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DividendPayoutPolicies
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Dividendpoliciesareoneoftheimportantdecisionstakenbythecompany.Severalfactorsaffect Search the site

the payout policy of the company, which includes various types of dividends model as well as
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repurchasingshares.Dividendpoliciescanbeframedaspertherequirementsofthecompanies.
Sharesrepurchasesarebecomingmorerelevantandcommonintherecenttimes. Search

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DefinitionofDividendPolicy:

Dividendpolicyofacompanyisthestrategyfollowedtodecidetheamountofdividendsandthe
timing of the payments. There are various factors that frame a dividend policy of the company.
 Availability of better investment opportunities, estimated volatility of future earnings, tax

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considerations, financial flexibility, flotation costs and various other legal restrictions affect a
companysdividendpolicy.
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Recourse and Non-Recourse

TypesofDividendPolicies: Factoring
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Notes Payable
There are three types of dividend policies depending on the amount and the frequency of the
Traditional Budgeting
dividendpayouts:
FINANCIAL MANAGEMENT SOURCES OF FINANCE WORKING CAPITAL FINANCING Activity Based Budgeting
FINANCIAL ANALYSIS
StableDividendPolicy Zero Based Vs. Activity Based
ConstantDividendPolicy Budgeting
ResidualDividendPolicy
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Stable Dividend Policy: Under the stable dividend policy, the company aims for a steady
dividendpayouteveryyear.Itdoesnotchangeeveniftheearningsarevolatileeveryyear.The
approximatelevelofthedividendpayoutisdeterminedbylookingataforecastofthecompanys
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longtermearnings.Thisapproachalignsthedividendgrowthrateofthecompanywithitslong
runearningsgrowthrate. Sources of Finance
July 21, 2009
Thestabledividendpolicyisthemostpopulardividendpolicy.Underthisapproach,shortterm
earningsvolatilityisnotreflectedinthepayouts.Hence,theshareholderscanbeleastuncertain
aboutthefuturedividendslevel.Thispolicyhasthefollowingveryrealpossibilities:
Advantages and
Disadvantages of Bank
Dividendsmayriseeveninperiodswhenearningsofthecompanydecline.
Overdraft
Dividendsmaynotincreaseatthesamehigherrateofearningsintheboomingyears.
April 21, 2015
Becauseofthese,thestabledividendpolicymaygraduallymovetowardsatargetpayoutratio.
Atargetpayoutratioisdefinedasastrategicgoalwhichrepresentstheshareofearningsthatthe Advantages and
company aims to distribute as dividends to shareholders over a longterm. One such model on Disadvantages of Leasing
theselinesofgradualadjustmentisthetargetpayoutratioadjustmentmodel.Underthismodel,if May 2, 2015
theearningsofthecompanyareexpectedtoriseandthecurrentdividendpayoutratioisbelow
the target dividend payout ratio, the investor can calculate the estimated future dividends as Capital Structure Theory
follows: Modigliani and Miller (MM)
Approach
 ExpectedDividend=(PreviousDividend)+[(ExpectedIncreaseinEPS)*(TargetPayoutRatio)* March 8, 2013

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(AdjustmentFactor)]
Dierence between Lease
Financing Vs. Hire Purchase
June 21, 2011
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Whereadjustmentfactor=1/numberofyearsoverwhichthedividendsadjustmentswillhappen.

Constant Dividend Policy: Under the constant dividend policy, a specific percentage of the
companysearningispaidoutasdividendseveryyear.Theshorttermearningsvolatilityaffects AUTHOR POSTS
thedividendsinthiscaseandhence,theamountofdividendsvariesdirectlywiththecompanys
Protability Index (PI) or
earnings.However,thispolicyisnotusedveryfrequentlyincompanies.
Benet-Cost Ratio
March 6, 2012 1
ResidualDividendPolicy:Undertheresidualdividendpolicy,thecompanypaysthedividends
Comment
from the funds left after the finances for the capital expenditures of the current period are
deducted from the internally generated funds of the company. This policy takes the companys
Dierence between Hire
investmentopportunityschedule,targetcapitalstructureandthecostofcapitalraisedexternally
Purchase vs. Installment
intoconsideration.
Purchase
May 25, 2014 1 Comment
Thefollowingstepsdeterminethepayoutratiotobeimplemented:
Equity Share and its Types
1.Theoptimalcapitalbudgetisidentified.
 2.The equity required to finance the identified capital budget under a given capital structure is November 30, 2011 3

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determined.
3.Retained earnings are used to the maximum extent possible to meet the requirements of
Comments

equity.
4.Dividends are paid from the residual earnings available after the requirements of the optimal
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Residualdividendpolicyhasthefollowingadvantages:

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Thismodelisverysimpletouse.Thecompanyutilizesthefundsforprofitableprojectsand
thendistributestheremainingtotheshareholders.
The management is free to pursue profitable opportunities without worrying about the
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dividendconstraints. DIVIDEND DECISIONS FINANCIAL ACCOUNTING FINANCIAL LEVERAGE

However,therearefewdisadvantagesaswell:

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The dividend payments are highly volatile as they fluctuate with the available investment
opportunities.
Theinvestorsmaydemandahigherrateofreturnontheirequitybecauseoftheambiguity
aboutfuturedividends.Itmayalsoresultinalowervaluation.

ShareRepurchase:

Thepayoutpolicyofacompanymayhaveaprovisionofsharerepurchasesalongwithdividend
payments. Under a share repurchase, the company buys back its own shares from the
shareholders. Since the company pays its own cash to buy back shares, this transaction is
consideredasagoodalternativetocashdividends.

CashDividendsversusRepurchasingShares:

Therationaleforrepurchasingsharesversuscashdividendsisasfollows:

PossibleTaxAdvantages:Whenthetaxratesondividendincomearehigherthanthoseon
capitalgains,peopleprefersharerepurchasestocashdividendsassharerepurchasehasatax
eFinanceManagement

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advantage.
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SupportfortheStockPrice:Whenacompanybuysbackitsownshares,itsendsasignal
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to the market that their stock is a good investment. Such signalling is important when there is
asymmetricinformationpresentinthemarket.Thisisoftenusedbythecompanywhenitsshare
priceisonadecliningspreeanditwantstosignalthepositivefutureoutlooktotheinvestors.
Flexibility:Sharerepurchasesgivealotofflexibilitytothecompanywithrespecttodividend
decisions.Thereisnoneedforthecompanytocommittosharingrepurchasesforthelongterm.
Hence, it can use this as a supplement to regular dividends to implement the residual dividend
policy.Moreover,thesharerepurchasescanbemarkettimedforthebestresults.
Offsetting Dilution: Employee stock options often dilute the EPS of the company when
exercised.Sharerepurchasesreducethisdilution.
Financial Leverage: Share repurchases increase the leverage of the company. The
management of the company can change the capital structure of the company by reducing the
percentageofequity.

Conclusion:Dividendpolicyisanimportantfactorinthevaluationofthecompany.Moreover,
thesignalsinterpretedbytheinvestorsfromthevariouschangesinthedividendpaymentsalso
affectthestockpriceofthecompany.Itisimportantfortheanalysttoknowtheimpactofvarious
dividendpoliciesandthesharerepurchasesonthestockanditsvaluation.

 Forindepthstudy,youcanreferthebookDividendandDividendPolicybyH.KentBaker.This

eFinanceManagement
bookisavailableonAmazon.YoucanpurchasethisbookfromAmazon.

References:

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http://managementation.com/4typesofdividendpolicy/
http://www.dividend.com/dividendeducation/dividendsvsshare
buybacksitsanobrainer/
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 About The Author
eFinanceManagement
Sanjay Bulaki Borad
SanjayBoradisthefounder&CEOofeFinanceManagement.Heis
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