What are the considerations for creating a good Dividend Policy?

The decisions that the management of an organization needs to take regarding the payout of dividends are known as Dividend Decisions. The companies usually want to maximize shareholders' wealth and hence a distribution policy of maximum dividend payout is required. However, if the company pays out all the profits, it may face cash constraints in the future. So, sustained earning is also necessary.

Looking at all these factors, a company needs to depend on the following factors to build a good dividend policy.

NoteA good dividend policy establishes faith in the shareholders' minds.

Considerations for Creating a Good Dividend Policy

  • Cash Requirements − As paying out dividends during times of constraints may place a company in danger, the cash revenues must be considered before taking a dividend decision.

  • Growth timing − A company must also consider the growth of the firm and frame the dividend policy accordingly. As growth requires cash, excess dividend payout may be costly for an organization.

  • Evaluation of price sensitivity − The dividend policy must not alter the stock price toward the negative. If the dividend payout policy is wrong, shareholders will notice it and this may result in a dive of the stock which is undesirable.

A Good Dividend Policy

There is no magic formula to construct a good dividend policy. An excellent dividend policy may mean a rotten one for another. So,companies should be careful in making dividend policies. For example, regular and frequent dividend payout is good for the banking industry but it is not good for the healthcare industry.

The following two factors should be considered before finalizing a dividend policy −

How much to pay − It is crucial to determine the right amount of dividend for the shareholders. Most shareholders look for good returns but paying good returns all the time is easier said than done. Therefore, companies must calculate the right dividend in order to remain competitive in the market.

NoteThe aim of a dividend policy is to make the shareholding pattern smooth and rewarding.

Impact on share prices: Dividend payout impacts share prices of a company. If the payout is good, it is a sign of growth and profitability. The negative share prices may seem to be unattractive by most investors. However, one thing that needs to be considered is it is not just dividend payout that affects share prices, there may be a gamut of other reasons for the fall.

Types of Dividends

Constant Dividends − This type of dividends are paid at certain intervals of time and a percentage of profits are paid. This type of decision is good for the beginning phase of a company. The investors are usually open to risks but this type of company also offers quite attractive returns sometimes.

Stable Dividends − These are dividends that are paid every year regardless of whether the company makes a profit or not. In such cases, shareholders are immune from market volatility and pricing. Long-lasting companies with a steady amount of cash flows can afford such a policy. In such systems, investors cannot ask for a portion of the company's profitability.

NoteThere are two types of dividend payout decisions depending on payment tenure and amount paid.

Updated on: 12-Aug-2021

1K+ Views

Kickstart Your Career

Get certified by completing the course

Get Started