COMMERCE DEPARTMENT

DPB50113 – BUSINESS FINANCE

TOPIC 5: DIVIDEND POLICY

INTRODUCTION

Dividend refers to a payment which a company pays to its shareholders. Payment of

dividends is not an expenses for the company, instead it is a distribution of assets
among the shareholders from the company’s profits or net earnings.

Dividend may be defined as the return that a shareholder gets from the company out
of its profits on his shareholdings.

Dividend is also a payment or reward made to the equity shareholders for their
investment in the company.

Dividend is a distribution of part of the company’s earnings to its equity shareholders.

The company’s board of directors decided the amount that the shareholders will
receive. The company can also state it in the form of a percentage.

DIVIDEND POLICY

Dividend policy means the practice or guideline that management follow in making
dividend payout decisions or in other words, the size and pattern of cash distributions
over time to shareholders.

Dividend policy determines the ultimate distribution of the firm’s earnings between
retention and cash dividend payments of shareholders. It is the decision about how
much of the earnings to pay out as dividend versus retaining or reinvesting earnings
in the firm.

Retained earnings are an important source of internal finance for long-term growth of
the company while dividend reduces the available cash funds of the company.

If the company has investment project whose return exceed its cost of capital, it will
retain earnings to finance these projects. There is a reciprocal relationship between
retained earnings and dividends. The larger the retained earnings, the lesser the
dividend and the smaller the retained earnings, the larger the dividends.
FORMS / TYPES OF DIVIDEND

1. CASH DIVIDEND
➢ The most common form of dividend.
➢ The shareholders receive cash for each share.
➢ The company should have enough cash in its bank account when cash
dividends are declared.
➢ In the case of the company with preference shareholders, the fixed preference
dividends have priority over the ordinary dividends and dividend payment on
the preference shares needs to be completed first before a single cent can be
paid out to the ordinary shareholders.

2. STOCK DIVIDEND / BONUS DIVIDEND / BONUS SHARES

➢ Instead of cash, company might issue more shares to existing shareholders at
no extra costs.
➢ Issuing bonus share increase the number of outstanding shares of the
company.
➢ The bonus shares are distributed proportionately to the existing shareholder
➢ There is no dilution of ownership.

3. INTERIM DIVIDEND
➢ Is a dividend payment made before a company’s annual general meeting and
final financial statements.
➢ This declared dividend usually accompanies the company’s interim financial
statements.
➢ The most common pattern applied by companies is to distribute an interim
dividend at the end of the first quarter or half-year and then the final dividend
at the financial year end.

4. SPECIAL DIVIDEND OR EXTRA DIVIDEND

➢ Is a non-repeated distribution of company assets, usually in the form of cash
to shareholders.
➢ A special dividend is larger compared to normal dividends paid out by the
company.
➢ Special dividends are declared after high company earnings results as a way to
distribute the profits directly to shareholders.
➢ A special dividend servers as a reward to shareholders designed to engender
loyalty.

5. REGULAR CASH DIVIDEND

➢ Is a payment made by a company out of its earnings to investors in the form
of cash (cheque or electronic transfer).
➢ This transfers economic value from the company to the shareholders instead
of the company using the money for operations or reinvestment.
➢ However, this will cause the company’s share price to drop by roughly the same
amount as the dividend.
➢ They may be paid quarterly, monthly, semi-annually or annually.
6. SCRIP DIVIDEND
➢ Scrip dividend are promises to make the payment of dividend at a future date
instead of paying the dividend now, the company elects to pay it at some later
date.
➢ The ‘scrip’ issued to shareholder is merely a special form of promissory note or
notes payable.

7. LIQUIDATING DIVIDEND
➢ If a company is claiming bankruptcy or will discontinue business operations,
the company will issue this type of payment to shareholders.
➢ Payments are based on how many shares a shareholder has in the company.
➢ This is a type of payment made by a corporation to its shareholders during its
partial or full liquidation.

8. PROPERTY DIVIDEND
➢ A property dividend can either include shares of a subsidiary company or
physical assets such as inventories that the company holds.
➢ The dividend is recorded at the market value of the asset provided.
➢ This type of payout structure is less common than the regular stock or cash
dividend system.
➢ From a corporate perspective, property dividends can be distributed if the
parent company does not wish to dilute its current share position or if it does
not have enough cash on hand to distribute healthy payments.

DETERMINANTS OF DIVIDEND POLICY

1. TYPE OF INDUSTRY

Industries that are characterized by stability of earnings may formulate a more

consistent policy as to dividends compared to industries with an inconsistent flow
of income.

2. AGE OF CORPORATION

Newly established enterprises would require most of their earnings for plant
improvement and expansion while old established companies which have attained
a longer earning experience can formulate clear dividend policies.

3. EXTENT OF SHARE DISTRIBUTION

A small company is likely to get consent of the shareholders for the suspension of
dividends or for applying a conservative dividend policy. However, a company with
a large number of shareholders who are widely scattered would face difficulty in
obtaining an agreement from shareholders.
4. NEED FOR ADDITIONAL CAPITAL

The extent to which the profit would be reinvested back into the business has
influence on the dividend policy. The income may be used to fulfil the requirement
of working capital or future expansion.

5. BUSINESS CYCLE

During an economic expansion, finance managers would create good financial

reserves for facing crisis and inflation periods. Higher rates of dividend are used
as a tool for marketing the securities in an otherwise depressed market.

6. CHANGES IN GOVERNMENT POLICIES

Government limits the rate of dividend declared by companies in a particular

industry or in all business activities. The government puts temporary restrictions
on payment of dividends by companies.

7. TRENDS OF PROFITS

The past trends of the company’s profits should be thoroughly examined to find
out the average earnings position of the company. The average earnings should
reflect the trends of the general economic condition. In a depression, only a
conservative dividend policy can be applied.

8. TAXATION POLICY

Taxation policy of the government also affects the dividend decision of a firm. A
high or low rate of business taxation affects the net earnings of a company and
thereby its dividend policy.

9. FUTURE REQUIREMENTS

It is not only the desires of the shareholders but also future financial requirements
of the company that have to be taken into consideration while making a dividend
decision. The management has to tolerate the conflicting interests of shareholders
and those of the company’s financial needs.

10. CASH BALANCE

If the working capital of the company is small, a liberal policy of cash dividend
cannot be adopted. Dividend has to take the form of bonus shares issued to the
member in lieu of cash payment.
CASH DIVIDEND PAYMENT PROCEDURES

1. DECLARATION DATE
o Is the date when a company’s board of directors announces that a specified
amount of dividend will be paid to the shareholders.
o The dividend is paid to shareholders who will be on the company’s record at
some particular future date.

2. DATE OF RECORD
o Together with dividend announcement, board of directors will specify a date of
record.
o The company prepare a list of shareholder from the stock transfer book at the
close of business on the date of record.

3. EX-DIVIDEND DATE
o The ex-dividend date is the date on which investors are cut off from receiving
a dividend.
o If an investor purchases a stock on the ex-dividend date, that investor will not
receive the dividend.

4. PAYMENT DATE
o Is the date on which the actual dividend is paid out to the shareholders of
record.