Some of the most important determinants of dividend policy are:
(i) Type of Industry
(ii) Age of Corporation
(iii) Extent of share distribution
(iv) Need for additional Capital
(v) Business Cycles
(vi) Changes in Government Policies
(vii) Trends of profits
(vii) Trends of profits
(viii) Taxation policy
(ix) Future Requirements and
(x) Cash Balance.
The declaration of dividends involves some legal as well as financial considerations. From the point of legal considerations, the basic rule is that dividend can only be paid out profits without the impairment of capital in any way. But the various financial considerations present a difficult situation to the management for coming to a decision regarding dividend distribution.
These considerations are discussed below:
(i) Type of Industry
Industries that are characterized by stability of earnings may formulate a more consistent policy as to dividends than those having an uneven flow of income. For example, public utilities concerns are in a much better position to adopt a relatively fixed dividend rate than the industrial concerns.
(ii) Age of Corporation
Newly established enterprises require most of their earning for plant improvement and expansion, while old companies which have attained a longer earning experience, can formulate clear cut dividend policies and may even be liberal in the distribution of dividends.
(iii) Extent of share distribution
A closely held company is likely to get consent of the shareholders for the suspension of dividends or for following a conservative dividend policy. But a company with a large number of shareholders widely scattered would face a great difficulty in securing such assent. Reduction in dividends can be affected but not without the co-operation of shareholders.
(iv) Need for additional Capital
The extent to which the profits are ploughed back into the business has got a considerable influence on the dividend policy. The income may be conserved for meeting the increased requirements of working capital or future expansion.
(v) Business Cycles
During the boom, prudent corporate management creates good reserves for facing the crisis which follows the inflationary period. Higher rates of dividend are used as a tool for marketing the securities in an otherwise depressed market.
(vi) Changes in Government Policies
Sometimes government limits the rate of dividend declared by companies in a particular industry or in all spheres of business activity. The Government put temporary restrictions on payment of dividends by companies in July 1974 by making amendment in the Indian Companies Act, 1956. The restrictions were removed in 1975.
(vii) Trends of profits
The past trend of the company’s profit should be thoroughly examined to find out the average earning position of the company. The average earnings should be subjected to the trends of general economic conditions. If depression is approaching, only a conservative dividend policy can be regarded as prudent.
(viii) Taxation policy
Corporate taxes affect dividends directly and indirectly— directly, in as much as they reduce the residual profits after tax available for shareholders and indirectly, as the distribution of dividends beyond a certain limit is itself subject to tax. At present, the amount of dividend declared is tax free in the hands of shareholders.
(ix) Future Requirements
Accumulation of profits becomes necessary to provide against contingencies (or hazards) of the business, to finance future- expansion of the business and to modernize or replace equipments of the enterprise. The conflicting claims of dividends and accumulations should be equitably settled by the management.
(x) Cash Balance
If the working capital of the company is small liberal policy of cash dividend cannot be adopted. Dividend has to take the form of bonus shares issued to the members in lieu of cash payment.
The regularity of dividend payment and the stability of its rate are the two main objectives aimed at by the corporate management. They are accepted as desirable for the corporation’s credit standing and for the welfare of shareholders.
High earnings may be used to pay extra dividends but such dividend distributions should be designed as “Extra” and care should be taken to avoid the impression that the regular dividend is being increased.
A stable dividend policy should not be taken to mean an inflexible or rigid policy. On the other hand, it entails the payment of a fair rate of return, taking into account the normal growth of business and the gradual impact of external events.
A stable dividend record makes future financing easier. It not only enhances the credit- standing of the company but also stabilizes market values of the securities outstanding. The confidence of shareholders in the corporate management is also strengthened.
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