The Setting of Dividend Policy

Topics: Finance, Dividend, Investment Pages: 2 (509 words) Published: May 28, 2013

Dividend policy is likely to be set in the form of a goal rather than a rigid rule, even though a definite policy has the advantage of providing the investor, or potential investor, a clear basis for choice. Investors knowing the dividend policy of the alternative companies can choose the type of company that best fits their individual investment goals. This is desirable, because stockholders differ in the extent to which they prefer dividends rather than opportunities for capital appreciation. One must remember that, while one group might well prefer capital gains, a second group of zero-tax investors may primarily be interested in dividends. This second group of investors includes universities, foundations, and private pension funds, all of which accrue no special tax advantages from capital gains as distinct from dividends. Sometimes a company will distinguish between a “regular” dividend and an “extra” dividend. Although this distinction does not have any cash flow significance, it is an important means by which the directors can signal their intentions to stockholders. By labeling part of a dividend payment as an “extra”, the directors are indicating that they do not necessarily expect to continue those payments in future years. By declaring the remainder of the dividend payment as a regular payment, the directors indicate an intention to maintain this dividend for the foreseeable future. Extras tend to occur in the fourth quarter of a good earnings year.

When a dividend increase is logical for a company, given its earnings and its traditional payout target, then the mere fact that an increase has not been declared May sometimes be interpreted as evidence that management does not expect the current level of earnings to be maintained. On the other hand, if a dividend increase takes place at a time when it is not expected on the basis of the company’s historical behavior, the financial community may interpret this as...
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