Page 197 - DMGT409Basic Financial Management

Basic Financial Management

Notes institutes and social institutes. Normally, companies are very much interested to have
these institutional investors in the list of their investors. Generally, this type of institutional
investors have large size of their ingestible funds, these funds will be invested in the
shares of those companies that have the record of paying stable dividends. So, to attract
institutional investors a firm may prefer to adopt a regular or stable dividend policy.

5. Raising Additional Finances: This is another advantage to the company that is following

a stable dividend policy, in raising external finance. Shares of this type of company appear
as investment rather than a speculation. Investors, who invest in this type of company’s
shares hold them for a long period of time and their loyalty and goodwill towards the fi rm
increase by adoption of stable dividend policy. If the company wants to raise additional
funds by issuing shares to the public, they would be more receptive to that offer. For
example recently in beginning of the year 2004, the public issue of ONGC, ICICI, IPTCL,
GAIL are over subscribed. Thus, rising of additional funds required by the fi rm becomes
very easy, even with high premium.

Limitations of Stable Dividend Policy

In spite of the above discussed advantages the stable dividend policy suffers from certain
limitations. They are:

1. Difficult to Change: Once a stable dividend policy is established, it cannot be changed

without affecting investors’ attitude and financial position of the company, in the minds of
investor.
2. Adverse Effect on Market Price of Share: As we have discussed in the advantages, about the
investors desire for current income to meet their living expenses, the investors who prefer
or depend on stable dividends, may feel bad, when the fi rm cuts dividend, consequently

they may sell some of their shares to fulfill the gap between expected dividend and the
actual dividend received (negative dividend. This leads to the reduction in the share price.
Hence, directors have to maintain stability in dividends, in lean years.

3. Long-Run Effect on Company: When a firm maintains stable dividend policy in lean years
over a period of time with borrowed funds it may lead to death in the long-run.

12.2.2 Irregular Dividend Policy

Some companies follow irregular dividend payments on account of the following:
1. Uncertainty of earnings.
2. Unsuccessful business operations.
3. Lack of liquid resources.
4. Fear of adverse effects of regular dividends on the financial standing of the company.

12.2.3 No Dividend Policy

A company may follow a policy of paying no dividends presently because of its unfavourable
working capital position or on account of requirements of funds for future expansion and
growth.
12.2.4 Residual Dividend Policy

When new equity is raised floatation costs are involved. This makes new equity costlier than

retained earnings. Under the Residual approach, dividends are paid out of profits after making
provision for money required to meet upcoming capital expenditure commitments.

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