Dividend Policy, Business Economics & Finance | Business Economics & Finance - B Com PDF Download

DEFINITION: DIVIDEND According to the Institute of Chartered Accountants of India, dividend is "a distribution to shareholders out of profits or reserves available for this purpose."7 

"The term dividend refers to that portion of profit (after tax) which is distributed among the owners / shareholders of the firm."8 "Dividend may be defined as the return that a shareholder gets from the company, out of its profits, on his shareholdings."9 

In other words, dividend is that part of the net earnings of a corporation that is distributed to its stockholders. It is a payment made to the equity shareholders for their investment in the company. 

As per the section 2(22) of the Income Tax Act, 1961, dividend defined as:- 

"Any distribution of accumulated profits whether capitalized or not, if such distribution entails a release of assets or part thereof".

Dividend is a reward to equity shareholders for their investment in the company. It is a basic right of equity shareholders to get dividend from the earnings of a company. Their share should be distributed among the members within the limit of an act and with rational behavior of directors.

The word dividend has not been defined in The Indian Companies Act, 1956. It may be described as a periodical cannot be declared from capital gains under following conditions: i) Provision in Articles of Association. 

ii) Capital gain must be realized. 

All assets & liabilities must be revalued before distributing this capital gain.

DEFINITION: DIVIDEND POLICY "Dividend policy determines the ultimate distribution of the firm's earnings between retention (that is reinvestment) and cash dividend payments of shareholders."10

"Dividend policy means the practice that management follows in making dividend payout decisions, or in other words, the size and pattern of cash distributions over the time to shareholders."11

In other words, dividend policy is the firm's plan of action to be followed when dividend decisions are made. It is the decision about how much of earnings to pay out as dividends versus retaining and reinvesting earnings in the firm.

Dividend policy means policy or guideline followed by the management in declaring of dividend. A dividend policy decides proportion of dividend and retains earnings. Retained earnings are an important source of internal finance for long term growth of the company while dividend reduces the available cash funds of company.

"As long as the firm has investment project whose returns exceed its cost of capital, it will use retained earnings to finance these projects".12

There is a reciprocal relationship between retained earnings and dividend i.e. larger the retained earnings, lesser the dividend and smaller the retained earnings, larger the dividend.

James E. Walter (1963) says "Choice of dividend policy almost effects the value of the enterprise”13

"Dividend policy must be evaluated in light of the objective of the firm namely, to choose a policy that will maximize the value of the firm to its shareholders" Financial Management and Policy.14 

As we know in corporation, owners are shareholders but management is done through Board of directors. It is the Board of Directors to decide whether to pay dividend or retain earnings for future projects. It is a matter of conflict between shareholders and directors. Shareholders expect a quick return on their capital. On the other hand, directors have to consider a number of factors in determining divided policy. 

Investors must keep an eye on the company's dividend policy for most companies regular boosts in the face of irregular earnings can be a warning signal. So can the refusal of Management to lower dividends when earning fall or capital requirement rise. Companies with high dividend and rising debt may be borrowing money to pay shareholders. For investors who are seeking stock that will advance on their performance and earning and earning per share, lower dividend may mean high returns. (Adopted from the Quality of earnings - Thornton O. Glove 1987)

The dividend policy of a company reflects how prudent its financial management is. The future prospects, expansion, diversification mergers are effected by dividing policies and for a healthy and buoyant capital market, both dividends and retained earnings are important factors. 

Most of the company follows some kind of dividend policy. The usual policy of a company is to retain a position of net earnings and distribute the remaining amount to the shareholders. Many factors have to be evaluated before forming a long term dividend policy.