The term dividend refers to that part of profits of a company which is distributed by the company among its shareholders. It is the reward of the shareholders for investments made by them in the shares of the company. The investors are interested in earning maximum return to maximize their wealth.
A firm needs funds to meet its long-term growth. If a company pays most of the profit as dividend, then for business requirement or further expansion then it will have to depend on outsiders for funds. Such as issue of debt or new shares.
Firms decision to pay dividend in equitable proportion of dividend and retained earnings.
Determinants Of Dividend Policy
1. Legal restrictions
Legal provision related to dividends are laid down in sec 93,205,205A, 206 and 207 of companies act.Dividend can be paid only out of current profit or past profit after providing depreciation Company providing more than 10% dividend to transfer certain percentage of current year profit to reserves.
2. Magnitude and trend of earnings
The amount and trend of earnings is an important in dividend policy. Dividend can be paid only out of present or past year‘s profit; earnings of a company fix the upper limit on dividends. Past trend is kept in mind while decision dividend decision .
3. Desire and type of shareholders
Discretion to declare dividend or not is decided by the board of directors. Directors give importance to the desire of the shareholder in declaration of dividends. Desire for dividend depends on their economic status. Investor such as retired person, widows and other economically weaker person view dividend as a source of funds to meet their day-to-day living expenses – the company will pay regular dividend. Investor with high income tax bracket will not prefer current dividend they will expect only capital gains.
4. Nature of industry
Nature of industry to which the company is engaged also affects dividend policy. Certain industry has steady and stable demand irrespective of prevailing economic condition. Eg : people used to drink liquor both in boom and in recession. Such firm gets regular earning and hence follows consistent dividend policy. Earning are uncertain in such case conservative dividend policy is used. Such firms should retain substantial part of their current earnings during boom period in order to provide funds to pay dividends in recession period
5. Age of the company
Age also influence the dividend decision of the company. Newly established concern has limit in payment of dividend and retain substantial part for financing future growth and development Older company has sufficient reserves can pay liberal dividends.
6. Future financial requirement
Future financial requirement is to be considered while deciding dividend. Company has profitable investment opportunities then the firm will pay limited amount as dividend and invest the remaining amount. If there is no investment opportunities then the company will pay more dividend
7. Government economic policy
The dividend policy of a firm has also to be adjusted to the economic policy of the government
In 1974 and 1975 companies were allowed to pay dividends not more than 33 % of their profits or 12% on paid-up value of the shares, whichever was lower
8. Taxation policy
A high or low rate of business taxation affect the net earnings of company and thereby its dividend policy. A firm‘s dividend policy may be dictated by the income-tax status of its shareholders. If the dividend income of shareholders is heavily taxed being in high income bracket, then the shareholder will prefer capital gains and bonus shares.