Page 212 - DMGT207_MANAGEMENT_OF_FINANCES

Unit 9: Dividend Decisions

9.3 Types of Dividend Policies Notes

Dividend decision of a firm is taken after taking into consideration, its operating and financial
condition. When there are variations in these conditions the firm may require to adopt the one
that is suitable for the present conditions. What are the different types of dividend policies
available to the financial manager? The different types of dividend policies are as follows:
Stable Dividend Policy: The term "stability" refers to the consistency or lack of variability in the
stream of dividend payments. In more precise terms, stable dividend means payment of a
certain minimum amount of dividend regularly. There are three distinct forms of stability, they
are:
(a) Constant Dividend per Share: A company that follows this policy will pay a fixed amount
per share as dividend. For example 2 as a dividend on the face value of share of 10 each.
The level of earnings would not affect this policy or the dividend payments. This type of
dividend policy is more suitable for the company whose earnings are stable over a number
of years. Stability of dividend does not mean stagnation in dividend payout. In fact, the
prime feature of this policy is to study positive change.
(b) Constant Payout Ratio: The ratio of dividend to earnings is known as payout ratio. In
other words, dividend per share is divided by earnings per share to get dividend payout
ratio. It is also known as constant percentage of net earnings. In this policy a fixed
percentage of earnings are paid as dividends each year. Here the ratio is fixed or constant,
but dividend per share varies according to the fluctuations in the earnings. For example,
it a company follows a 30 per cent payout ratio it means for every one rupee of net
earnings, 0.30, paid as dividends. Assume if a company earned 10 last year and 15 in
the current year. Then the dividend amount for last year is 3 (10 × 30/100) and 4.5
(15 × 30/100) for the current year. The relationship between EPS and DPS is shown in
Figure 9.1.
Figure 9.1: Relationship between EPS and DPS

EPS EPS
and
DPS DPS
( )

This policy is suitable for a company that is not confident getting stable earnings.
(c) Stable Rupee Dividend Plus Extra Dividend: Under this policy the management fixes 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 fluctuate.

9.3.1 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,

LOVELY PROFESSIONAL UNIVERSITY 207