Financial and Strategic Management

What are the Determinants of Dividend Policy?

In the company/organization, dividend policy is determined by the Board of directors has taken into consideration a number of factors which include legal restrictions imposed by the Government to safeguard the interests of various parties or the constituents of the company.

The main considerations are as follows:

(1) Legal: As regards cash dividend policy several legal constraints bear upon it – a firm may not pay a dividend which will impair capital. The dividend must be paid out of the firm’s earnings/current earnings. Contract/ Agreements for bonds/loans may restrict dividend payments. The purpose of the legal restriction is to ensure that the payment of dividends may not cause insolvency.

(2) Financial: There are financial constraints to dividend policy. A firm can pay dividends only to the extent that it has sufficient cash to disburse; a firm can’t pay dividends when its earnings are in accounts receivables or the firm does not have adequate liquidity.

(3) Economic Constraints: Besides, there are economic constraints also. The question arises, does the value of dividend affects the value of the firm. If the answer to it is yes then there must be some optimum level of dividend, which maximizes the market price of the firm’s stock.

(4) Nature of Business Conducted by a Company: A company having a business of the nature that gives regular earnings may like to have a stable and consistent dividend policy. Industries manufacturing consumer/ consumer durable items have a stable dividend policy.

(5) Existence of the Company: The length of existence of the company affects dividend policy. With their long-standing experience, the company may have a better dividend policy than the new companies.

(6) Type of Company Organisation: The type of company organization whether a private limited company or a public limited company affects dividend decisions. In a closely held company, a view may be taken for acquiescence and conservative dividend policy may be followed but for a public limited company with widespread a shareholder, a more progressive and promising dividend policy will be the better decision.

(7) Financial Needs of the Company: Needs of the Company for additional capital affects the dividend policy. The extent to which the profits are required to be invested in the company for business growth is the main consideration in dividend decisions. The working capital position of a company is an important condition that affects the dividend policy as no company would declare a dividend to undermine its financial strength and threaten its solvency and existence.

(8) Market Conditions: Business cycles, boom, and depression, affects dividend decisions. In a depressed market, higher dividend declarations are used to market securities for creating a better image of the company. During the boom, the company may like to save more, create reserves for growth and expansion, or meeting its working capital requirements.

(9) Financial Arrangement: In case of financial arrangements being entered into or being planned like a merger or amalgamation with another company, a liberal policy of dividend distribution is followed to make the share stock more attractive.

(10) Change in Government Policies: Changes in Government Policies particularly those affecting earnings of the company are also taken into consideration in settling dividend decisions. For example, a higher rate of taxation will definitely affect company earnings and carry an impact on dividend decisions. Besides, fiscal, industrial, labor, industrial policies do affect in different magnitude the dividend decisions of individual corporate enterprises.

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Shreya Kushwaha

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