Page 313 - DMGT405_FINANCIAL%20MANAGEMENT

Unit 14: Management of Surplus & Dividend Policy

Self Assessment Notes

Fill in the blanks:
10. A stock split is a change in the number of ……………shares through a proportional reduction
11. The ………..shares allows the firms to declare a dividend without using up cash that may
be needed for operations or expansion.
12. A ………………is the right to purchase a specified number of shares of common shares
during a stated time period and a stipulated price.

14.5 Corporate Dividend Behaviour

A firm’s dividend policies consider division of the firms after tax income into two categories:
1. Funds to finance long-term growth: These are represented in the Balance Sheet as Retained
Earnings, also known as ploughing back of profits in the firm.
2. Funds to be distributed to shareholders: These are cash dividends declared by the Board of
Directors and paid to common shareholders.

Two possible approaches to dividend decisions
1. As a long-term financing decision: In this approach, all the firms after tax profits can be
considered as source of long-term financing. Thus, the payment of cash dividends reduces
the funds available to finance growth and either restricts growth or forces the firm to find
out other financing sources. Thus, the firm might accept a guideline to retain earnings as
long as either of the conditions exists.
(a) Sufficient profitable projects are available: Acceptances of highly profitable projects
represents a growth goal for most of the firms. As long as such projects are available,
the firm can retain earnings to finance them.
(b) Capital structure needs equity funds: Among a variety of sources of long-term funds
and to avoid, the high risk associated with excessive debt, the firm must have a
balance of debt and equity financing. Because of the costs of floating common shares,
retained earnings are profitable as equity financing.
With either of the guidelines, cash dividends are viewed as a remainder.
2. As maximization of wealth: With this approach, the firm recognizes that the payment of
dividends has a strong influence on the market price of the common shares.

14.5.1 Legal and Procedural Aspects in Connection with Payment of
Dividend

Legal Aspects

The amount of dividend that can be legally distributed is governed by the company law, judicial
pronouncements in leading cases and contractual restrictions. The important provisions of
company law pertaining to dividends are given below:
1. Company can pay only cash dividends (with the exception of bonus shares)

2. Dividends can be paid only out of the profits earned during the financial year after providing
for depreciation and after transferring to reserves, such percentage of profits as prescribed
by law.

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