Very broadly the distribution policy is concerned with issues like how much of its earnings should a firm pay by way of dividends, whether it makes sense to buy back shares.
Key Considerations Influencing Dividend Policy:
The key Consideration influencing a firm’s dividend is as follows:
Earnings Prospects: If the firm expects its earnings to grow in future it may be inclined to pay more by way of dividends. On the other hand, if it is uncertain about its earnings prospects it may pay less by way of dividends.
An important factor influencing the payout ratio of a firm is its requirement for funds in the foreseeable future. This is usually assessed with the help of financial forecasts prepared in the context of long range planning. Generally firms have substantial investment opportunities and consequently considerable funding resources for growth.
Dividend Record: The past dividend record of a firm has a bearing on its current dividend payment. Firms generally pursue a policy of gradually varying (this mostly implies increasing but occasionally means decreasing) the rupee level of dividend over time.
Liquidity Position: Dividends entail cash payment. Hence, the liquidity position of the firm has a bearing on its dividend. A firm may be unable to distribute more than a small fraction of its earnings, despite it desire to do so, if it is hard pressed for liquidity.
Shareholder Preferences: The preference of shareholders may influence the dividend payout ratio of the firm. When equity shareholders have grater interest in current dividend vis-à-vis capital gains, the firm may be inclined to follow a liberal dividend payout policy. On the other hand, if equity shareholders have strong preferences for capital gains, the firm may plough back a larger proportional of its earnings.
Control: External financing, unless it is through a rights issue involves dilution of control. If external finances are raised through a public issue of equity capital, the existing shareholders will have to share control with the new shareholders internal financing by way of retained earnings, on the other hand, leads to no dilution of control. Hence, if the shareholders and management of the firm are averse to dilution of control, the firm should rely more on retained earnings.
Shares issued to existing shareholders as a result of the capitalization of reserves are called bonus shares.
Effect of a Bonus Issue on the Balance Sheet>
Part A: Equity Portion before the Bonus Issue
Paid up hare Capital Rs 10,000,000
(1,000,000 shares of Rs 10 each fully paid)
Reserves and Surplus Rs 30,000,000
Part B: Equity Portion After the Bonus Issue in the Ratio 1:1
Paid up share Capital Rs 20,000,000
(2,000,000 shares of Rs 10 each fully paid)
Reserves and surplus Rs 20,000,000
In the wake of the bonus issue:
1. The shareholders’ proportional ownership remains unchanged.
2. The book value per share, the earnings per share, and the market price per share decrease, but the number of shares increases.
From the above it appears that the issue of bonus shares is more or less a financial gimmick without any real impact of the welfare of equity shareholders. Yet, firms do issue bonus shares and shareholders eagerly look forward to such issues. Why? The primary reason is that shareholders regard a bonus issue as a firm indication that the prospects of the company have brightened. Further, they feel reassured that the management is investor friendly. A secondary reason is that the bonus issue brings the rice of the share in a more popular trading range.
In a stock split, the par value per share is reduced and the number of shares is increased proportionately.
Effects of a Stock split on the Equity Portion of the balance Sheet>
Part A: Equity Portion of the Balance Sheet
Paid up share Capital Rs 5,000,000
(100,000 shares of Rs 50 each fully
Paid ) Reserves and Surplus Rs 10,000,000
Part B: Equity Proton Stock Split in the Ratio 5:1
Paid up shares Capital Rs 5,000,000
(500,000 shares of Rs 10 each fully
Paid) Reserves and surplus Rs 10,000,000.