Question

You are the finance manager of a company. The board of directors have asked you to decide the dividend policy. What factors would you keep in mind to perform this function?

Answer 1

Dividend decisions relate to how much of the company’s after tax profit is to be distributed to the share holders and how much of it should be retained in the business for future requirements.

Factors affecting dividend decisions are:

(i) Stability of dividend: Companies generally have a policy of stabilizing dividends, i.e. increase in dividend is only done when the earning potential of the company has gone up and not just the current year’s earnings. Thus, dividend per share is not altered when the change is small or temporary in nature.

(ii)Shareholders’ preference: While declaring dividends, management must keep in mind the preferences of the shareholders in this regard. If the shareholders in general desire that at least a certain amount is paid as dividend, the companies are likely to declare the same. There are always some shareholders who depend upon a regular income from their investments.

(iii)Legal constraints: Certain provisions of The Companies Act place restrictions on payouts as dividend. Such provisions must be adhered while declaring the dividend.

(iv) Access to capital market: Large and reputed companies generally have easy access to the capital market and, therefore, may depend less on retained earning to finance their growth. These companies tend to pay higher dividends than the smaller companies.