What is Dividend Policy?
Dividend policy is the policy that the company adopts for paying out the dividends to the shareholders of the company which includes the percentage of the amount at which the dividend is to be paid out to the stockholders and how frequent the dividend amount is to be paid by the company.
In simple words, Dividend Policy is the set of guidelines or rules that the company frames for distributing dividends in years of profitability. Generally, listed companies draft their dividend policies and keep it on the website for the investors. It enhances the confidence of the investors in the distribution of the dividend.
The above snapshot is an example of Telefonica.
Components of Dividend Policy
An ideal policy will give the following answers:
- Why this policy?
- What will the policy mean in practice?
- What are the risks and constraints associated with this policy?
- What was done in practice to deliver under the policy?
Under any law, there is no specified format provided which all the company has to follow.
However, This is having the following components:
- Objective, intention, and strategic vision – while declaring the dividend.
- Laws applicable to companies concerning dividend;
- Discretion of Board, for the declaration of dividend.
- The utilization of Retained earningsRetained EarningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company. for distribution
- The calculation process followed at the time of declaration of dividend.
- Factors to be considered while calculating the profit and earnings available for shareholdersEarnings Available For ShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company's total shares.
- Revision and Availability of the policy
The ideal policy should have all the components mentioned above. Every company, based on its plans and policies, will formulate the dividend policy, get it approved with investors, and will be kept publicly on the website.
There are various types of dividend policyTypes Of Dividend PolicyA Dividend Policy is a business strategy that deals with the amount of dividend to be paid & the frequency of payment. It has 4 major types, i.e., Regular Dividend, Stable Dividend, Irregular Dividend, & No Dividend Policy. based on the company’s intent to distribute dividends. The payout ratio and intent to progress the dividend payment determine all the policies.
It can be a regular policy, Stable policy, constant dividend per shareDividend Per ShareDividends per share are calculated by dividing the total amount of dividends paid out by the company over a year by the total number of average shares held., constant dividend payout ratio, etc. All the policies have their facts, which will apply to suitable market scenarios.
Example of Dividend Policy
“Dividends are only one part of the total returnTotal ReturnThe term “Total Return” refers to the sum of the difference between the opening and closing value of all the assets over a particular period of time and the returns thereon. To put it simply, the changes in opening and closing values of assets plus the number of returns earned thereof is the Total Return of the entity over a period of time. that investors receive, but for many, it is the most important part, and therefore good disclosure is fundamental.”
In the UK, in 2014, the Financial Reporting Council’s Financial Reporting Lab initiated Project Lab for the listed companies under UK stock exchanges. Under the same, they urge all the listed companies to disclose dividend policy and capacity of the company adequately. It should also represent any constraint that can be faced by the company while declaring the dividend. Furthermore, they need to disclose strategic intent.
This project assists the investors in the UK to understand the companies in a better manner. Company’s current practices and their future strategic aspects about the payout through the dividend. As per the project, about 40% of the companies covered gave information about distributable profits.
Pros and Cons
It reflects management thinking. Hence investors, based on their perception, can take the details given policy either as beneficial or in detriment.
However, the following are the advantages –
- The intent of the company becomes visible: In the market, there is a company that is rigorously paying a dividend. At the same time, there are companies whose primary intention is to plow back the funds and reinvest the same in the business. Investors based on their fund requirements and earning strategy will invest by checking dividend policy.
- Trends of the dividend payout will be readily available: Investors will need to verify the past trend of the company to declare the dividend. In this policy, it will be readily available. Hence it will be a kind of one-stop source of information about the dividends.
Also, the following are the cons –
- Deviation from the constant dividend payout: Any change in the dividend payout, in variation to the policy or trend, will directly impact the market image of the company. It will give guidance to the analyst, and if anything goes in deviation to the same, it may crash the prices of the shares.
- Future borrowing of funds: As discussed above, This will give guidance to the market and fund providers. Fund providers will always make sure that their funds should be used for the business purpose and, not as a dividend, get distributed to promoters.
Modification and Changes
Any modification or changes in the dividend policies will require the approval of the shareholders. Also, if any material changes are undertaken from statutory requirements, then there is also a requirement to intimate the concerned state department.
Such modification will affect the mindset of the investors, analysts, and credit rating agencies. Hence, it is of utmost importance to remain alert and cautious while making changes in the policy. Such policy changes require strategic thinking duly supported with future business aspects.
In the actual market scenario, corporates will always try to provide guidelines in the policy in a highly generalized manner, which will give insight to the investor. No specific transaction-related data will be disclosed. Hence no additional disclosure will be needed to be added or modified in the future.
As per the Financial Reporting Council, UK, Dividend disclosures are fundamental to companies and investors as they are essential in demonstrating and assessing board stewardship and the investment case. Such disclosures will help in knowing the strategic thinking and liquidity risks that companies can face in the future. Also, investors will be able to assess the fairness of the fair value of the shares of the company with respect to the market price of the company. It is highly complex to determine the profit distributable by any company.
This article has been a guide to what is Dividend Policy. Here we discuss the critical components of dividend policy and practical examples along with its pros and cons. You can learn more about financing from the following articles –