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What are the Main Factors that Influence the Dividend Decisions?
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Main factors that influence the dividend decisions are as follows:

The corporate, institutional and legal factors that influence the dividend decision of a firm include the growth and profitability of
the firm its liquidity position, the cost and availability of alternative forms of financing concerns about the managerial control of
the firm, the existence of external (largely legal) restriction and the impact of inflation of cash flow.

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Growth and Profitability:

The amount of growth a firm can sustain and its profitability is related to its dividend decisions, so long as the firm (because of
managerially imposed to external market constraints) cannot issue additional equity.

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Firms with strong growth prospects maintain low target payout ratios. In fact all the firms that experience above-average
growth rates are expected to have low dividend payout ratios since, in line with the residual theory of dividends, a greater
number of profitable investment opportunities should result (other things being equal in a greater need for earnings retention.

This interrelationship among the firms growth, its profitability, and its investment, financing, and dividend decisions cannot be
overemphasized.

Liquidity:

The liquidity position of a firm is often an important consideration in dividend decisions. Since dividends represent a cash
outflow, it follows that the better the cash position and overall liquidity of the firm, the greater is the firms ability to pay (and
maintain) a cash dividend.

A growing, profitable firm may not be liquid, since it needs funds for new capital expenditures and to build up its permanent
working capital position.

Likewise, firms in cyclical industries may experience times when they lack liquidity due to general economic conditions. Hence,
the degree of liquidity is a variable of concern when a firms dividend policy is being assessed.

Cost and Availability of Alternative Forms of financing:

The ability of a firm to raise money externally will have a direct bearing on the level of dividends paid to shareholders. Clearly,
a company that has easy access to the capital markets, and that can conveniently and economically raise funds in a number of
alternative ways, will have greater latitude in setting dividend policy than a firm that has to rely heavily on earnings retention
as a source of financing.

In essence, the key question is whether or not a firm can (if the need arises) finance its dividend payments externally. Those
that can are likely to set higher dividend levels than those that cannot.

Two aspects that tend to work against this approach to dividend payments are the cost of financing and issue expenses.
Financing dividends externally may have merit so long as the cost of financing is relatively low.

However, when interest rates rise, the idea of financing dividends begins to lose its appeal. Moreover, issue expenses and other
flotation costs will lower desired payout ratios, since they raise the cost of financing.

This is particularly true when the amount of external financing involved is fairly small, for flotation costs are inversely related
to the size of the issue and tend to rise rapidly as the size of an issue declines.

Managerial Control:

In some cases, control of the firm may be a factor to consider when establishing dividend policy. Suppose a fairly substantial
proportion of the firm is owned by a controlling group, and the remainder of the stock is publicly held. Under these
circumstances, the higher the payout ratio, the more likely that a subsequent issue of equity may be needed to finance capital
expenditures.

Those in control might prefer to minimise the likelihood of an offering of equity to avoid any dilution in their ownership position.

Hence, they would prefer a low payout policy. On the other hand, a firm may establish a relatively high dividend payout ratio (if
it believes that is what shareholders desire) as a way to keep the firm from being acquired in a merger or acquisition.

Legal constraints:

The legal rules act as boundaries within which a company can declare dividends. In general, cash dividends must be paid from
current earnings or from previous earnings that have been retained by the corporations after providing for depreciation.
However, a company may be permitted to pay dividend in any financial year out of the profits of the company without
providing for depreciation.

Though the dividends should be paid in cash, but it doesnt prohibit a company from capitalising its profits or reserves (retained

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earnings) for the purpose of issuing fully paid bonus shares (stock dividend).

Access to the Capital Market:

Another matter for consideration by management in setting an appropriate dividend policy is the companys ability to obtain
cash on relatively short notice. This may be achieved by the company negotiating for a bank overdraft limit or having access to
other short-term sources of funds.

However, if a companys ability to make a new issue of shares or to issue debt is restricted, it is likely that it will retain a higher
proportion of its profits than a company which has ready access to funds from the capital market.

Companies which are likely to have difficulties raising funds on the capital market include small companies, new companies, and
companies in what may be termed venture capital fields.

Inflation:

Inflation must be taken into account when a firm establishes its dividend policy. On the one hand, investors would like to
receive larger cash dividends because of inflation.

But from the firms viewpoint, inflation causes it to have to invest substantially more to replace existing equipment, finance
new capital expenditures, and meet permanent working capital needs. Thus, in inflationary times, there may be a tendency to
hold down cash dividends.

External Restrictions:

The protective covenants in a bond indenture or loan agreement often include a restriction on the payment of cash dividends.
This restriction is imposed to preserve the firms ability to service its debt.

These restrictions may be in the form of coverage ratio, sinking fund etc. Presence of these restrictions forces a company to
retain earnings and follow a low payout.

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