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Chapter 18 :-

Dividend Policy

Prepared byPrepared by

Arpit & shikha Arpit & shikha

Chapter 18 Dividend Policy



What is Dividend Policy?

What is Dividend Policy?

Dividend PolicyDividend Policy





Dividend PolicyDividend PolicyWhat is It?What is It?

Dividend Policy refers to the explicit or implicit Dividend Policy refers to the explicit or implicit

decision of the Board of Directors regarding thedecision of the Board of Directors regarding the

amount of residual earnings (past or present)amount of residual earnings (past or present)that should be distributed to the shareholdersthat should be distributed to the shareholders

of the corporation.of the corporation.

± ± This decision is considered aThis decision is considered a f inancing decisionf inancing decision

becausebecause the profits of the corporation are anthe profits of the corporation are animportant source of financing available to theimportant source of financing available to the

firm.firm.




A firm dividend Policy has the effect of A firm dividend Policy has the effect of

dividing its net earning into two parts.dividing its net earning into two parts.

Corporate Profits A fter Tax

Retained Earnings

Dividends

Dividends a Financing DecisionDividends a Financing Decision




Firm investment Opportunities & FinancialFirm investment Opportunities & Financial

needs.needs.

Growth firm may give precedence to theGrowth firm may give precedence to theretention of earning over the Payment of retention of earning over the Payment of dividend into order to finance its expandingdividend into order to finance its expandingactivitiesactivities.. There foreThere fore they have low payout they have low payout ratio.ratio.

Matured firm may give precedence toMatured firm may give precedence to

distribute most of their earning as adistribute most of their earning as a

dividend.dividend. They have high payout ratioThey have high payout ratio

for e.g. for e.g. Procter & gambleProcter & gamble distribute most of distribute most of

their earning as a dividend.their earning as a dividend.



Shareholder ExpectationShareholder Expectation

A wealthy shareholder or a speculativeA wealthy shareholder or a speculative

person in a high tax bracket, may beperson in a high tax bracket, may be

interested in capital gain than current interested in capital gain than current

dividenddividend

A retired person with a small mean. WhoseA retired person with a small mean. Whose

regular source of income is dividend may beregular source of income is dividend may beinterested in dividend, rather than capitalinterested in dividend, rather than capital

gain.gain.




Continue..Continue..

Institutional Investor who Purchase largeInstitutional Investor who Purchase large

block of share relatively for a long period of block of share relatively for a long period of

time , and are able to influence thetime , and are able to influence the

composition of board of director by theircomposition of board of director by theirvoting rightsvoting rights




Constraint in paying dividendConstraint in paying dividend

Legal Requirement :Legal Requirement :-- The director are not The director are not

legally compelled to declare dividend.legally compelled to declare dividend.

Liquidity :Liquidity :-- Although a firm may have adequateAlthough a firm may have adequateearning to declare dividend, it may not have aearning to declare dividend, it may not have a

sufficient cash to pay dividend.sufficient cash to pay dividend.

Restriction in loan agreement :Restriction in loan agreement :-- Lenders mayLenders may

generally put restriction on dividend Payment togenerally put restriction on dividend Payment to

protect their interest protect their interest




Continue«Continue«

Control :Control :-- When a company pays a largeWhen a company pays a large

dividend, its cash is affected. As a result, thedividend, its cash is affected. As a result, the

company will have to issue new shares to raisecompany will have to issue new shares to raise

fund, as a result the fund, as a result the control of the existingcontrol of the existingshareholdershareholder will be diluted if they do not want orwill be diluted if they do not want or

buy additional share.buy additional share.




Stability of paying DividendStability of paying Dividend

Stability Of Dividend :Stability Of Dividend :-- It mean regularity inIt mean regularity in

paying dividend annually.paying dividend annually.

Three form of such stability may beThree form of such stability may bedistinguished.distinguished.

Constant Dividend per share or dividend rateConstant Dividend per share or dividend rate

Constant Payout Constant Payout

Constant Dividend per share Plus extraConstant Dividend per share Plus extra

dividend.dividend.




Continue«Continue«

Con stant Dividend per shareCon stant Divid end per shar e ::-- A co mpan yA co mpan y

f o llo w th e po licy o f pa yin g a fixed a mo unt per f o llo w th e po licy o f pa yin g a fixed a mo unt per

shar e or a fixed rat e on paid up ca pita l a sshar e or a f i xed rat e on paid up ca pita l a s

divid end ev er y year .divid end ev er y year .

Con stant Pa yo ut Con stant Pa yo ut ::-- it mean a pa yin g a f i xed it mean a pa yin g a f i xed

per centa ge o f n et earnin g ev er y year , with thi sper centa ge o f n et earnin g ev er y year , with thi s

po li cy th e a mo unt o f divid end wi ll fluct uat e with po li cy th e a mo unt o f divid end wi ll fluct uat e with earnin g.earnin g.




Continue..Continue..

Con stant Divid end per shar e Plus extra Con stant Divid end per shar e Plus extra

divid end divid end ::-- In thi s th e small divid end o f per In thi s th e small divid end o f per

shar e i s f i xed to r edu ce th e po ssi bilit y o f ev er shar e i s f i xed to r edu ce th e po ssi bilit y o f ev er

mi ssin g a divid end pa yment . A co mpan y pa ymi ssin g a divid end pa yment . A co mpan y pa yint eri m divid end wh en co mpan y i s in int eri m divid end wh en co mpan y i s in

pro sperit y.i .e a hi gh er pro f it« pro sperit y.i .e a hi gh er pro f it«




Merit of stability of dividendMerit of stability of dividend

Resolution of investors uncertainty.Resolution of investors uncertainty.

To attract Institutional investor(L.I.C,U.T.I)To attract Institutional investor(L.I.C,U.T.I)

Raising Additional finance.Raising Additional finance.

Investor desire for current income.Investor desire for current income.




Forms of DividendsForms of Dividends


F orms of Dividends

Cash

Bonus share( stock

dividend)

Shares buy back



Cash as a dividendCash as a dividend

A company should have enough cash balanceA company should have enough cash balance

in bank account when they issue dividend.in bank account when they issue dividend.

when a company follow a stable dividend stablewhen a company follow a stable dividend stablepolicy, it should prepare a cash budget for thepolicy, it should prepare a cash budget for the

coming period to indicate necessary fund,coming period to indicate necessary fund,

which would be needed to meet regularwhich would be needed to meet regular

dividend.dividend.




Bonus ShareBonus Share

Bonus share :Bonus share :-- Bonus share is the distribution of Bonus share is the distribution of

shares to the existing shareholder free of cost.shares to the existing shareholder free of cost.

It supplement cash dividend by bonus share.It supplement cash dividend by bonus share.

It increase the number of outstanding sharesIt increase the number of outstanding sharesof the company.of the company.

Bonus share are issued Proportionately to theBonus share are issued Proportionately to the

existing shareholder..hence there is no dilutionexisting shareholder..hence there is no dilution

of ownership.of ownership.

it reduce the reserves and surplus ( retainedit reduce the reserves and surplus ( retained

earning)earning)




Merit of bonus shareMerit of bonus share

Shareholder benefit Shareholder benefit

Tax Benefit.Tax Benefit.

indication of higher future profit.indication of higher future profit.

Future dividend may increase.Future dividend may increase.

Psychological valuePsychological value

Company benefit Company benefit Conservation of cashConservation of cash




Limitation of Bonus shareLimitation of Bonus share

Share holder wealth remain unaffectedShare holder wealth remain unaffected

Costly to administerCostly to administer

Problem of adjusting EPSProblem of adjusting EPS




Back Buy of Shares:Back Buy of Shares:--

The buy back of shares is the repurchase of itsThe buy back of shares is the repurchase of its

own shares by a company.own shares by a company.

Condition relating to issue buy back of a shareCondition relating to issue buy back of a share

A company buying back its share will not issue fresh A company buying back its share will not issue fresh

capital, except bonus issue for the next 12 months.capital, except bonus issue for the next 12 months.

The buy back of shares can be affected only using freeThe buy back of shares can be affected only using freereserves.reserves.

The company will not borrow funds to buy back shares.The company will not borrow funds to buy back shares.




MeritsMerits of Buy back of shares:of Buy back of shares:--

Returns of surplus cash to share holder .Returns of surplus cash to share holder .

Increase in the share value/E.P.S.Increase in the share value/E.P.S.

Tax saving by company.Tax saving by company.




Drawback of buy back of shares:Drawback of buy back of shares:--

Share holders do not like the buyback.Share holders do not like the buyback.

Loss to the remaining shareholders.Loss to the remaining shareholders.

Signal of low growth opportunities.Signal of low growth opportunities.




SummarySummary

Bonus Share have a Psychological appeal theyBonus Share have a Psychological appeal they

do not increase the value of share.do not increase the value of share.

A stable dividend policy doest not meanA stable dividend policy doest not meanConstant Dividend per share. It meanConstant Dividend per share. It mean

predictable dividend policy.predictable dividend policy.

The purpose of buy back is to provideThe purpose of buy back is to provide

companies the flexibility of improving theircompanies the flexibility of improving their

E.P.S.E.P.S.




ReferenceReference

I.I. I.M Pandey bookI.M Pandey book

I.I. www. Investopedia.comwww. Investopedia.com


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