Introduction

One of the basic functions of a public business organization is that it has to pay dividend to its shareholders. Many times an organization is not sure of the amount of the dividend to be given to the shareholders and what dividend policy should the company adopt. Following are the factors that an organization can keep in mind before adopting a particular dividend policy.

Classification of Dividend Policy:

• An oscillating dividend policy is when dividend per share (DPS) is constantly fluctuating.
• A stagnant dividend policy is when DPS is stagnant or constant throughout the years.
• A stable dividend policy is one when DPS is having constant increase throughout successive years.

Important considerations while structuring dividend policy

Dividend decision of a company is a financial decision and aim of any financial decision of the company is achievement of growth for the organization i.e.; maximizing the growth rate of the organization or at least maintaining the existing growth rate.

Now here comes the role of dividend, it has to be understood that G = BR where G signifies growth, B signifies retained earnings and R signifies the Return on Investment (ROI) which the company is providing to a shareholder. Now, B (i.e.; retained earnings) = 1 – Payout and here payout is nothing but dividend since dividend decision is nothing but deciding about the payout ratio which the corporation has to provide for.

The earnings of an organization can be divided into dividend and retained earnings. These retained earnings are also signified, as stated above, as B or 1-PO (payout which is same as dividend).So, if dividend rises, B or retained earnings would fall and since B is one of the parameters of growth of the company (g = br), there would be decline in the growth rate of the company. Hence, a general proposition that can be formulated here is that increase in Payout would lead to decrease in growth rate and vice versa.

Also, here one more factor is to be taken into account, a company is justified in retaining earnings if it is sure that it can earn return from that earnings higher than what market can give to the particular shareholder i.e.; a shareholder could be compelled to sacrifice his dividend only when company is able to earn more or at least equal to the market rate of return.   

Therefore, a general proposition which comes out from above observation is that PO (payout) can be kept low when r (i.e..; Company’s rate of Return) > k (i.e.; Market rate of return).

Now, dividend policy, which can be adopted by a company, may be Liberal, Conservative or Realistic. Liberal means when PO ratio is high and the company is distributing major portions of its earnings to its shareholders, Conservative is when PO ratio is very low and Realistic is when PO ratio is moderate.

It is advised here that if a company has its R > K, then it should go for conservative policy since low PO ratio means high Retention, which means high r and which in turn means high growth (g = br). Now, if a company has its R < K, then it should go for liberal policy since it do not has the right to retain earnings of the shareholders, without any justification, if it cannot provide them higher return than the market rate. Also, here since r is low, it is fault of management and hence corrective actions should be taken so that this is not repeated in future. Moderate payment signifies moderate growth and r & k do not substantially differ.

Non-financial consideration in dividend policy:

Peer group:

Company cannot exist in isolation and it cannot give dividend without considering the dividend given by it’s per group. Its PO has to be similar with that of the peer group.

Liquidity position of company:

According to Section 207 of the Companies Act in India dividend has to be paid within 42 days of the AGM. For that the company has to have adequate cash in its hand.

Future plans:

To justify retained earnings before the shareholders, the company has to show plans for the future that would explain why it requires so many funds. Future plans might include expansion, diversification, redemption of debt, etc.

Tax considerations:

Dividend can be taxed two ways:

• Taxing the dividend the shareholders receive, or
• Taxing the company-Dividend distribution tax- Here, a percentage of the total dividend is taken by the government as tax. 

Here, for instance, if bonus share is not taxed but dividend is taxed then, it is much better to go for bonus shares issue as tax liability either on the company or on the shareholder or both will be less then.

It has to be noted that taxing policy of the government with regard to dividend is not permanent in nature and varies year to year. If pre-budget estimate shows that capital market is sluggish (which indicate that investment, which is a function of growth is sluggish), then the targeted growth rate of the year may not be achieved. So the government may remove the dividend taxes as it gives boost to the market and it may lead to greater investment and growth. In India, The UPA government removed dividend distribution tax when it first came to power to restore market confidence. Again if the tax burden on dividend is placed on the company, the individual feels the effect less. If the individual is taxed the impact and incidence is high.

Again, in case of euphoria in the market, if the government thinks there is too much investment, it may have high dividend taxation.

Dividend tax represents less than 2% of the total tax collected. But it is important tool for the government to give direction to the capital market. So it changes the dividend taxation policy as per the dictates of the circumstances prevailing in the stock market.

Future plans of the company to raise resources:

If company wants to approach the capital market for resources then it needs to impress the investors specially the short-terms ones i.e. the operators. So it will go for high dividend and a liberal distribution policy. If it has no such plans, it does not need to impress the investors and can go for conservative dividend policy.