Page 299 - DMGT405_FINANCIAL%20MANAGEMENT

Unit 14: Management of Surplus & Dividend Policy

to investment leads to less cash available for payment of dividends. Thus, there is a relation Notes
between investment decision and financing decision. Distribution of net earnings between
dividends and retention would obviously affect owners’ wealth. Now the company is in dilemma
which alternative is consistent to maximise shareholders wealth. The firm has to pay dividends
to shareholders if dividends lead to the maximisation of wealth for them, otherwise the company
should retain them for financing profitable investment opportunities.

14.2.1 Types of Dividend Policies

The firm’s dividend policy is formulated with two basic objectives in mind – providing for
sufficient financing and maximizing the wealth of the firm’s shareholders. Three of the more
commonly used dividend policies are:
1. Constant Payout Ratio Dividend Policy

2. Regular Dividend Policy
3. Low Regular and Extra-dividend Policy

Constant Payout Ratio Dividend Policy

With constant target payout ratio, a firm pays a constant percentage of net earnings as dividend
to the shareholders. In other words, a stable dividend payout ratio implies that the percentage
of earnings paid out each year is fixed. Accordingly, dividends would fluctuate proportionately
with earnings and are likely to be highly volatile in the wake of wide fluctuations in the
earnings of the company. As a result, when earnings of the firm decline substantially, or there
are a loss in a given period, the dividends according to the target payout ratio, would be low or
nil.

Example: If a firm has a policy of 50% target payout, its dividends will range between
5 and zero per share, if the earnings per share are 10 per share and zero (or less) per share
respectively.

Did u know? What is payout?
The term payout refers to the ratio of dividend to earnings or the percentage of share of
earnings used to pay dividend.

Regular Dividend Policy

The regular dividend policy is based on the concept of a fixed rupee dividend in each period.
This policy provides the owners with positive information thereby minimizing the uncertainty.
Another variant of this policy is to increase the regular dividend once a proven increase in
earnings has occurred.
Often, a regular dividend policy is built around a target dividend payout ratio but without
letting the dividends fluctuate, it pays a stated rupee dividend and adjusts that dividend towards
the target payout as proven earnings happen.

Low Regular and Extra Dividend Policy

Some firms have the policy of low regular and extra dividend, meaning the firms keep the
regular earnings as low as possible which is supplemented by additional dividend when earnings

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