CHAPTE

DIVIDEND POLICY
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 LEARNING OBJECTIVES
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 Explain the objectives of dividend policy in practice

 Understand the factors that influence a firm’s
dividend policy
 Focus on the importance of the stability of dividend.
 Discuss the significance and implications of bonus
shares and stock splits and the share buyback
 Explain Lintner's model of corporate behaviour of
dividends
 OBJECTIVES OF DIVIDEND
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POLICY
 Firm’sNeed for Funds
 Shareholders’ Need for Income
PRACTICAL CONSIDERATIONS
IN DIVIDEND POLICY
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 Firm’sInvestment 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
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 Constant Dividend per Share or Dividend Rate.

 Constant Payout.
 Constant Dividend per Share Plus Extra
Dividend.
 Constant dividend per share
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policy
 Dividend policy of constant
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payout ratio
 Significance of Stability of Dividends
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 Resolutions of investors uncertainty.

 Investors’ desire for current income.
 Institutional Investors’ Requirement.
 Raising Additional Finances.
TARGET PAYOUT AND DIVIDEND
SMOOTHING: LINTNER’S MODEL OF
CORPORATE DIVIDEND BEHAVIOUR
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 FORMS OF DIVIDENDS
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 CashDividends
 Bonus Shares (Stock Dividend)
 Advantages of Bonus Shares
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 To shareholders:
 Tax benefit
 Indication of higher future profits
 Future dividends may increase
 Psychological value
 To company:
 Conservation of cash
 Only means to pay dividend under financial difficulty and
contractual restrictions
 More attractive share price
 Limitations of Bonus Shares
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 Shareholders’ wealth remains unaffected

 Costlyto administer
 Problem of adjusting EPS and P/E ratio
 Conditions for the Issue of Bonus
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Shares
 Residual reserve criterion
 Profitability criterion
 Share split
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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.
 Example
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 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:
 Bonus Share vs. Share Split
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 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.
 Reasons for Share Split
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 To make trading in shares attractive

 To signal the possibility of higher profits in the
future
 To give higher dividends to shareholders
 Reverse Split
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 Under the situation of falling price of a company’s 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.
 BUYBACK OF SHARES
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 Thebuyback 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.
 In India the following conditions
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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.
 Methods of Shares Buyback
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 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.
 Effects of the Shares Buyback
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 Itis believed that the buyback will be financially

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

 Increase in the company’s debt-equity ratio due to

reduced equity capital.
 Advantages of the Buyback
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 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
 Tax savings by companies
 Protection against hostile takeovers
 Drawbacks of the Buyback
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Not an effective defence against takeover

Shareholders do not like the buyback
Loss to the remaining shareholders
Signal of low growth opportunities