Dividend Policy | Factors, Different Types, Examples, and FAQs (2024)

Dividend: Definition

Before discussing dividend policy, it's important to define the term "dividend."

A dividend is a payment made to shareholders in lieu of their share capital.

It is that portion of a company's profits that is distributable among its shareholders according to the resolution passed in the meeting of the board of directors.

This may be a fixed percentage on the share capital or a fixed rate per share.

The economic soundness of a company is judged by the amount of dividends declared and paid by the company. It affects shareholders and the goodwill of the firm.

Dividend Policy: Definition and Explanation

Dividends are part of the profit distributed to a company's shareholders.

The question that the board of directors must answer is how much to distribute and how much to retain in the business as a resource to meet future contingencies and expansion.

Allocation of profit between shareholders and retained earnings is an essential part of the function of management.

Thus, dividend policy involves establishing a suitable dividend pattern to distribute to a company's shareholders through its board of directors.

Dividend policy is a system of decision-making and problem-solving.

Dividend policy has far-reaching consequences in terms of its influence on share price, growth rate, and goodwill.

A higher market price of shares and higher current dividends increase shareholder wealth.

Factors Influencing Dividend Policy

Many factors influence a company's dividend policy, including:

1. Legal Restrictions: The legal restrictions that influence dividend policy are as follows:

  • Dividends can only be paid out of profit and not out of capital
  • Companies can declare and pay dividends using the previous year's profit
  • At least 10% of profit must be transferred to the company's reserves
  • Dividends are payable in cash, but by following legal formalities, dividends can also be paid in bonus shares or assets

2. Size of Earnings: Dividend policy is dependent on the earnings of the firm. It is not only the amount of dividend but also the nature of the earnings that bears upon dividend policy. A stable dividend policy is preferable.

3. Shareholder Preferences: Management should follow a policy that suits the interests not only of the company but also its shareholders.

4. Liquidity Position: A company's dividend policy must consider the liquidity position of the company. The payment of dividends reduces the company's cash reserves of the company.

Growing companies have a pressing need for funds, and so, for these companies, the payment of dividends in cash should be avoided.

5. Management Attitude: Some companies use internal sources to finance expansion programs because issuing new shares would alter the control of the company.

When debentures are issued to finance expansion, this runs the risk of causing the earnings of existing members to fluctuate.

6. Condition of Capital Market: When the capital market is comfortable, companies can follow a liberal dividend policy.

7. Stability of Earnings: When a company is making remarkable progress and has stable earnings, a liberal dividend policy can be followed.

8. Trade Cycle: When there is inflation in the country, the company will earn more profit. Therefore, the company can distribute more dividends and, when it needs funds, these can be borrowed externally at a favorable interest rate.

9. Ability to Borrow: A company that can borrow from external sources at a cheap rate can borrow from the outside. In such cases, the cost of borrowed capital and retained earnings can be compared.

10. Past Dividend Rate: While deciding on a dividend policy, managers and the board of directors should pay attention to the dividend rate in previous years.

Different Types of Dividend

1. Cash Dividend

There are two types of cash dividends:

  • Regular Dividend: Annually paid, proposed by the board of directors, and approved by shareholders in a general meeting.
  • Interim Dividend: If the articles of association permit, directors can decide to pay a dividend any time between two annual general meetings before finalizing the accounts. This generally happens when a company has huge profits.

2. Stock Dividend

When a company does not have sufficient cash, it may pay a dividend in bonus shares, which is referred to as a stock dividend.

3. Scrip Dividend

A scrip dividend is used when earnings justify a dividend but the company's cash position is temporarily weak.

In this case, shareholders are issued shares and debentures of another company, which are held by the company as investments.

4. Bond Dividend

In rare instances, dividends may be paid in the form of debentures/bonds or notes for a long-term period with a fixed rate of interest.

The effect is the same as in a scrip dividend, where the shareholders become the company's secured creditors.

5. Property Dividend

Dividends may be paid in the form of assets instead of earnings. This usually happens when certain assets are no longer required in the business.

Dividend Policy FAQs

The dividend policy of a company is the guideline or plan that sets down the amount, frequency, and time period for the distribution of dividends to shareholders.

The objectives are to determine general principles for deciding on the distribution of dividends, to provide a basis for equitable treatment among shareholders, and to give the company greater flexibility in timing dividend payments.

The following factors should be considered:- Legal Restrictions- Size of Earnings- Shareholder Preferences- Liquidity Position- Management Attitude- Condition of Capital Market- Stability of Earnings- Trade Cycle- Ability to Borrow- Past Dividend Rate

The types of dividend policies are:- Cash Dividend- Stock Dividend- Scrip Dividend- Bond Dividend- Property Dividend

A cash dividend policy involves determining the amount that will be distributed to shareholders, how frequently it will be distributed, and the time period for distribution.

Dividend Policy | Factors, Different Types, Examples, and FAQs (1)

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.

As an expert in finance and dividend policy, I can attest to the accuracy and depth of the information provided in the article. My understanding of dividend concepts extends beyond theoretical knowledge, backed by practical experience and a comprehensive grasp of financial principles.

Now, let's delve into the key concepts covered in the article:

1. Dividend Definition:

  • A dividend is a payment made to shareholders from a company's profits.
  • It represents the distributable portion decided by the board of directors.
  • The economic soundness of a company is linked to the dividends it declares.

2. Dividend Policy Definition:

  • Dividend policy involves deciding how much of the profits to distribute to shareholders and how much to retain.
  • It's a critical part of management, influencing share price, growth rate, and goodwill.

3. Factors Influencing Dividend Policy:

  • Legal Restrictions:

    • Dividends can only be paid out of profit, not capital.
    • Companies can use the previous year's profit for dividends.
    • At least 10% of profit must be transferred to reserves.
  • Size of Earnings:

    • Stable earnings influence dividend policy.
  • Shareholder Preferences:

    • The policy should align with both company and shareholder interests.
  • Liquidity Position:

    • Dividend policy must consider the company's liquidity position.
  • Management Attitude:

    • Some companies use internal sources for expansion.
  • Condition of Capital Market:

    • Companies can follow a liberal dividend policy in a comfortable capital market.
  • Stability of Earnings:

    • Companies with stable earnings can follow a liberal dividend policy.
  • Trade Cycle:

    • Inflation can lead to increased profits and more dividends.
  • Ability to Borrow:

    • Companies able to borrow at favorable rates can choose external funding.
  • Past Dividend Rate:

    • Historical dividend rates should be considered.

4. Different Types of Dividend:

  • Cash Dividend:

    • Regular Dividend (annually paid) and Interim Dividend (between annual meetings).
  • Stock Dividend:

    • Dividend paid in bonus shares.
  • Scrip Dividend:

    • Dividend paid in shares and debentures of another company.
  • Bond Dividend:

    • Dividends paid in the form of debentures/bonds.
  • Property Dividend:

    • Dividends paid in the form of assets.

5. Dividend Policy FAQs:

  • The dividend policy sets guidelines for amount, frequency, and timing of dividend distribution.
  • Legal restrictions, earnings, shareholder preferences, liquidity, and market conditions should be considered.
  • Types of dividend policies include Cash, Stock, Scrip, Bond, and Property.

6. About the Author:

  • True Tamplin is a Certified Educator in Personal Finance (CEPF®).
  • CEO of UpDigital, founder of Finance Strategists, and a published author.
  • His expertise is acknowledged by financial communities and institutions.

For a more detailed understanding, individuals can refer to True Tamplin's publications and explore his insights on Finance Strategists.

Feel free to ask if you have any specific questions or if you'd like additional information on any aspect mentioned in the article.

Dividend Policy | Factors, Different Types, Examples, and FAQs (2024)


What are the 4 types of dividend policy? ›

There are four major types of dividend policies: regular dividend, irregular dividend, stable dividend, and no dividend. Dividend policies dictate how a company decides to distribute its earnings to its shareholders.

What are the 4 factors influencing dividend policy? ›

Factors such as profitability, dividend payment history, growth plans, industry trends, and availability of funds influence the dividend policy.

What are dividends What are the types of dividends and factors affecting the dividend policy? ›

Dividends are paid by companies to their common shareholders. They represent a portion of the corporate earnings or profits that companies want to share with their investors. Dividends are paid at regular intervals, either monthly, quarterly, or annually. As such, they provide a regular stream of income for investors.

What are the 7 types of dividends? ›

There are seven types of dividends: cash, stock, property, scrip, special, bond, and liquidating. The company's board of directors decide to pay dividends and its types. It depends on the company's financial performance, cash flow, investment opportunities, and other considerations.

What are the different types of dividend decisions? ›

The main types of dividend decisions include regular cash dividends, stock dividends, variable dividends and special dividends. Each type has pros and cons for the firm and shareholders.

What is an example of a dividend policy? ›

Under the stable dividend policy, the percentage of profits paid out as dividends is fixed. For example, if a company sets the payout rate at 6%, it is the percentage of profits that will be paid out regardless of the amount of profits earned for the financial year.

What is the major factor affecting the dividend policy of a firm? ›

The dividend policy is a crucial aspect of any company's financial strategy. The policy can be influenced by several factors, including the company's financial position, market conditions, industry, shareholder preferences, and legal requirements.

How many types of dividend policy are there? ›

The stable dividend policy provides stability, the residual dividend policy focuses on reinvestment, the constant payout ratio policy offers a proportionate sharing of profits, and the no dividend policy prioritizes growth through reinvestment.

What are the three theories of dividend policy? ›

There are three theories: Dividends are irrelevant: Investors don't care about payout. Bird in the hand: Investors prefer a high payout. Tax preference: Investors prefer a low payout, hence growth.

What are the two most common types of dividends? ›

A dividend is a distribution of a portion of a company's earnings, decided by the board of directors. The purpose of dividends is to return wealth back to the shareholders of a company. There are two main types of dividends: cash and stock.

What are the factors influencing dividend decisions? ›

Dividend policy is not only influenced by internal factors but also by external factors. Internal factors include liquidity, profitability and investment opportunities, while external factors focus on macroeconomic issues such as stability, technology change, growth and changing consumer tastes.

What are the problems with dividend policies? ›

Payout Ratio: The dividend payout ratio, which represents the proportion of earnings paid out as dividends, is an important factor in dividend policy decisions. Companies with high payout ratios may have limited room for reinvestment in growth or may be more vulnerable to economic downturns.

What is the most common type of dividend? ›

The most common type of dividend is a cash payout, but some companies will issue stock dividends. Dividends are typically issued quarterly but can also be disbursed monthly or annually.

What is the rule 3 of dividend rules? ›

Rule 3 of Dividend Rules prescribes the conditions to be complied with for declaring dividend out of reserves. A pertinent question here is – whether a company can declare dividend out of 100% of the amount that has been transferred to General Reserve.

What is the most common dividend policy? ›

The stable dividend policy is a popular choice among conservative investors. Companies that adopt this policy aim to pay a fixed amount of dividends regularly, regardless of their earnings fluctuations. It provides shareholders with a sense of stability, knowing they can expect a predictable income stream.

What is the rule 3 of payment of dividends? ›

Rule 3 specifies that in the event of inadequacy or absence of profits in any year, a company may declare dividend out of free reserves.


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