Page 215 - DMGT207_MANAGEMENT_OF_FINANCES

Management of Finances

Notes

Notes The dividend payout ratio of a firm should be determined with reference to two
objectives - first maximization of shareholders' wealth and second providing sufficient
funds to finance growth. The determinants of dividend policy will vary from firm to firm.

The following are the various factors that have a bearing on the dividend policy:

1. Nature of Business: The nature of business has an important bearing on the dividend
policy. The industrial units that are having stability of earnings may formulate (adopt)
stable or a more consistent dividend policy than other, that are having unstable earnings,
because they can predict easily their earnings. Firms that are involved in necessities suffer
less from stable incomes than the firms that are involved in luxury goods. The industries/
firms that are having stable earnings can adopt stable or high dividend policy, while the
other firms that are having instable earnings should follow a variable or low dividend
policy.

2. Age of Company: The age of company has more impact on distribution of profits as
dividends. A newly started and growing company may require much of its earnings for
financing expansion programs or growth requirements and it may follow rigid dividend
policy, where in, most of the earnings are retained while an old company with good track
record and good name in the public can formulate a clear cut and more consistent dividend
policy. This type of companies may even pay 100 per cent dividend payout ratio and the
required amount for growth can be raised from the public.
3. Liquidity Position of Company: Generally dividends are paid in the form of cash, hence,
it entails, cash. Although, a firm may have sufficient profits to declare dividends, but it
may not have sufficient cash to pay dividends. Thus, availability of cash and sound financial
position of the firm is an important factor in taking dividend decision. The liquidity of a
company depends very much on the investment and financial decisions of a firm, while in
turn determining the rate of expansion and the manner of financing. If cash position of a
firm is weak, stock dividend will be better and if cash position is good it can go for
payment of dividend by cash.
4. Equity Shareholders Preference for Current Income: Legally, the Board of Directors has
discretion to decide the distribution of the earnings of a firm. The shareholders who are
legal owners of the firm appoint the (BODs). Hence, directors have to take into consideration
owners' preferences, while deciding dividend payment. Shareholders' preference for current
dividends or capital gains, that is, depend on their economic status and the effect of tax
differential on dividends and capital gains. When shareholders' have more preference in
current dividend than capital gains, the firm may be required to follow liberal dividend
policy, on the other hand if shareholders have preferred capital gains (it may be due to tax
or economically sound) than the current dividend, then the firm may be required to retain
more earnings.

5. Requirements of Institutional Investors: Institutional investors like LICs, GICs and Mutual
Funds (UTI), have investment policy, which says that these type of institutes have to invest
only in companies that have a continuous dividend payment record with stability. These
purchase large blocks of shares for relatively, to hold a long period of time. Hence, they
represent a significant force in the financial markets, and their demand for company's
securities may increase the share price and there by owners' wealth. To attract institutional
investors firms may require to follow stable dividend policy. Apart from theoretical
postulates for the desirability of stable dividends, there are also many empirical studies,

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