Designing Dividend

Policy

OBJECTIVES OF DIVIDEND POLICY

Firms Need for Funds
Shareholders Need for Income

PRACTICAL CONSIDERATIONS IN DIVIDEND

POLICY
Firms Investment Opportunities and Financial Needs
Shareholders Expectations
Constraints on Paying Dividends

Legal restrictions
Liquidity
Financial condition and borrowing capacity
Access to the capital market
Restrictions in loan agreements
Inflation
Control

STABILITY OF DIVIDENDS
Constant Dividend per Share or Dividend Rate.
Constant Payout.
Constant Dividend per Share Plus Extra Dividend.

Constant dividend per share policy

Dividend policy of constant payout ratio

Constant Dividend Per Share Plus Extra Dividend

Interim Dividend

Significance of Stability of Dividends

Resolutions of investors uncertainty.
Investors desire for current income.
Institutional Investors Requirement.
Raising Additional Finances.

FORMS OF DIVIDENDS
Cash Dividends
Bonus Shares (Stock Dividend)

The cash account and the reserve account of a company will be reduced
when the cash dividend is paid
Both the Total Assets and Net Worth of company will be reduced
Market Price of the share should drop by the amount of cash dividend paid

Bonus Shares

Walchund Ltd. pays bonus shares in ratio 1:10. At the time of issue bonus
shares, the MPS is Rs 30. The bonus shares are issued at the market pricea premium of Rs 20 over the face value of Rs 10 each share
Rs
Crore
Paid up Share Capital(1 cr
Share, Rs10/share)
Share Premium
Reserve & Surplus

10
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Rs
Crore
Paid up Share Capital(1
cr Share, Rs10/share)
Share Premium
Reserve & Surplus

Does the issue of bonus shares increase the wealth of

shareholders?

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17
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Advantages of Bonus Shares

To shareholders:
Indication of higher future profits
Future dividends may increase
Psychological value

To company:
Conservation of cash
More attractive share price

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Limitations of Bonus Shares

Shareholders wealth remains unaffected
Taxation Impact STCG Taxable @15% COI is zero
Costly to administer
Problem of adjusting EPS and P/E ratio

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Conditions for the Issue of Bonus Shares

A company is not allowed to declare bonus shares
unless partly paid up shares have been converted into
fully paid up shares
Bonus shares are made out of share premium and free
reserves
Minimum Reserves need to be maintain: It requires
that the reserve remaining after the amount capitalized
for bonus shares should be at least 40% of the
increased capital

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Share split

A share split is a method to increase the number of

outstanding shares through a proportional reduction in
the par value of the share. A share split affects only the
par value and the number of outstanding shares; the
shareholders total funds remain unaltered.

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Example

The following is the capital structure of Walchand Sons

& Company:

Walchand Company split their shares two-for-one. The

capitalization of the company after the split is as follows:

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Bonus Share vs. Share Split

The bonus issue and the share split are similar except
for the difference in their accounting treatment.
In the case of bonus shares, the balance of the
reserves and surpluses account decreases due to a
transfer to the paid-up capital and the share premium
accounts. The par value per share remains
unaffected.
With a share split, the balance of the equity accounts
does not change, but the par value per share changes.

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Reasons for Share Split

To make trading in shares attractive
To signal the possibility of higher profits in the future
To give higher dividends to shareholders

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Reverse Split

Under the situation of falling price of a companys share, the

company may want to reduce the number of outstanding
shares to prop up the market price per share.

The reduction of the number of outstanding shares by

increasing per share par value is known as a reverse split.

The reverse split is generally an indication of financial

difficulty, and is, therefore, intended to increase the market
price per share.

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BUYBACK OF SHARES

The buyback of shares is the repurchase of its own

shares by a company.

As a result of the Companies Act (Amendment) 1999,

a company in India can now buyback its own shares.

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In India the following conditions apply in

case of the buyback shares:

A company buying back its shares will not issue fresh capital,
except bonus issue, for the next 12 months.
The company will state the amount to be used for the buyback
of shares and seek prior approval of shareholders.
The buyback of shares can be affected only by utilizing the
free reserves, viz., reserves not specifically earmarked for
some purpose.
The company will not borrow funds to buy back shares.
The shares bought under the buyback schemes will be
extinguished and they cannot be reissued.

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Methods of Shares Buyback

First, a company can buy its shares through

authorized brokers on the open market.

Second, the company can make a tender offer, which

will specify the purchase price, the total amount and
the period within which shares will be bought back.

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Effects of the Shares Buyback

It is believed that the buyback will be financially

beneficial for the company, the buying shareholders
and the remaining shareholders.

Increase in the companys debt-equity ratio due to

reduced equity capital.

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Advantages of the Buyback

Return of surplus cash to shareholders
Increase in the share value
Increase in the temporarily undervalued share price
Achieving the target capital structure
Consolidating control
Protection against hostile takeovers

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Drawbacks of the Buyback

Not an effective defence against takeover
Shareholders do not like the buyback
Loss to the remaining shareholders
Signal of low growth opportunities

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