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DIVIDEND POLICY
Updated Version
PROF. V. RAMACHANDRAN
SIESCOMS,NERUL,
NAVI MUMBAI-400706
 What is Dividend
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 Dividend is that part of profits of a company which

is distributed amongst its Shareholders.

 Therefore it is a return that shareholder gets from

a company out profits on his shareholdings
 Dividend Policy
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 Dividend Policy refers to

 the policy /decision
 On quantum of profits
 to be distributed as dividend to share holders

 It also implies
 A Dividend payment pattern or trend of a company
 It is evolved through its Board of Directors and by the
shareholders
 keeping in view its bearing on present & future actions
 Dividend Decisions
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 Basically a company has three options for utilizing its

profits after tax:-
 Plough back the earnings by retaining them for long term
projects having good growth potential and which have
sufficient profitability or
 Distribute the same to shareholders as dividends for
maximization of shareholders wealth or
 A mix of the above viz: Partly distribute dividends and
partly retain profits for future development.
 Dividend policy
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Underlying Objective – is to Maximize Shareholders

Return.
 the dividend policy decides,

 pay out ratio.( Dividend as a % to PAT)

 the retention ratio (Profit retained as a %to PAT)

The returns to the shareholders are either

 by way of the dividend or

 capital gains

 Both are affected by the dividend policies of the firms.

Types of dividend policy
KINDS OF DIVIDEND
 Payment Procedures

 Declaration Date

 Holder-Of-Record Date

 Ex-Dividend Date
Standard Method of Cash Dividend Payment

Cash Dividend - Payment of cash by the

Company to its shareholders.

Ex-Dividend Date - Date that determines

whether a stockholder is entitled to a
dividend payment; anyone holding stock
before this date is entitled to a
dividend.

Record Date - Person who owns stock

on this date is entitled to receive the
dividend.
 Procedure for Cash Dividend Payment

Ex- Record Payment

Declaration Cum-
Date Date
Date dividend dividend
Date Date
Declaration Date: Date on which payment of dividends is announced .

Cum-Dividend Date: The last day up to which shares can be bought and
the buyer of a stock is entitled to the dividend.
Ex-Dividend Date: The first day from which the seller of a stock is entitled
to the dividend.
Record Date: The date on which register of members is closed by the company
to list of all Shareholders who are stockholders as of cum -dividend. date

Payment date : The dividend shall be paid within 30 days from the date of declaration
 Dividend Policy
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 A few models which studies the relationship of

stock prices and the dividend policies of firms
are given below and discussed-
 Traditional Model
 Walter Model
 Gordon Model
 Miller & Modigliani Model
 Rational Expectations Model.
 Traditional Position
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 The traditional approach to the dividend policy was

given by B Graham and DL Dodd ‘
 This approach clearly lays emphasis on the
relationship between the Dividend and the Stock
Market Prices.
 According to this approach the stock value responds
positively to higher dividend and negatively when
there are low dividend
 Limitations of The Traditional Approach
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 The traditional approach states that the P/E ratios are

directly related to the dividend pay-out ratios

 A high dividend pay-out ratio will increase the P/E

and vice-versa.

 The above may not be true in all situations.

 Share price may increase even with low dividend

where high growth rate /companies earnings are
increasing and the capital gains will be higher than cash
dividend
 Limitations of The Traditional Approach
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 Similarly a high dividend pay out with a low

growth rate there may be negative impact on
market price.

 Few investors may prefer regular low dividend to

a uncertain capital gains

 Few others may prefer low taxed capital gains

than high dividend
 The above conflicting situations have not been
addressed appropriately by the approach
 Walter Model
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 Similar to traditional approach, this model also considers

that Dividends do affect the Share price.
 The model studies relationship between internal rate of
return (r) and the cost of Capital (k or ke) to give a
dividend policy that maximizes the shareholders wealth
 The model deals with the dividend policy
 under three situations
r >ke
r < k e
r = k e
 Walter Model-
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Where r > k e - Zero pay out

The earnings can be retained by the company since it has better
and more profitable investment options than the investors which
suggests Zero pay out dividend policy
Where r < k e- 100% payout
In this situation the investors have better and more
profitable options than the company which suggests a
dividend policy of 100% payout which would maximize
the value of the firm
Where r = ke is Zero to a 100% payout ratio
In this situation the dividend policy of the company will
not affect the of the firm value. The optimum dividend
policy will range from Zero to a 100% payout ratio since
the value of the firm will remain constant in all situation
 Assumptions
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 Retained earnings are only deployed and no

outside debts or additional equity is used
 Constant Return and Cost of Capital with no
change in risk and return profile
 100% Payout or Retention
 Constant EPS and DIV
 Infinite Time
 Criticism
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 No external Financing
 Constant Rate of Return
 Constant opportunity cost of capital
 Gordon's Model -
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Assumptions
 All Equity Firm

 No External Financing

 Return and Cost of Capital are constant

 Perpetual Earnings

 No Taxes

 Constant Retention

 Cost of Capital greater than Growth Rate

 Optimum Payout Ratio
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 Growth Firms – Retain all earnings

 Normal Firms – No effect

 Declining Firms – Distribute all earnings

 Modigliani and Miller
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 According to M-M,
 Under a perfect market situation, the dividend
policy of a firm is irrelevant and does not
affect the value of the firm.

 The value of the firm depends on firms

earnings which results from its investment policy
and when investment decision of the firm
is given, dividend decision is of no
significance.
 Rational Expectations Model
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 According to the rational expectations model, there would

be no impact of the dividend declaration on the market
price of the share as long as it is at the expected rate.
 However it may show some adjustments in case the
dividends declared are higher or lower than the
expected level.
 Further, with maximization of shareholder wealth being
the most important issue, the dividend policies of a firm
will vary, depending on the operational environment.
 Operational Environment
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External Factors
 General State Of economy

 State of Capital Market

 Legal restrictions

 onCompanies and Income tax Act etc on

declaration of Dividend
 Contractual restriction – convents of FIs
 Tax policy
 incentives retention/reinvestment etc
 Operational Environment
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Internal Factors
 Share holders Expectations /desires

 Financial needs of the company

 Nature of earnings- Predictable/Unpredictable

 Retention/ loss of control-Closely held or widely held

 Liquidity position
 Industry Scenario
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Finance division provides the following details to

Board of Directors to enable them recommend
Dividends to shareholders:
 Composition of Share holders

 Share holders expectations

 Dividend History of the Company - 5 /10 years

 Profit/Dividend/Share price etc of other significant

players in the Industry
 Industry Scenario
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 Company’s Profitability details (past 5years)

-PBT/PAT/Effective Tax rate
 Book Value, EPS. Dividend Per Share P/E .
 Profitability Projections for next 2/3 years
 MajorCapital Expenditure envisaged in the near
future
 Cash flow Projections for the next 2 years
 Profits and taxation
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1500 40

1172.6
1200 38
1085.9
1042

900 36
787.9 PBT
709.9
34.9 678.5 PAT
607 591
34.1 34.6 Effective Tax Rate
600 34

399.8 396.4 32.8

32.9
300 32

0 30
2002 2003 2004 2005 2006
 Shareholding Pattern
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3.9% 1.3% Forign Collaborators

7.9% Public financial institutions,

banks and Govt. Companies
22.4% Individuals

51%
F.I.I's/ O.C.B's/ N.R.I's/
Mutual Funds
13.5% Domestic companies

Directors and relatives

 Dividend and Other details
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250 233.1 250

200 176.8 200 200
147.2
150 116.4 150 150
104.2
100 100 100 100
78 40.2
50 23.7 23.5 24.1 26.7 50
12.5 14.4 10.7 10.3 13.2
0 0
2002 2003 2004 2005 2006

EPS Book Value

Dividend per share P/E Ratio
 Thank
You

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