Page 196 - DMGT409Basic Financial Management

Unit 12: Dividend Policy

Notes
Figure 12.1

This policy is suitable for a company that is not confident getting stable earnings.

3. Stable Rupee Dividend Plus Extra Dividend: Under this policy the management fi xes
the minimum dividend per share to reduce the possibility of net paying dividend. An
extra dividend is paid in the years of prosperity. This type of policy is more suitable to the
company having minimum earnings and over the minimum, the earnings may fl uctuate.

Advantages of Stable Dividend Policy

A stable dividend policy is advantageous for both the company and the shareholders because:

1. Building Confidence Among Investors: Payment of stable dividends may help the company

in creating and building confidence among shareholders with regard to regularity.
A company that follows stable dividend policy will not change the amount of dividends,
even though there are any variations in its earnings. Thus, when the earnings of a fi rm go
down, the company does not cut the amount of dividend. But to its presents investors, a
very bright future, and thus, gains confidence of the shareholders.

2. Investors Desire for Current Income: A company may have many investor categories, of
them a few groups of investors depend on dividend income to meet their portion of living
expenses. Investor group may include old and retired persons etc., who require the current
income. Their living expenses are fairly stable from the period to period increase over time.
Therefore, sharp changes in dividend income may create a need to sell shares to get funds
in order to meet current expenses and vice versa. Sale of securities involves inconvenience
and it involves transaction costs. Stable dividend policy avoids sale of securities, which
automatically avoids inconvenience and transaction cost, hence, such investors may prefer
stable dividends.
3. Information about Firms Profi tability: There is another reason for adopting a stable dividend

policy that is, investors are thought to use dividends and the fluctuation in dividends as a
source of information about the company’s profitability. A growth in dividends indicates

improved earnings prospects, a downward trend in dividends implies less earnings and
stable dividends means unchanged prospects. In other words, the dividend decision of a
firm resolves uncertainty in the minds of investors. Variation in dividend policy cannot

resolve uncertainty in the investor minds. Hence, companies may tries to change dividend
policy in response to a certain long-term changes in future prospects.
4. Institutional Investors Requirements: Companies shares are not only purchased by
individuals but also institutional investors like LIC companies, GIC’s, MF’s, educational

LOVELY PROFESSIONAL UNIVERSITY 189