D i v i d e n dD e c i s i o n s

5.13

pET
TERMINANTS OF DIVIDEND POLICY
The payment of dividend involves some legal as well as financial considerations. It is difficult to
dividend policy which can be followed by different firms at different times because the
i n e a general

dividend decision
hasto be taken considering the special circumstances of an individual case. The following
the important factors which determine the dividend policy of a firm
1. Legal Restrictions. Legal provisions relating to dividends as laid down in sections 93,205,205A, 206
are significant because they lay down a framework within which
dividend
and 207 of the Companies Act, 1956
and or past
iev is formulated. These proVISIons require that dividend can be paid only out of current profits
policy of
or out of the moneys provided by Government for the payment
orofits after providing for depreciation Profits to
Government. The Companies (Transfer of
dividends in pursuance of a guarantee given by the certain
a company providing more than ten per cent dividend to transfer
Reserves) Rules, 1975 require that dividends cannot
nercentage' of the current year's profits to reserves. Companies Act, further, provides of its
it will amount to reduction of capital adversely affecting the security
he paid out of capital, becauSe
creditors.
is an important aspect of
Magnitude and Trend of Earnings. The amount and trend of earnings
2.
As dividends can be paid only out of
dividend policy. It is rather the starting point of the dividend policy.
of a company fix the upper limits on dividends. Thedividends should,
present or past year's profits, earnings become
as the retained earnings of the previous years
generally, be paid out of current year's earnings only The trend of the
business to earn current profits. past
more or less a part of permanent investment in the
consideration while making the dividend decision.
company's earnings should also be kept in
3. Desire and Type of Shareholders. Although, legally, the discretion as to whether to declare dividend
to the desires of
or not has been left
with the Board of Directors, 1he directors should give the importance
as they are the representatives of shareholders.
Desires of
shareholders in the declaration of dividends
status. Investors, such as retired persons, widows and
shareholders for dividends depend upon their economic
a source of funds to meet their day-to-day living
other economically weaker persons view dividends as
the companies should pay régular dividends. On the other hand, a (wealthy
expenses. To benefit such investors,
benefit by high current dividend incomes. Such an investor may
investorin a high income tax bracket may not It is difficult to reconcile these conflicting
be interested in lower current dividends) and high capital gains.
interests of the different type of shareholders, büt a company should adopt its dividend policy after taking into
of shareholders.
consideration the interests of its várious groups
is engaged also considerably affects
4. Nature of Industry. Nature of industry to which the company
che dividend policy. Certain industries have a comparatively steady and stable demand irrespective of the
used to drink liquor both in boom as well as in recession.
orevailing economic conditions. For instance, people consistent dividend policy. On the other hand, if
Buch firms expect regular earnings and hence can follow a should be followed. Such firms
he earnings are uncertain, as in the case of luxury goods, conservative policy
hould retain a substantial part of their current earnings during boom period in order to provide funds to pay
in the recession periods. Thus, industries with steady demand of their products can follow
dequate dividends ratio.
higher dividend payout ratio while cyclical industries should follow a lower payout
5. Age of the Company. The age of the company also influences the dividend decision of a company.

newly established concern has to limit payment of dividend and retain substantial part of earnings for
anancing its future growth and development, while older companies which have established sufficient reserves
an afford to pay liberal dividends.
6. Future Financial Requirements. it is not only the desires of the shareholders but also future
nancialrequirements of the company that have to be taken into consideration while making a dividend decision.
he management of a concerm
has_to reconcile the conflicting interests
of shareholders
and
ompany's financial needs. If a company has highly profitable investment opportunities it can convincetne
those of the
hareholders of the need for limitation of dividend to increase the future earnings and stabilise its financial
OS BuAiQUADSAMERAent opportunities, do not exist then the company may not be Justified m
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 5.15
D h i d e n dL e c i s i o n s

the firms having fluctuating earnings from

als some extra dividend in years of high profits is suitable to
share

year to year.

DETERMINANTS OF DIVIDEND POLICY

.Legal Restrictions

2 Magnitude and Trend of Earnings

3. Desire and Type of Shareholders
4 Nature of Industry
5 Age of the Company
6 Future Financial Requirements
7. Government's Economic Policy
8 Taxation Policy
9. Inflation

10. Control Objectives

of Institutional Investors
11. Requirements
12. Stability of Dividends
13. Liquid Resources

Resources. The dividend policy of a firm is also influenced by the availability of liquid
13. Liquid to declare dividends, yet it may
not be desirable
a firm may have sufficient available profits is
resources. Although,
Hence the liquidity position of company
a
it does not have sufficient liquid resources.
to pay dividends if dividends.
consideration in paying
to declare stock-dividend i.e. issue of bonus
an important
does not have liquid resources, it is better
If a company
The issue of bonus shares also amounts to
distribution of firm's earnings
shareholders.
shares to the existing
shareholders without affecting
its cash position.
among the existing

YPES OF DIVIDEND POLICY follows

discussed as
of dividend policies
are
The various types

(a) Regular Dividend Policy dividend. The investors such as

retired
dividend at the usual rate is termed as regular
Payment of dividend
to get regular dividends. A regular
persons, widows and other
economically weaker persons prefer
policy offers the following advantages.
record of the company.
(a) It establishes a profitable
the shareholders.
(b) It creates confidence amongst
financing and renders financing easièr.
(c) It aids in long-term
value of shares.
(d) It stabilises the market source of funds to meet
their day-to-day living
shareholders view dividends as a
(e)The ordinary
expenses. shareholders may have to pay a higher
and are retained, the
DIf profits are not distributed regularly
accumulated profits are distributed.
rate of tax in the year when of long
remembered that regular dividends can be maintained only by companies
However, it be must
dividend at a lower rate as compared
and stable earnings. A company
should establish the regular
anding
to the average earnings of the company.
2. Stable Dividend Policy
in the stream of dividend
A l Q U A D O A M E R i d e n d s ' means consistency or lack of variability
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 FORMS OF DIVIDEND in the ordinary
course business are
of
Dividends paid
various forms. dividends. A dividend
Dividends can be classified in are known
as Liquidalion
dividends paid out of
capital dividend, while the
dividend which is
known as Prefit dividends, while is called interim
which is declared between two
annual general meeting known as final
dividend.
is
to the shareholders at the annual general meeting
recommended
in which they are paid:
also be classified on the basis of medium
Dividends may dividends. Payment of dividend
in

dividend is a usual method of paying

(a) Cash Dividend. A cash the shareholders get an
the company's net worth, though
cash results in outflow of funds and reduces shareholders prefer to receive
the cash in manner they desire.
This is why the ordinary
opportunity to invest any or provide for such resources
resources at its disposal
dividends in cash. But the firm must have adequate liquid
dividends.
so that its liquidity position is not adversely
affected on account of cash
to the shareholders at a future specific date.
(b) Scrip or Bond Dividend. A scrip dividend promises pay
dividends in cash, it may issue notes or bonds for
In case a company does not have sufficient funds to pay
amounts due to the shareholders. The objective of scrip
dividend is to postpone the immediate Payment of cash

A scrip dividend bears interest and is accepted as a collateral security.

(c) Property Dividend. Property dividends are paid in the form of some assets other than cash. They
are distributed under exceptional circumstances and are not popular in India.
IF
(a) Stock Dividend. Stock dividend means the issue of bonus shares to the existing shareholders.
a
company does not have liquid resources it is better to declare stock dividend. Stock dividend amounts to
capitalisation of earnings and distribution of profits among the existing shareholders without affecting the cash
position of the firm. This has been discussed in detail under "Bonus Issue",