Dividend policy is one of the most important factors that attract the investors toward a company. Different companies pay dividend following own policies and some companies do not pay the dividend at all. For example Microsoft (MSFT). This article discusses some of the very common dividend policies companies take into account before declaring or paying dividends.
Factors determining the dividend policy of a company are as given below:
Liquidity: For paying the dividend, a company will require access to cash. Even very profitable companies might sometimes have difficulty in paying dividends if the resources are tied up in other forms of assets. In nutshell, companies with more liquidity pay dividend more frequently than companies having funds tied up in fixed assets or inventories.
Repayment of debt: Dividend payout may be made difficult if the debt is scheduled for repayment. Because paying interest on interest-bearing securities is must in almost all the countries. Shareholders get anything remaining after discharging liabilities of debt-holders.
Stability of profits: Other things remaining constant, a company with stable profits is more likely to pay out a higher percentage of earnings than a company with fluctuating profits.
Control: The use of retained earnings to finance a new project preserves the company’s ownership and control. This can be advantageous in firms where the present disposition of shareholding is of importance.
Legal Considerations: The legal provisions lay down boundaries within which a company can declare dividends.
Likely effect of the declaration and quantum of dividend on market prices.
Tax Considerations, and
Other factors such as dividend policies adopted by unites similarily placed in the industry, management attitude on dilution of existing control over the shares, fear of being branded as incompetent or inefficient, conservative policy vs non-aggressive one.
Inflation: Inflation must be taken into account when a firm establishes it’s dividend policy. This effect has been discussed in models of the dividend.