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Unit 9: Financial Management Decisions

Internal constraints are unique to a firm and include liquid assets, growth prospects, and Notes

financial requirements, availability of funds, earnings stability and control.
4. Owner’s considerations: The dividend policy is also likely to be affected by the owner’s
considerations of the tax status of the shareholders, their opportunities of investment and
the dilution of ownership.
5. Capital market considerations: The extent to which the firm has access to the capital

markets, also affects the dividend policy. In case the firm has easy access to the capital
market, it can follow a liberal dividend policy. If the firm has only limited access to capital

markets, it is likely to adopt a low dividend payout ratio. Such companies rely on retained
earnings as a major source of financing for future growth.

6. Infl ation: With due to inflation, the funds generated from depreciation may not be suffi cient
to replace obsolete equipments and machinery. So, they may have to rely upon retained
earnings as a source of fund to replace those assets. Thus, inflation affects dividend payout

ratio in the negative side.
7. Company’s reinvestment rate lower than that of shareholders: Sometimes, there are
companies that do not have significant reinvestment opportunities. More precisely, we say

the reinvestment rate of the company is lesser than the reinvestment rate of shareholders.
In such cases, obviously, it is better to pay earnings out than to retain them. As the classic
theories of impact of dividends on market value of a share suggest, or what is anyway
intuitively understandable, retention of earnings makes sense only where the reinvestment
rate of the company is higher than that of shareholders.

8. Tax disparities between current dividends and growth: In case of indifference between
current dividends and share price appreciation, taxes do play a spoilsport.

Example: If a company distributes dividends, the same may be taxed (either as income
in the hands of shareholders, or by way of tax on distribution – like dividend distribution tax
in India). Alternatively, if the shareholders have a capital appreciation, which they encash by
partial liquidation of holdings, shareholders have a capital gain. Taxability of a capital gain may
not be the same as that of dividends. Hence, taxes may differentiate between current dividends
and share price appreciation.
9. Shares with fi xed returns: Needless to say, there is no relevance of dividend policy where
dividends are payable as per terms of issue – for example, in case of preference shares.
10. Entities requiring minimum distribution: There might also be situations where entities are
required to do a minimum distribution under regulations.

Example: In case of real estate investment trusts, a certain minimum distribution is
required to attain tax transparent status.
There might be other regulations or regulatory motivations for companies to distribute

their profits. These regulations may impact our discussion on relevance of dividend policy
on price of equity shares.
11. Unlisted companies: Technically speaking, in case of unlisted firms too, retained earnings

belong to the shareholders, as shareholders after all are the owners of the residual wealth
of the company. However, that residual ownership may be a myth as companies do not
distribute assets except in event of winding, and winding up is a rarity.

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