A company’s dividend policy affects the performance of its share price and the overall value of the company. The dividend policies chosen must align with the company’s goals and objectives in addition to maximising the company’s value to its shareholders. There are 4 main types of dividend policies: regular dividend, stable, irregular and no dividends. The factors affecting dividend policy are both external and internal. Issues such as the business cycle, profitability and the overall industry among other various issues affect a firm’s dividend policy.
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What Is a Dividend Policy
A dividend policy is the structure a company uses to pay out dividends to its shareholders. As such this policy determines how much and how often dividends are paid out. When profits are made, a firm needs to decide what to do with them, to either pay out dividends or retain the profit.
The nature of Industry
The nature of the industry a company operates in is one of the major factors affecting dividend policy. Industries where earnings are stable or consistent may adopt a dividend policy where dividends are given out on a regular basis. Companies that operate in industries where earnings are uncertain have a dividend policy that is inconsistent. For example, companies that operate in industries that provide basic needs and services such as the food industry have earnings that are relatively consistent compared to other industries that sell luxury goods and services such as the hospitality industry. In such a case the dividend policy of a food manufacturer will be more consistent than that of a luxury car manufacturer.
The Ownership Structure of a company
The ownership structure of a company is another important factor that affects the dividend policy of a firm. If the majority of the ownership of a company is comprised of large institutions, the shareholders will favour high dividend pay-outs in order to increase management control. A company with a higher promoter’s holdings will opt for a low dividend pay-out in order to avoid the decrease in the company’s stock price.
Age of Corporation
The number of years a firm has been operating for is an important factor affecting dividend policy. Newly formed or listed companies will need to retain a lot of their earnings in order to raise capital reserves thus, their dividend policy will be conservative. However, companies that have been operating for a longer period of time may have a generous dividend policy compared to newly established ones.
The size of the company
In addition to the age of the company, the size of the company is a factor affecting dividend policy. This is because a firm with a large number of shareholders will have a hard time convincing them to agree to low dividend payments but a smaller company with few shareholders can easily convince the shareholders to agree to low dividend pay-outs. The size of an organisation can also be advantageous for firms. If the shareholders are few, the dividend pay-outs are likely to be high because profits are spread over a small group of people, when there is a large number of shareholders dividend pay-outs are lower.
Different shareholders have different expectations. The expectations of shareholders that are retired is not the same with the expectations of young investors. This is an important factor that affects dividends policies. Retired investors are more interested in large dividend payments whereas young investors are more concerned with capital growth. Thus, it is important for investors to take the expectations of the majority of the investors into account in formulating their dividend policy.
Leverage is a financial factor affecting dividend policy. If a company has a lot of debt its dividend payments will be low compared to a company that uses other forms of finance other than debt. This is because a company that has a large debt burden needs to divert most of its revenue paying off interest and debt. As a result, the dividend payments will be lower. On the other hand, a company that has alternative sources of finance can give out high dividend payments.
Business cycles are one of the major macroeconomic factors affecting dividend policy. During a boom dividend payments are high and during a recession dividend payments may decrease. Also, companies may take a conservative approach in dividend pay-outs in order to save funds to sustain them during a recession. This way, a reasonable amount in dividend payments can be paid out when there is not much business activity to maintain the confidence of current shareholders and to attract new investors. Depending with the future investments plans of the company dividends payments are normally generous when the economy is expanding.
Profitability is one of the primary factors affecting dividend policy. In fact, if there is not profit then no dividend payments can be made. Therefore, profitable companies are able to pay high dividends to their shareholders whilst companies that do not make much profit cannot. In some cases, companies may even hold back on dividend payments if they wish to reinvest the profits for business expansion. The average profit level of a firm needs to be determined to devise the best dividend policy that is suitable for the firm’s income. This can be done through analysing the past profit performance of the organisation. Also forecasting profits to determine the future performance of an organisation will also be useful in determining the right dividend policy.
Another factor affecting dividend policy is the taxation policy in a given country. Corporate taxes affect dividend policy directly and indirectly. The overall profit level of a firm is taxed and that directly reduces the profits an organisation can redistribute in dividends. In addition, if dividend income is taxed whilst capital gain isn’t then a firm may not pay out large amounts of dividends. Instead, it will focus on retaining its profits in order to increase the price of the company’s share. This is done in order to give the maximum return to shareholders.
Liquidity is another financial factor affecting dividend policy. The availability of cashflow in an organisation is directly related to the dividend policy. Often, companies that have high profits may have most of their profits tied up in working capital but with low cashflow. In such instances the dividend policy is conservative. High dividends payments are only possible when the company is liquid.