What is Dividend Policy?
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. This enhances the confidence of the investors in the distribution of the dividend.
The above snapshot is the dividend policy example of Telefonica
Components of Dividend Policy
Any 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 in relation to dividend.
- Discretion of Board, for the declaration of dividend.
- The utilisation of Retained earnings for distribution
- Calculation process to be followed at the time of declaration of dividend.
- Factors to be considered while calculating the profit and earnings available for shareholders
- Revision and Availability of the policy
Ideal Dividend policy should have all the above-mentioned components. Every company, based on their 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 policy based on the intent of the company’s intent to distribute dividends. All the policy will be determined by the payout ratio and intent to progress the dividend payment.
It can be a regular dividend policy, Stable dividend policy, constant dividend per share, constant dividend payout ratio, etc. All the dividend policy has its own facts which will be applicable to suitable market scenarios.
Example of Dividend Policy
“Dividends are only one part of the total return 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 properly disclose dividend policy and capacity of the company. It should also represent any constraint that can be faced by the company while declaring the dividend. Also, strategic intent was needed to be disclosed.
This project assists the investors in the UK to understand the companies in a better manner, about their 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 of the dividend policy:
- Intent of the company becomes visible: In the market, there is the company which is rigorously paying a dividend while there are companies whose main intention is to plough 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 kind of one-stop source of information about the dividends.
Also, the following are the cons, we have to consider while drafting the dividend policy:
- Deviation from the constant dividend pay-out: Any change in the dividend payout, in deviation to the policy or trend, will directly impact the market image of the company. This 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 in the Dividend Policy
Any modification or changes in the dividend policies will require the approval of the shareholders. Also, if any, material changes are undertaken from statutory requirement per se, then there is also a requirement to intimate the concern state department.
Such modification will affect the mindset of the investors, analyst 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 important 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 assess the profit distributable by any companies.
This has been a guide to what is Dividend Policy. Here we discuss the key components of dividend policy and practical examples along with its pros and cons. You can learn more about financing from the following articles –