The 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.
The Dividends are the proportion of revenues paid to the shareholders. The amount to be distributed among the shareholders depends on the earnings of the firm and is decided by the board of directors.
Types of Dividend
- Cash Dividend: It is one of the most common types of dividend paid in cash. The shareholders announce the amount to be disbursed among the shareholder on the “date of declaration.” Then on the “date of record”, the amount is assigned to the shareholders and finally, the payments are made on the “date of payment”. The companies should have an adequate retained earnings and enough cash balance to pay the shareholders in cash.
- Scrip Dividend: Under this form, a company issues the transferable promissory note to the shareholders, wherein it confirms the payment of dividend on the future date.A scrip dividend has shorter maturity periods and may or may not bear any interest. These types of dividend are issued when a company does not have enough liquidity and require some time to convert its current assets into cash.
- Bond Dividend: The Bond Dividends are similar to the scrip dividends, but the only difference is that they carry longer maturity period and bears interest.
- Stock Dividend/ Bonus Shares: These types of dividend are issued when a company lacks operating cash, but still issues, the common stock to the shareholders to keep them happy.The shareholders get the additional shares in proportion to the shares already held by them and don’t have to pay extra for these bonus shares. Despite an increase in the number of outstanding shares of the firm, the issue of bonus shares has a favorable psychological effect on the investors.
- Property Dividend: These dividends are paid in the form of a property rather than in cash. In case, a company lacks the operating cash; then non-monetary dividends are paid to the investors. The property dividends can be in any form: inventory, asset, vehicle, real estate, etc. The companies record the property given as a dividend at a fair market value, as it may vary from the book value and then record the difference as a gain or loss.
- Liquidating Dividend: When the board of directors decides to pay back the original capital contributed by the equity shareholders as dividends, is called as a liquidating dividend. These are usually paid at the time of winding up of the operations of the firm or at the time of final closure.
Thus, it is found out that usually the dividends are paid in cash, but however in certain situations, there could be the other forms of dividend as explained above.
The Dividend Policy is a financial decision that refers to the proportion of the firm’s earnings to be paid out to the shareholders. Here, a firm decides on the portion of revenue that is to be distributed to the shareholders as dividends or to be ploughed back into the firm.
The amount of earnings to be retained back within the firm depends upon the availability of investment opportunities. To evaluate the efficiency of an opportunity, the firm assesses a relationship between the rate of return on investments “r” and the cost of capital “K.”
As per the dividend models, some practitioners believe that the shareholders are not concerned with the firm’s dividend policy and can realize cash by selling their shares if required. While the others believed that, dividends are relevant and have a bearing on the share prices of the firm. This gave rise to the following models:
- Miller and Modigliani Hypothesis- Dividend Irrelevance Theory
- Walter’s Model – Dividend Relevance Theory
- Gordon’s Model- Dividend Relevance Theory
As long as returns are more than the cost, a firm will retain the earnings to finance the projects, and the shareholders will be paid the residual dividends i.e. the earnings left after financing all the potential investments. Thus, the dividend payout fluctuates from year to year, depending on the availability of investment opportunities.