ing dividend in cash and called +Bonus (hares+. Basicall there is no change in the equit of shareholders. 7ertain guidelines have been used b the compan 8aw Board in respect of Bonus (hares. 6666666666666666666

(*) &' ip Dividend! (crip dividends are used when earnings -ustif

dividend, but the cash position of the compan is temporaril wea&. (o, shareholders are issued shares and debentures of other companies. (uch pa ment of dividend is called (crip Dividend. (hareholders generall do not li&e such dividend because the shares or debentures, so paid are worthless for the shareholders as directors would use onl such investment is which were not . (uch dividend was allowed before passing of the 7ompanies 4!mendment5 !ct .:;/, but thereafter this unhealth practice was stopped. (+) ,ond Dividends! %n rare instances, dividends are paid in the form of debentures or bounds or notes for a long-term period. The effect of such dividend is the same as that of pa ing dividend in scrips. The shareholders become the secured creditors as the bonds has a lien on assets. (-) P ope #y Dividend! (ometimes, dividend is paid in the form of asset instead of pa ment of dividend in cash. The distribution of dividend is made whenever the asset is no longer required in the business such as investment or stoc& of finished goods. 6666666666666666666 But, it is, however, important to note that in %ndia, distribution of dividend is permissible in the form of cash or bonus shares onl . Distribution of dividend in an other form is not allowed.

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.a'#o s /ffe'#ing Dividend Poli'y

1! &#a0ili#y of Ea nings! The nature of business has an important bearing on the dividend polic . %ndustrial units having stabilit of earnings ma formulate a more consistent dividend polic than those having an uneven flow of incomes because the can predict easil their savings and earnings. =suall , enterprises dealing in necessities suffer less from oscillating earnings than those dealing in luxuries or fanc goods. "! /ge of 'o po a#ion! !ge of the corporation counts much in deciding the dividend polic . ! newl established compan ma require much of its earnings for expansion and plant improvement and ma adopt a rigid dividend polic while, on the other hand, an older compan can formulate a clear cut and more consistent polic regarding dividend. %! Li1uidi#y of .unds! !vailabilit of cash and sound financial position is also an important factor in dividend decisions. ! dividend represents a cash outflow, the greater the funds and the liquidit of the firm the better the abilit to pa dividend. The liquidit of a firm depends ver much on the investment and financial decisions of the firm which in turn determines the rate of expansion and the manner of financing. %f cash position is wea&, stoc& dividend will be distributed and if cash position is good, compan can distribute the cash dividend.

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>. E2#en# of s3a e Dis# i0u#ion! 2ature of ownership also affects the dividend decisions. ! closel held compan is li&el to get the assent of the shareholders for the suspension of dividend or for following a conservative dividend polic . ?n the other hand, a compan having a good number of shareholders widel distributed and forming low or medium income group, would face a great difficult in securing such assent because the dividend. 1. Needs fo /ddi#ional Capi#al! 7ompanies retain a part of their profits for strengthening their financial position. The income ma usuall be conserved for meeting the increased requirements of wor&ing capital or of future expansion. (mall companies find difficulties in raising finance for their needs of increased having no other wor&ing capital for expansion programmes. The dividend at low rates and retain a big part of profits. ;. T ade Cy'les! Business c cles also exercise influence upon dividend )olic . Dividend polic is ad-usted according to the business oscillations. During the boom, prudent management creates food reserves for contingencies which follow the inflationar period. Higher rates of dividend can be used as a tool for mar&eting the securities in an otherwise depressed mar&et. The financial solvenc can be proved and maintained b the companies in dull ears if the adequate reserves have been built up. will emphasise to distribute higher

alternative, use their ploughed bac& profits. Thus, such 7ompanies distribute

@. 4ove n$en# Poli'ies! The earnings capacit of the enterprise is widel affected b the change in fiscal, industrial, labour, control and other government policies. (ometimes government restricts the distribution of dividend be ond a certain percentage in a particular industr or in all spheres of business activit as was done in emergenc . The dividend polic accordingl in those enterprises. A. Ta2a#ion Poli'y! High taxation reduces the earnings of he companies and consequentl the rate of dividend is lowered down. (ometimes government levies dividendtax of distribution of dividend be ond a certain limit. %t also affects the capital formation. %n %ndia, dividends be ond ./ 0 of paid-up capital are sub-ect to dividend tax at @.1 0. :. Legal Re1ui e$en#s! %n deciding on the dividend, the directors ta&e the legal requirements too into consideration. %n order to protect the interests of creditors and outsiders, the companies !ct .:1; prescribes certain guidelines in respect of the distribution and pa ment of dividend. 3oreover, a compan is required to provide for depreciation on its fixed and tangible assets before declaring dividend on shares. %t proposes that Dividend should not be distributed out of capita, in an case. 8i&ewise, contractual obligation should also be fulfilled, for example, pa ment of dividend on preference shares in priorit over ordinar dividend. has to be modified or formulated

15! Pas# dividend Ra#es! "hile formulating the Dividend )olic , the directors must &eep in mind the dividend paid in past ears. The current rate should be around the average past rate. %f it has been abnormall increased the shares will be sub-ected to speculation. %n a new concern, the compan should consider the dividend polic of the rival organi,ation. 11! /0ili#y #o ,o o6! "ell established and large firms have better access to the capital mar&et than the new 7ompanies and ma borrow funds from the external sources if there arises an need. (uch 7ompanies ma have a better dividend pa -out ratio. "hereas smaller firms have to depend on their internal sources and therefore the will have to built up good reserves b reducing the dividend pa out ratio for meeting an obligation requiring heav funds. .9. Poli'y of Con# ol! )olic of control is another determining factor so far as dividends are concerned. %f the directors want to have control on compan , the would not li&e to add new shareholders and therefore, declare a dividend at low rate. Because b adding new shareholders the fear dilution of control and diversion of policies and programmes of the existing management. (o the prefer to meet the needs through retained earrings. %f the directors do not bother about the control of affairs the will follow a liberal dividend polic . Thus control is an influencing factor in framing the dividend polic .

.<. Repay$en#s of Loan! ! compan having loan indebtedness are vowed to a high rate of retention earnings, unless one other arrangements are made for the redemption of debt on maturit . %t will naturall lower down the rate of dividend. (ometimes, the lenders 4mostl institutional lenders5 put restrictions on the dividend distribution still such time their loan is outstanding. *ormal loan contracts generall provide a certain standard of liquidit and solvenc to be maintained. 3anagement is bound to hour such restrictions and to limit the rate of dividend pa out. .>. Ti$e fo Pay$en# of Dividend! "hen should the dividend be paid is another consideration. )a ment of dividend means outflow of cash. %t is, therefore, desirable to distribute dividend at a time when is least needed b the compan because there are pea& times as well as lean periods of expenditure. "ise management should plan the pa ment of dividend in such a manner that there is no cash outflow at a time when the underta&ing is alread in need of urgent finances. .1. Regula i#y and s#a0ili#y in Dividend Pay$en#! Dividends should be paid regularl because each investor is interested in the regular pa ment of dividend. The management should, inspite of regular pa ment of dividend, consider that the rate of dividend should be all the most constant. *or this purpose sometimes companies maintain dividend equali,ation *und.

1. Stability of Earnings. The nature of business has an important bearing on the dividend policy. Industrial units having stability of earnings may formulate a more consistent dividend policy than those having an uneven flow of incomes because they can predict easily their savings and earnings. Usually, enterprises dealing in necessities suffer less from oscillating earnings than those dealing in luxuries or fancy goods. . !ge of corporation. !ge of the corporation counts much in deciding the dividend policy. ! newly established company may re"uire much of its earnings for expansion and plant improvement and may adopt a rigid dividend policy while, on the other hand, an older company can formulate a clear cut and more consistent policy regarding dividend. #. $i"uidity of %unds. !vailability of cash and sound financial position is also an important factor in dividend decisions. ! dividend represents a cash outflow, the greater the funds and the li"uidity of the firm the better the ability to pay dividend. The li"uidity of a firm depends very much on the investment and financial decisions of the firm which in turn determines the rate of expansion and the manner of financing. If cash position is wea&, stoc& dividend will be distributed and if cash position is good, company can distribute the cash dividend. '. Extent of share (istribution. )ature of ownership also affects the dividend decisions. ! closely held company is li&ely to get the assent of the shareholders for the suspension of dividend or for following a conservative dividend policy. *n the other hand, a company having a good number of shareholders widely distributed and forming low or medium income group, would face a great difficulty in securing such assent because they will emphasise to distribute higher dividend. +. )eeds for !dditional ,apital. ,ompanies retain a part of their profits for strengthening their financial position. The income may be conserved for meeting the increased re"uirements of wor&ing capital or of future expansion. Small companies usually find difficulties in raising finance for their needs of increased wor&ing capital for expansion programmes. They having no other alternative, use their ploughed bac& profits. Thus, such ,ompanies distribute dividend at low rates and retain a big part of profits. -. Trade ,ycles. .usiness cycles also exercise influence upon dividend /olicy. (ividend policy is ad0usted according to the business oscillations. (uring the boom, prudent management creates food reserves for contingencies which follow the inflationary period. 1igher rates of dividend can be used as a tool for mar&eting the securities in an otherwise depressed mar&et. The financial solvency can be proved and maintained by the companies in dull years if the ade"uate reserves have been built up. 2. 3overnment /olicies. The earnings capacity of the enterprise is widely affected by the change in fiscal, industrial, labour, control and other government policies. Sometimes government restricts the

distribution of dividend beyond a certain percentage in a particular industry or in all spheres of business activity as was done in emergency. The dividend policy has to be modified or formulated accordingly in those enterprises. 4. Taxation /olicy. 1igh taxation reduces the earnings of he companies and conse"uently the rate of dividend is lowered down. Sometimes government levies dividend5tax of distribution of dividend beyond a certain limit. It also affects the capital formation. ) India, dividends beyond 16 7 of paid5up capital are sub0ect to dividend tax at 2.+ 7. 8. $egal 9e"uirements. In deciding on the dividend, the directors ta&e the legal re"uirements too into consideration. In order to protect the interests of creditors an outsiders, the companies !ct 18+- prescribes certain guidelines in respect of the distribution and payment of dividend. :oreover, a company is re"uired to provide for depreciation on its fixed and tangible assets before declaring dividend on shares. It proposes that (ividend should not be distributed out of capita, in any case. $i&ewise, contractual obligation should also be fulfilled, for example, payment of dividend on preference shares in priority over ordinary dividend. 16. /ast dividend 9ates. ;hile formulating the (ividend /olicy, the directors must &eep in mind the dividend paid in past years. The current rate should be around the average past rat. If it has been abnormally increased the shares will be sub0ected to speculation. In a new concern, the company should consider the dividend policy of the rival organisation. 11. !bility to .orrow. ;ell established and large firms have better access to the capital mar&et than the new ,ompanies and may borrow funds from the external sources if there arises any need. Such ,ompanies may have a better dividend pay5out ratio. ;hereas smaller firms have to depend on their internal sources and therefore they will have to built up good reserves by reducing the dividend pay out ratio for meeting any obligation re"uiring heavy funds. 1 . /olicy of ,ontrol. /olicy of control is another determining factor is so far as dividends are concerned. If the directors want to have control on company, they would not li&e to add new shareholders and therefore, declare a dividend at low rate. .ecause by adding new shareholders they fear dilution of control and diversion of policies and programmes of the existing management. So they prefer to meet the needs through retained earing. If the directors do not bother about the control of affairs they will follow a liberal dividend policy. Thus control is an influencing factor in framing the dividend policy. 1#. 9epayments of $oan. ! company having loan indebtedness are vowed to a high rate of retention earnings, unless one other arrangements are made for the redemption of debt on maturity. It will naturally lower down the rate of dividend. Sometimes, the lenders <mostly institutional lenders= put restrictions on the dividend distribution still such time their loan is outstanding. %ormal loan contracts generally provide a certain standard of li"uidity and solvency to be maintained. :anagement is bound to hour such restrictions and to limit the rate of dividend payout. 1'. Time for /ayment of (ividend. ;hen should the dividend be paid is another consideration. /ayment of dividend means outflow of cash. It is, therefore, desirable to distribute dividend at a time when is least needed by the company because there are pea& times as well as lean periods of expenditure. ;ise management should plan the payment of dividend in such a

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manner that there is no cash outflow at a time when the underta&ing is already in need of urgent finances. 1+. 9egularity and stability in (ividend /ayment. (ividends should be paid regularly because each investor is interested in the regular payment of dividend. The management should, inspite of regular payment of dividend, consider that the rate of dividend should be all the most constant. %or this purpose sometimes companies maintain dividend e"uali>ation %und. 5 dinesh

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