Dividend Decision

in Financial
Management

Rep o rt ers :
J a y s o n A. Tu l d a
La i l a n i e M. Bo n a o b ra
What are Dividend Decisions?
Dividend decisions, as the very name suggests, refers to the decision-
making mechanism of the management to declare dividends. It is crucial
for the top management to determine the portion of earnings distributable
as the dividend at the end of every reporting period. A company’s ultimate
objective is the maximization of shareholders wealth. It must, therefore, be
very vigilant about its profit-sharing policies to retain the faith of the
shareholders.

Dividend payout policy derive enormous importance by virtue of being a

bridge between the company and shareholders for profit-sharing. Without
an organized dividend policy, it would be difficult for the investors to judge
the intentions of the management.

Moreover, the dividend policies of an organization have a significant

bearing on the market value of stocks. Dividends must be distributed
in line with the industry standards. The shareholders will otherwise
perceive this variability negatively. It casts a suspicion on the
financial health and motives of the management (signaling effect). In
aggregate, an inefficient dividend decision mechanism would
adversely impact the valuation of the company.
Objects of Dividend Decisions
 Cash Requirement
 The financial manager must take into account the capital fund
requirements while framing a dividend policy. Generous
distribution of dividends in capital-intensive periods may put the
company in financial distress.

 Evaluation of Price Sensitivity

 Companies chosen by investors for its regularity of dividend must
have a more stringent dividend policy than others. It becomes
essential for such companies to take effective dividend decisions
for maintaining stock prices.

 Stage of Growth
 Dividend decision must be in line with the stage of the company-
infancy, growth, maturity & decline. Each stage undergoes
different conditions and therefore calls for different dividend
decisions.
 Good Dividend Policy
 What Constitutes a Good Dividend Policy?
 There does not exist a single dividend
decision process that works for every
organization. A decision suitable for one
company may prove fatal for another
company.
 For example, businesses with a
consistent order book such as telecom
and banking are expected to pay regular
dividends. It may impact the stock prices
if they do not pay dividends regularly. To
the contrary, sectors of pharmaceutical
and technology are highly research
oriented. Huge cash expenses are
required to further their operations.
 Therefore they cannot afford to pay a
regular dividend. Investors of such
stocks earn income mainly through
capital appreciation. In essense, there
are a lot of
factors affecting dividend policy or decisi
on.
We can refer to following renowned theories on
Dividend Policy:
:
Modigliani- Miller Theory on Dividend Policy
Gordon’s Theory on Dividend Policy
Walter’s Theory on Dividend Policy
A good financial manager must, therefore, answer the following questions before taking
crucial dividend decisions
Types of Dividend Decision
There are various types of dividends and dividend decisions.
Stable Dividends
Same amounts of dividends are paid out every year irrespective of the
profitability.
Shareholders remain immune to fluctuations and volatility faced by the
company.
Only long-standing and established companies with steady cash flows
can afford to follow this policy
Investors that buy into these companies have a low risk appetite. They
also do not get to participate in the profits of the company

Constant Dividends
Dividends are paid at a fixed percentage of the profits.
The brunt of recession is as much borne them as much they reap
benefits of the boom.
This policy is suitable for companies in their infancy stage as well as
those prone to volatility.
Investors of these companies are risk-taking. They prefer to swing with
the company in its earnings
Alternate Dividend Decisions
A company may not always issue the dividend in cash. A stock dividend is a
significant option with the management for recourse to non-cash options. It is a
handy tool to which management may resort to when it wants to balance both,
shortage of cash and shareholder expectations. Such decisions are only made in
exceptional circumstances.
References: Dividend Decisions, Strategic Financial Management, CA Final.
CFA Curriculum L I&II

Cash Dividend: Meaning

The main thrust and important objective of any commercial organization is to
earn profits through its business activities. Any company can either reinvest
those profits to grow and generate more business or give a part or all of it as
dividends to its shareholders. A dividend is that portion of a business
organization’s profit that it gives back to its shareholders. Dividends are of two
types: cash dividends and stock dividends. A cash dividend is a dividend that a
company pays out in cash by means of a cheque or electronic transfer. A
company can give away dividends in the form of stock by issuing more of its
shares to the shareholders as bonus shares.
Q. What will be the impact of dividend decision on the share prices of the company?
To answer this question, it is important to know the dividend history of the company. If
the company is known for regularly paying dividends, a pressure for maintaining the
payout hovers over it. A one-off year, where it may not want to pay dividends and divert
the funds for capital investment or retention may be hazardous. Conversely, an interesting
phenomenon occurs in cases of company depicting no stability in dividend policies.
When it does declare a dividend, the share prices see a huge spike before the ex-dividend
date. More and more people seek to make a quick buck by buying its shares on dividend
declaration. These shares are then sold as soon as the dividends are declared. This is
followed by a fall in the share prices (dividend stripping). Thus the shares of a sparsely
dividend paying company undergo great volatility between the date of dividend
declaration and payment.
Q. How much dividend should a company
distribute to its shareholders?
The ideal dividend decision should be commensurate with the profitable
investment opportunity available with the company. If it can invest a
dollar and reap two, it is insensible to lose out on that dollar by paying
dividends. Industry standards are another input to be factored in. A
company paying fewer dividends than its peers can face problems while
raising capital. It also depends on the kind of investors which the
company wants to attract. For example, companies such as American
Express and Coke can be relied upon for their stable dividend policies.
They attract investors with a longer horizon and larger disposable funds
since they are compensated by steady cash flows.
Q. What is the consequential impact of inability
to maintain dividend year after year?
Only a company with sustainable profitability and
cash flows can expect to reasonably pay dividend
year after year. If any other company claims the
same, it is a hoax. If the stock of the company in
question is a growth stock such as Qualcomm
(NYSE), the shareholders may pardon a stingy
dividend policy. Such shareholders expect to be
compensated via a fat capital appreciation and
hardly through the dividend. On the hand, if the
shareholders are sensitive to dividend decisions of
the company it is not a good idea to have an
irregular policy.
Record Date – Meaning, Example and More
Record Date is a date that one would come across in case of a dividend.
Basically, it is the cut-off date that a company sets to find out the shareholders,
who are eligible for dividends. As shares continuously trade, their ownership also
keeps changing. Thus, for a company, it becomes very difficult to decide on the
shareholders to whom it will pay dividends.

Cash Dividend Vs Stock Dividend:

All you need to Know Cash Dividend and Stock Dividend (also known as scrip
dividend) are types of dividends released to the shareholders of the company.
Although they both are types of dividends, there are few subtle differences
between the two and so comes the question of Cash Dividend Vs Stock
Dividend.

Cash Dividends and Stock Dividends are like a share in the profits of the
company for the shareholders. The release of dividends to the shareholders is a
form of rewarding them for investing and staying with the company. Moreover, whenever
the company releases dividends, it reduces the quantum of retained earnings or plowing
back profits in the company.
Liquidating Dividend – Meaning, Example, and More
When a company decides to terminate the operation, it liquidates all its
assets. These assets include not just inventory, but also machines,
building, and other financial assets it has. The objective of the company
is to accumulate funds by liquidating all the assets to pay all its debts
and use the remaining assets/distribute the available funds to pay a
dividend to the shareholders in the form of a liquidating dividend.

Stock Dividend Investing – Strategies, Tax Implications And More

Stock Dividend Investing is a way for shareholders to generate extra
income in addition to the appreciation in the market value of their
portfolio. Herein, investors buy dividend stocks, which reward them with
regular dividends. And, thanks to the power of compounding (or
reinvesting), even a small amount of regular dividends can turn into a
big amount over a period of time.
Types of Dividend
A dividend is a return you earn on the investment on the equity
or preference share of a company. The objective of giving divided is to give
the investor some return on their investment apart from capital appreciation.
The return does not necessarily have to be in the cash. It can be in different
forms. There are three main types of dividends.

 Cash Dividend
 When a company shares a portion of its net earnings with its shareholders in the form of cash, we
call it a cash dividend. The date on which the board of directors declared the dividend is called the
‘declaration date’. A shareholder is eligible to receive the dividend when his or her name is listed in
the shareholder’s register on ‘record date’.
 Benefits to Investors:
 Among the various types of dividend, cash dividend is the one which is most preferred by investors.
This is because there is a direct cash flow for the investor which makes the return more lucrative.
Investors, looking out for regular income, prefer companies which give regular cash dividend. This is
because it gives the investor an idea about the regularity of cash flow he can expect over a course of
time.
 Another reason why investors prefer cash dividend among various types of dividend is that it is
easier to predict when the company will be giving out cash dividend. Cash dividends are paid out of
the residual profit of the company. An investor can expect a payout when the company is making
good profits and has enough cash flow.
 While receiving cash dividends has its own benefits, these cash dividends attract tax. The tax payout
reduces the effective rate of return on the investment.
 A company may choose to re-invest the money in the business and not pay out the cash. This is
where the company may prefer another type of dividend over cash dividend.
Stock Dividend
A stock dividend is a type of dividend, under which instead of paying cash, the
company gives out shares. A company gives out a stock dividend when it wants
to reward the shareholders but does not want to pay out cash.
Stock dividends are also known as bonus shares. Under the stock dividend
issue, the company issues additional shares in a ratio to the investor’s current
holding. So if bonus issue is in the ratio of 1:1, an investor holding 50 shares will
get additional 50 shares. While the number of shares with an investor increases,
the market value of the shares remain the same.
For example, XYZ decides to issue bonus share in the ratio 1:1, the current
market price of the share is $100. After the issue, the market price of the share
will be $50. An investor holding 1000 shares will now have 2000, but the total
value of his investment will remain the same at $100,000.
Now, how does an investor benefit from this kind of dividend if the total value of
investment remains the same? Here the investor can sell share the additional
1000 shares, raise some cash immediately and still have the same number of
shares of the company. Or the can wait and enjoy capital appreciation on a
higher number of shares.
Another advantage of this type of dividend is that it is tax exempt. The tax is paid
only when there is profit on sales.
Stock Repurchase
Under this type of dividend, the investor gets an option to sell his shares
back to the company at a fixed rate. Generally, the fixed rate is higher than
the prevailing market rates. This way the investor gets some money back in
his pocket and the promoters/management gets higher shares in the
company.
Stock repurchase is a type of dividend which helps the management in
showing the market that it believes that the shares are undervalued. It also
helps in reducing the price-to-earnings (P/E) ratio of the share. The
earnings per share (EPS) of the company will also increase.
After the repurchase, the number of shares will decrease. Thus, when the
management pays out the dividend in cash, each shareholder will get a higher
percentage of the payout, thereby increasing dividend yield.
THANK YOU!!!