DIVIDEND POLICY: PRACTICAL ASPECTS
A firm cannot normally treat its dividend policy as irrelevant. It must carefully evaluate its circumstances and the environment in which it operates while hammering out its dividend policy. Most companies seem to accord a great deal of importance to their dividend decisions. The dividend policy and the bonus policy are debated at great length. Sometimes there are companies that make a short cut of the dividend policy. The share holders bother a great deal about the dividend policy, financial economists considered the dividend policy as relevant, and corporate management treat the dividend policy as a near after thought.
Recognizing the importance of dividend policy we are discussing the factors and considerations relevant for formulating the dividend policy.
Dividend Policy: Pay Out Ratio:
Two Important dimensions for a firmâ€™s dividend policy are the average pay out ratio and how stable should be the dividend for the period of time. These two dimensions are conceptually distinct from one another. The average payout ratio can be high or low regardless of whether the dividend stream is steady or fluctuating.
A key factor influencing the pay out ratio of a firm is its requirement for funds in the foreseeable future. This may be assessed with the help of financial forecast prepared in the context of long range planning. Generally, firms which have substantial investment opportunities and consequently considerable funding needs tend to keep their payout ratio rather low to conserve resources for growth. Reliance Industries Limited for example kept its pay out ratio low, as it has been expanding rapidly. On the other hand firms which have rather limited investment avenues usually pursue a more generous pay out policy.
Dividends entail cash payments. The liquidity position of the firm has a bearing on the dividend decision. A firm may be able to distribute more than a small fraction of its earnings despite its desire to do so, because of insufficient liquidity. This is typically the case of highly profitable but rapidly expanding firms. This is because of there investments and other commitments for expansion they do not have abundant liquidity.
Access to External Sources of Financing:
Generally a firm which has easy access to external sources of financing may feel less constrained in its dividend decision. For such a firm its dividend decision is some what independent of its investment decision as well as its liquidity position. Enjoying a greater degree of flexibility easier availability of external financing such a firm is inclined to be more generous in its dividend pay out policy. On the other hand a firm which has difficulty in mobilizing finance externally is likely to lean heavily on internally generated funds. Given the investment and other commitments and a lesser degree of financing latitude, such a firm is likely to pursue a somewhat conservative dividend payout policy.
Share holders Preference:
The preference of share holders may influence the dividend pay out of the firm. When equity shareholders have greater interest in current dividend as compared to capital gains the firm may be inclined to follow a liberal dividend payout policy. On the other hand if equity shareholders have a strong preference for capital gains the firm may plough back a larger proportion of its earnings.
While the preference of equity share holders has some influences over the dividend policy of the firm it appears that the dividend policy of the firm tends to have a greater impact over the kind of share holders that are attracted towards it. Each firm is likely to draw to itself a â€œclienteleâ€? which find its payout policy attractive.