Dividend policy is the decision for the firm to pay out earnings verses retaining and reinvesting them. Dividend decision has remained one of the tough challenges for financial economists. We are yet to understand completely the factors that influence dividend decision and the manner in which these factors interact.
From the practitioner’s viewpoint dividend policy of a firm has an implication for investors, managers, lenders and other stakeholders. For investors, dividends whether declared today or accumulated and provided at a later date are not only a means of regular income, but also an important input in valuation of a firm. Similarly, manager’s flexibility to invest in projects is also dependent on the amount of dividend that they can offer to shareholders as more dividends may mean fewer funds available for investment. Lenders may also have interest in the amount of dividend firm declares, as more the dividend paid less would be the amount available for servicing and redemption of their claims.
At the end of each year, every publicly traded company has to decide whether to return cash to its stockholders, and if yes, and how much in the form of dividends. The owner of a private company has to make a similar decision about how much cash he plans to with draw from the business, and how much he has to reinvest, this we called the dividend decision. Factors That Influence Dividend
Following are the factors involved in formulating dividend policy. 1. Legal Constraints:
Most states prohibits companies from paying out as cash dividends any portion of the firm’s legal capital, which is measured by the par value of common stock. Other states define legal capital to include not only the par value of the common stock, but also any-paid in –capital in excess of par. These capital impairment restrictions are generally established to provide a sufficient equity base to protect creditor’s claims. 2. Contractual...