Page 198 - DMGT409Basic Financial Management

Unit 12: Dividend Policy

12.3 Determinants of Dividend Policy Notes

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.

Example: 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.
2. Age of Company: The age of company has more impact on distribution of profi ts 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.
3. Liquidity Position of Company: Generally dividends are paid in the form of cash, hence, it

entails, cash. Although, a firm may have suffi cient profits to declare dividends, but it may

not have sufficient cash to pay dividends. Thus, availability of cash and sound fi nancial
position of the firm is an important factor in taking dividend decision.

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 (BOD’s). Hence, directors have to take into consideration
owners’ preferences, while deciding dividend payment.
5. Legal Rules: Legal rules restrictions are significant as they provide framework within

which dividend policy is formulated. In other words, dividend policy of a fi rm has to be
evolved within the legal framework and rules and regulations. The legal rules have to do

with capital impairment rule, net profits and insolvency rule.
Example: The dividend can be paid from earnings either from current years earnings or

from past years earnings and be reflected in the earned surplus.
6. Financial Needs of the Company: This is one of the key factors, which influence the dividend

policy of a firm. Financial needs means funds required for foreseeable future investment.

7. Access to the Capital Market (External Sources): Access to the capital market means the
firms ability to raise funds from the capital market. A company, which has easy access

to the capital market provides that flexibility in deciding dividend policy. Easy access

is possible only to the companies that are well established and hence here a profi t track
record.
8. Control Objective: Control over the company is also an important factor, which infl uences

dividend policy. When a firm distributes more earning as dividends in the form of cash it
reduces its cash position. As a result, the firm will have to issue shares to the public to raise

funds required to finance investment opportunities that leads to loss of control, since, the
existing shareholders will have to share control with new owners. Financing investment
projects by way of internal source avoids, loss of control.
9. Inflation: Inflation is the state of economy in which the prices of products or goods have

been increasing. Inflation is a factor that influences dividend policy indirectly. Indian

accounting system is based on historical costs. The funds accumulated from depreciation

may not be sufficient to replace the absolute asset or equipment, since depreciation is
provided based on historical costs. Consequently, to replace assets and equipment, fi rm
has to depend upon retained earnings, this leads to the payment of low dividend, during
infl ation period.

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