Dividend Decision: Retained Earnings vs. Dividend Decision

Dividend Decision is one of the crucial decisions made by the finance manager relating to the payouts to the shareholders. The payout is the proportion of Earning per Share given to the shareholders in the form of dividends.

The companies can pay either dividend to the shareholders or retain the earnings within the firm. The amount to be disbursed depends on the preference of the shareholders and the investment opportunities prevailing within the firm.

The optimal dividend decision is when the wealth of shareholders increases with the increase in the value of shares of the company. Therefore, the finance department must consider all the decisions viz. Investment, Financing and Dividend while computing the payouts.

If attractive investment opportunities exist within the firm, then the shareholders must be convinced to forego their share of dividend and reinvest in the firm for better future returns. At the same time, the management must ensure that the value of the stock does not get adversely affected due to less or no dividends paid out to the shareholders.

The objective of the financial management is the Maximization of Shareholder’s Wealth. Therefore, the finance manager must ensure a win-win situation for both the shareholders and 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:

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 essence, there are a lot of factors affecting dividend policy or decision.

Types of Dividend Decision

(i) 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

(ii) 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

(iii) 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.