What is Dividend Decisions? Definition, Types, and Policies

What is Dividend?

Types of Dividend

• Equity Dividend: Paid on equity shares, set by the board and approved by shareholders.
• Preference Dividend: Paid on preference shares, fixed at issuance, prioritized over equity dividends.
• Interim Dividend: Paid before year-end accounts are closed, based on heavy earnings during the year.
• Regular Dividend: Paid at a usual rate, preferred by investors seeking consistent income.
• Cash Dividend: Paid in cash, resulting in outflow of funds, preferred by ordinary shareholders.
• Stock Dividend: Bonus shares issued to existing shareholders, conserves cash, capitalizes earnings.
• Scrip or Bond Dividend: Promises future payment, issued when cash is insufficient, bears interest.
• Property Dividend: Paid in assets other than cash, rare in India.
• Composite Dividend: Paid partly in cash and partly in property.
• Optional Dividend: Shareholders choose between cash or property dividend.
• Extra or Special Dividend: Abnormal, non-recurring dividend, declared from good profits or reserves without adjusting the regular rate.

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Determinants Of Dividend Policy

Types Of Dividend Policy

• Constant dividend per share: In this case, reserve fund is created to pay fixed amount of dividend in the year when the earning of the company are not enough. It is suitable for the firms having stable earning.

• Constant payout ratio: Under this type the payment of fixed percentage of earning is paid as dividend every year.

• Stable rupee dividend + extra dividend: Under this type, there is payment of low dividend per share constantly + extra dividend in the year when the company earns high profit. The extra dividend may be considered as a “bonus” paid to the shareholders as a result of a usually good year for the firm. This additional amount of dividend may be paid in the form of cash or bonus shares, subject to the firm’s liquidity position.

Also Check: What is Costing? Operational Approach to Financial Decision

1. 1. Due to uncertain earning of the company.
   2. Due to lack of liquid resources.
   3. The company is sometime afraid of giving regular dividend.
   4. Due to uncertainty of business.

Dividend Theories / Dividend Models

Relationship between Dividend Policy and Value of Firm: Dividend decision is a financial decision. There are conflicting theories regarding the impact of dividend decisions on the valuation of a firm. For the sake of convenience, these theories can be grouped into the following two categories:

Irrelevant concept of Dividend

• Perfect Capital Markets: This assumption implies that information is freely available to all investors, transaction and floatation costs do not exist, and no single investor is large enough to influence market prices.

• Rational Investor Behavior: It assumes that investors behave rationally, meaning they make decisions based on maximizing their utility or wealth.

• Tax Neutrality: The hypothesis assumes either no taxes exist or there are no differences in tax rates between dividends and capital gains. In other words, investors view dividends and capital gains equally in terms of taxation.

• Fixed Investment Policy: The firm's investment policy is assumed to be fixed, meaning it does not change over time.

• Certainty and No Risk: It assumes that there is no risk or uncertainty in the market. Investors are able to accurately forecast future prices and dividends with certainty. Additionally, it assumes that a single discount rate is appropriate for valuing all securities over time periods.

Relevant concept of Dividend

Walter’s model is based on the following assumptions:

• The firm finances all investment through retained earnings; that is debt or new equity is not issued;
• The firm’s internal rate of return (r), and its cost of capital (k) are constant;
• All earnings are either distributed as dividend or reinvested internally immediately.
• Beginning earnings and dividends never change. The values of the earnings per share (E), and the dividend per share (D) may be changed in the model to determine results, but any given values of E and D are assumed to remain constant forever in determining a given value.
• The firm has a very long or infinite life.

• The firm is an all equity firm.
• No external financing is available. Only retained earnings will be used to financing expansion.
• The internal rate of return is constant.
• The cost of capital (or discount rate) for the firm remains constant and it is greater than the grow rate, i.e., CR > br (or g).
• The retention ratio, b, once decided upon, is constant.
• The firm and its stream of earnings are perpetual. Thus, the growth rate, g = br, is constant for ever.
• The corporate taxes do not exist.