A policy is a guideline for action. What are the guidelines followed in respect of dividend function? The guidelines relate to forms, scale, stability and timing of dividend payment. Accordingly dividend policies of diverse nature are available. Prominent of them are dealt with below.
- Policy of No Immediate Dividend: Generally, management follows a policy of paying no immediate dividend in the beginning of its life, as it requires funds for growth and expansion. In case, when the outside funds are costlier or when the access to capital market is difficult for the company and shareholders are ready to wait for dividend for sometime, this policy is justified, provided the company is growing fast and it requires a good deal of amount for expansion. But such a policy is not justified for a long time, as the shareholders are deprived of the dividend and the retained earnings built up which will attract attention of laborers, consumers etc. It would be better if the period of dividend is followed by issue of bonus shares, so that later on rate of dividend is maintained at a reasonable level.
- Regular or Stable Dividend Policy: When a company pays dividend regularly at a fixed rate, and maintains it for a considerably long time even though the profits may fluctuate, it is said to follow regular or stable dividend policy. Thus stable dividend policy means a policy of paying a minimum amount of dividend every year regularly. It raises the prestige of the company in the eyes of the investors. A firm paying stable dividend can satisfy its shareholders and can enhance its credit standing in the market. Not only that the dividend must be regularly paid but the dividend must be stable. It may be fixed amount per share or a fixed percentage of net profits or it may be total fixed amount of dividend on all the shares etc. The benefits of stable dividend policy are (1) it helps in raising long-term finance. When the company tries to raise finance in future, the investors would examine the dividend record of the company. The investors would not hesitate to invest in company with stable dividend policy. (2) As it will enhance the prestige of the company, the price of its shares would remain at a high level. (3) The shareholders develop confidence in management. (4) It makes long-term planning easier.
- Regular Dividend plus Extra Dividend Policy. A firm paying regular dividends would continue with its pay out ratio. But when the earnings exceed the normal level, the directors would pay extra dividend in addition to the regular dividend. But it would be named ‘Extra dividend’, as it should not give an impression that the company has enhanced rate of regular dividend, This would give an impression to shareholders that the company has given extra dividend because it has earned extra profits and would not be repeated when the business earnings become normal. Because of this policy, the company’s prestige and its share values will not be adversely affected. Only when the earnings of the company have permanently increased, the extra dividend should be merged with regular normal dividend and thus rate of normal dividend should be raised. Besides, the extra dividend should not be abruptly declared, but the shareholders should have some idea in advance, so that they may sell their shares, if they like. This system is not found in India.
- Irregular Dividend Policy: When the firm does not pay out fixed dividend regularly, it is irregular dividend policy. It changes from year to year according to changes in earnings level. This policy is based on the management belief that dividend should be paid only when the earnings and liquid position of the firm warrant it. This policy is followed by firms having unstable earnings, particularly engaged in luxury goods.
- Regular Stock Dividend Policy: When a firm pays dividend in the form of shares instead of cash regularly for some years continuously, it is said to follow this policy. We know stock dividend as bonus shares. When a company is short of cash or is facing liquidity crunch, because a large part of its earnings are blocked in high level of receivables or when the company is need of cash for its modernization and expansion program, it follows this policy. It is not advisable to follow this policy for a long time, as the number of shares will go on increasing, which would result in fall in earnings per share. This would adversely affect the credit standing of the firm and its share values will go down.
- Regular Dividend plus Stock Dividend Policy: A firm may pay certain amount of dividend in cash and some dividend is paid in the form of shares (stock). Thus, the dividend is split in to two parts. This policy is justified when (1) The company wants to maintain its policy of regular dividend and yet (2) It wants to retain some part of its divisible profit with it for expansion. (3) It wants to give benefit of its earnings to shareholders but has not enough liquidity to give full dividend in cash. All the limitations of paying regular stock dividends apply to this policy.
- Liberal Dividend Policy: It is a policy of distributing a major part of its earnings to its shareholders as dividend and retains a minimum amount as retained earnings. Thus, the ratio of dividend distribution is very large as compared to retained earnings. The rate of dividend or the amount of dividend is not fixed. It varies according to earnings. The higher is the profit, the higher will be the rate of dividend. In years of poor earnings, the rate of dividend will be lower. In fact, it is the policy of Irregular Dividend.
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