Dividend is the portion of earnings available to equity shareholders that equally(per share bias) is distributed among the shareholders.

The different forms of dividend are:

1. cash dividend
It is an important form of dividend policy. Generally many companies pay dividends in the form of cash. But there should be enough cash for the company to pay dividends in the form of cash.

2. scrip dividend
In this form of dividends, the equity shareholders are issued transferable promissory notes for a shorter maturity period that may or may not be interest bearing. It is a simple payment of dividends in the form of promissory notes. Payment of dividends in this form takes place only when the firm is suffering from shortage of cash or weak liquidity position.

3. Bond dividend
Both bond dividend and scrip dividend are same, but they differ in terms of maturity. The only difference between these two is bond dividend bears interest.

4. Property dividend
Payment of dividend in the form of assets is called property dividend. This form of dividend takes place only when a firm has assets that are no longer necessary in the operation of business and shareholders are ready to accept dividend in the form of assets.

5. Stock dividend (Bonus shares)

stock dividend is the payment of additional shares of common stocks to the ordinary shareholders. In other words, distribution of bonus shares to the shareholders instead of cash dividend.

External Factor Internal Factor

There are 5 external factors

General State of Economy State of Capital Market Legal Restrictions Contractual Restrictions Tax Policy

1.General State of Economy

The management may prefer to retain the whole or part of the earnings with a view to building up reserves.

2. State of Capital Market

A firm can follow a liberal dividend policy if it has an easy access to the capital market on account of its financial strength or favorable conditions prevailing in the capital market.

3. Legal Restrictions
The Companies Act of 1956 contains several restrictions relating to the declaration and payments of dividends.

4. Contractual Restrictions
In the loan agreement that the firm shall not pay dividend to its shareholders more than 8% until the loan is repaid or dividend is not declared unless the liquidity ratio is to be more than 1:1.

5. Tax Policy
The government provides tax incentives to those companies which retain most of their earnings. In such a situation, the management is inclined to retain a larger amount of the firms earnings.

i)Desire of the shareholders:

As the shareholders are technically the owners of the company, their desire cannot be overlooked in spite of the directors liberty of the disposal of firms earnings.
a)Reduce uncertainty:
Future distribution of earnings is more uncertain than a distribution of current earnings

b)Indicate strength:
The declaration and payment of cash dividend is a sign of a firms reasonable strength and health. c)Need for current income: As most of the shareholders are in need of income from the investment to meet their current living expenses, they are generally reluctant to dispose their shares for the purpose of capital gain.

ii)Dividend Payout Ratio:

Dividend Payout Ratio is the percentage share of the net earnings distributed to the shareholders by way of dividends. It involves the decision either to pay out the earnings or to retain the same for re-investment within the firm.

iii) Nature of Earnings : A firm whose income is stable can afford to have a higher dividend payout ratio than a firm which does not have such stability in its earnings.

iv)Liquidity position:
the payment of dividends usually involves cash flow. Thus sometimes, a firm which has adequate earnings may not have sufficient cash to pay dividends. It is therefore, the duty of the management to see the liquidity aspect of the firm and after payment of dividends while taking the dividend decision.

v) Desire

of control:

The desires of the shareholders or management should also influence the dividend policy of the firm. If a firm issues additional equity shares for raising funds, it will dilute control which is detrimental to the existing equity shareholders.

 Dividend decision is one of the major areas of financial management

as the firm is to choose one between the two alternatives, Distribute the profits to the shareholders as dividend, Retain profits in business(i.e., ploughing back of profit). The impact of dividend decision on the valuation of a firm has

bought about conflicting theories. TWO SCHOOLS: Dividend decision materially affects the shareholders wealth and the valuation of the firm. Dividend decision materially does not affects the shareholders wealth and the valuation of the firm.

View points of these two schools of thoughts are brought under the following two groups:
1. Relevance Concept of Dividend 2. Irrelevance Concept of Dividend According to Myron Gordon, James Walter, John Linter and Richardson, Dividend policy has direct effect on position of a firm in stock market. Higher dividend, higher value of stock, and vice-versa. Dividends actually communicate information relating to profit earning capacity of a firm to the investors.

According to Gordon, dividends of most companies are expected to grow and evaluation of value of shares based on dividend growth is often used in valuation. Assumptions: Retained earnings represent the only source of finance. Rate of return is constant. Cost of capital remains constant and is greater than the growth rate.

Rate of return is more than discount rate, price per share increases, and viceversa. If Rate of return is same with discount rate, price per share remains constant. Where, PE = Market price per share (exFORMULA: dividend) do = Current year dividend P= do(1+g) E g = Constant annual growth rate of K -g E dividends. KE = Cost of Equity Capital (expected rate of return)

Prof. James E. Walter suggested that dividend policy and investment policy are interlinked and hence dividend decision always affects

the value of the firm.

According to him, if the firms return on investment is more than the cost of capital , it must retain its earnings and otherwise it should distribute its earnings to the shareholders. FORMULA: P = D+ Ra/Rc(E-D) Rc
Where, P = Market price of equity share D = Dividend per share E = Earnings per share (E-D )= Retained earnings per share Ra = Internal rate of return on investment Rc = Cost of capital

According to Franco Modigliani and Morton H. Miller and E. Solomon, dividend policy has no effect on the share prices of a company. Investors do not differentiate between dividends and capital

gains. The shareholders are only interested in income whether it is in the form of dividend or in capital gains.
According to them the value of shares of a firm is determined by its earnings potentiality and investment policy and never by the pattern of income distribution.

This hypothesis states that the value of the firm is determined by its earnings and its risk. Thus the firms value depends on its asset investment policy rather than on how earnings are split between dividends and retained earnings.

Dividend policy is one of the important policies of management of a corporate entity. It indicates the performance of the firm to the investors, lenders, bankers and to the society in general. 1) Payout Ratio: Dividend payout ratio refers to the percentage of ratio of dividend to the earnings. This would be decided on the basis of policy of retained earnings. 2) Stability of dividends: Stability of the returns refers to regularity in paying some dividend annually, even though the earnings of the company fluctuates wildly. The decision of stable dividend of equity share holders will be given to maintain consistency in the market value of the share.