Due to inefficient management and negligence of the Board of Directors, ABC Ltd. is sustaining huge losses but Board of Directors has paid dividends out of the share capital to hide these inefficiencies and to uphold the goodwill. But the Board of Directors has decided to pay very less dividend out of profits earned without giving any satisfactory' reason for this decision.
(i) What will be the immediate or short-run effects of ABC Ltd.'s decision?
(ii) Explain how or whether it will be beneficial for the company legally or otherwise?
Due to inefficient management and negligence of the Board of Directors, ABC Ltd. is sustaining huge losses but Board of Directors has paid dividends out of the share capital to hide these inefficiencies and to uphold the goodwill. But the Board of Directors has decided to pay very less dividend out of profits earned without giving any satisfactory' reason for this decision.
(i) What will be the immediate or short-run effects of ABC Ltd.'s decision?
(ii) Explain how or whether it will be beneficial for the company legally or otherwise?
(i) Declaring dividends will increase the value of shares in the stock market. However, as the dividends are lesser and unstable, it may reflect their inability to pay off short-term liabilities.
(ii) As per Companies Act 1956, they are supposed to transfer certain percentage of profits as reserves if they paid dividend more than 10%. But losses and low dividend payment may affect their reserves. Secondly, ABC Ltd. is bound by contractual constraints with lenders who cannot allow ABC Ltd. to issue dividend in case of large amount of outstanding debt. Thirdly, tax rates are directly proportional to declaration of dividend policy. Fourthly, their cash flow position will be restricted if dividends are declared and ABC Ltd. will not be able to operate smoothly.
(i) Declaring dividends will increase the value of shares in the stock market. However, as the dividends are lesser and unstable, it may reflect their inability to pay off short-term liabilities.
(ii) As per Companies Act 1956, they are supposed to transfer certain percentage of profits as reserves if they paid dividend more than 10%. But losses and low dividend payment may affect their reserves. Secondly, ABC Ltd. is bound by contractual constraints with lenders who cannot allow ABC Ltd. to issue dividend in case of large amount of outstanding debt. Thirdly, tax rates are directly proportional to declaration of dividend policy. Fourthly, their cash flow position will be restricted if dividends are declared and ABC Ltd. will not be able to operate smoothly.
