Introduction

 Net earning has two parts- Retained

earning and Dividends
 Retained earning used for further
investment
 Dividends are paid in cash to
shareholders
 Dividend increases the value of share
Practical Consideration in Paying
Dividends
 Depend upon firms financial needs, growth
plans and investment opportunity
 Signaling information about prospects of the
company
 Investor preference for dividend than capital
receipts for his own investments
 Control over the company may be lost
 Resolution of investors uncertainty
 Ability to raise additional finance
 Closely / Widely Held Company
Firm’s need for fund
 Growing firm generally keep major proportion of net earning.
 Growth firms have large number of investment opportunity
hence they should give precedence to retention of earning.
 Matured firms have infrequent investment opportunity hence
they should distribute most of their earning.
 It is argued that when IRR (return on investment) is greater
than cost of capital, it is profitable to reinvest the net earning
or most of it.
 Retained earnings are preferred than external equity as they
does not involve floatation costs.
 Some companies prefer to raise external equity for financing
investment decision.
Investor preference for dividend than capital
receipts

 Some shareholder’s may prefer near dividends

than future dividend or capital gain.
 Depends upon economic status, the effect of tax
differential on dividends and capital gains.
 In closely held companies, director knows
shareholder’s expectations well and frame
dividend policy accordingly.
 Institutional investors avoid speculation
Control over the firm

 Ifdividends are paid, cash may affected

 For further expansion company may
have to issue new share
 The control of existing shareholders will
be diluted if they do not want or cannot
buy new shares
 Hence payment of dividend may
withheld and earning may be retained
Investor preference for dividend than
capital receipts

 Widely held companies : Small investors,

Retired or old person and Wealthy investors.
 Shareholder’s income may go against
company’s investment and long term growth
 Management should properly trade off
between dividend and retained earning
Resolution of investors uncertainty

 Dividends have informational value.

 It resolves uncertainty in the mind of
investor.
 Companies generally have to pay small
amount of income even when earnings fall.
 It conveys that future of the company is
bright.
Other Practical Consideration in
Paying Dividends
 Risk taking capability of firm
 Firm’s constraints- financial and legal.
 Policy of the company: whether stable
dividend per share or payout ratio
 Liquidity requirement
 Taxation treatment
Other Practical Consideration in
Paying Dividends
 Temporary excess cash on account of
windfall gains and not the better
investment option available to firm

 Capital Budgeting decision-

- If policy is independent (No impact)
- If Dependent (Higher payout means
lower capital budgeting)
Stability of dividends
 It has the positive effect on market price of the
share.
 It also mean regularity in paying some dividend
annually.
 Three forms of dividend stability
 Constant dividend per share (dividend rate)
 Constant payout
 Constant dividend per share plus extra dividend.
Constant dividend per share
 InIndia, companies announces dividend as a
percent of the paid-up capital per share.
 Dividend rate may increase.

EPS

EPS
& DPS
DPS

Time
Constant Dividend per Share plus
Extra Dividend

 Generally adopted by companies with fluctuating

earnings.
 Policy to pay a minimum dividend per share with
a step up feature.
 Paying extra in period of prosperity.
 Known as interim dividend with final dividend.
 It helps in paying dividend without a default.
Merits of stability of dividends

 Ithas several advantages.

 Resolution of investors uncertainty.
 Investors’ desire for current income.
 Institutional investors requirements.
 Raising additional finances.
Danger of stability of dividends

 Once established, difficult to change.

 It creates a clientele that depends on it.
 Have to maintain the stability even
during lean years.
 Hence dividend rate should be fixed at
conservative figures.
Constant Payout
 The rate of dividend to earning is known as payout
ratio.
 Some company may follow a policy of constant
payout ratio.
 Paying a fixed percentage of earning per year.
 Amount of dividend fluctuates in direct proportion
to earning.
 In losses, no dividend shall be paid.
Constant Payout

EPS

EPS
and DPS
DPS

Time
Constraints on paying dividends
A high leveraged firm expected to retain more to
strengthen its position.
 Raising much external equity will adversely
affect the firm’s financial flexibility.
 Financial flexibility includes the firm’s ability to
access external funds at later date.
 Access to capital market.
 Restriction in loan agreements.
 Lenders may put restrictions on dividend
payment until some conditions met.
Issues in dividend policy

 Low policy payout may produce

higher share price but not always
 Dividend is a current earning while
capital gain is a future earning
 Dividend yield = dividend per share/
market price per share
 Dividend are generally taxed more
than capital gain
Legal and procedural aspects to be
considered in dividend policy
 Companies can only pay cash dividend
(with the exception of bonus shares)
 Dividend can not be declared for past
years
 Dividend can be declared out of the
profit of the same financial year and after
providing for the government dues and
depreciation under companies act
Conclusion
 Don’t pay dividend on the expense of new
project can give better returns than cost of
equity
 Try to avoid the new equity raising
 Frame dividend policy based on
- Targeted debt-equity ratio
- Investment needs of the company
- Capital market norms and tax code
- Avoid dividend cuts
Thank You
Thank You