Factors affecting Dividend Policy

Dividend policy of a company sets the guidelines to be followed while deciding the amount of dividend to be paid out to the shareholders. The company needs to adhere to the dividend policy while deciding the proportion of earnings to be distributed and the frequency of the distribution. There are various types of dividend policies – regular, stable, constant and irregular. In this post, we will discuss various factors affecting dividend policy.

Factors affecting Dividend Policy

A company needs to analyze certain factors before framing their dividend policy.

The following are the various factors/determinants that impact the dividend policy of a company:

Type of Industry

The nature of the industry to which the company belongs has an important effect on the dividend policy. Industries, where earnings are stable, may adopt a consistent dividend policy as opposed to the industries where earnings are uncertain and uneven. They are better off in having a conservative approach to dividend payout.

Ownership Structure

The ownership structure of a company also impacts the policy. A company with a higher promoter’ holdings will prefer a low dividend payout as paying out dividends may cause a decline in the value of the stock. Whereas, a high institutional ownership Determinants of Dividend Decisionswill favor a high dividend payout as it helps them to increase the control over the management.

Age of corporation

Newly formed companies will have to retain major part of their earnings for further growth and expansion. Thus, they have to follow a conservative policy unlike established companies, which can pay higher dividends from their reserves.

The extent of Share Distribution

A company with a large number of shareholders will have a difficult time in getting them to agree to a conservative policy. On the other hand, a closely held company has more chances of succeeding to finalize conservative dividend payouts.

Different Shareholders’ Expectations

Another factor that impacts the policy is the diversity in the type of shareholders a company has. A different group of shareholders will have different expectations. A retired shareholder will have a different requirement vis-a-vis a wealthy investor. The company needs to clearly understand the different expectations and formulate a successful dividend policy.

Leverage

A company having more leverage in their financial structure and consequently, frequent interest payments will have to decide for a low dividend payout. Whereas a company utilizing their retained earnings will prefer high dividends.

Future Financial Requirements

Dividend payout will also depend on the future requirements for the additional capital. A company having profitable investment opportunities is justified in retaining the earnings. However, a company with no internal or external capital requirements should opt for a higher dividend.

Business Cycles

When the company experiences a boom, it is prudent to save up and make reserves for dips. Such reserves will help a company declare high dividends even in depressing markets to retain and attract more shareholders.

Growth

Companies with a higher rate of growths, as reflected in their annual sales growth, a ratio of retained earnings to equity and return on net worth, prefer high dividend payouts to keep their investors happy.

Changes in Government Policies

There could be the change in the dividend policy of a company due to the imposed changes by the government. The Indian government had put temporary restrictions on companies to pay dividends during 1974-75.

Profitability

The profitability of a firm is reflected in net profit ratio, current ratio, and ratio of profit to total assets. A highly profitable company generally pays higher dividends and a company with less or no profits will adopt a conservative dividend policy.

Taxation Policy

The corporate taxes will affect dividend policy, either directly or indirectly. The taxes directly reduce the residual earnings after tax available for the shareholders. Indirectly, the dividend distribution is taxable after a certain limit.

Trends of Profits

Even if the company has been profitable over the years, the trend should be properly analyzed to find the average earnings of the company. This average number should be then studied in relation to the general economic conditions. This will help in opting for a conservative policy if a depression is approaching.

Liquidity

Liquidity has a direct relation with the dividend policy. If a firm has a strong liquidity and enough cash for its working capital, it can afford to pay higher dividends. However, a firm with less liquidity will choose a conservative dividend policy.

Legal Rules

There are certain legal restrictions on the companies for dividend payments. It is legal to pay a dividend only if the capital is not reduced post payment. These rules are in place to protect creditors’ interest.

Inflation

Inflationary environments compel companies to retain major part of their earnings and indulge in lower dividends. As the prices rise, the companies need to increase their capital reserves for their purchases and other expenses.

Control Objectives

The firms aiming for more control in the hands of current shareholders prefer a conservative dividend payout policy. It is imperative to pay fewer dividends to retain more control and the earnings in the company.

In a nutshell, the management of a company is completely free to frame the required dividend policy. There are no obligations to be adhered to. So, the company needs to judiciously weigh all the above-mentioned factors and formulate a balanced dividend policy. A dividend policy can also be revised in the wake of changes in any of the factors.

References:

Last updated on : August 31st, 2017
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