Factors that affecting Dividend Policy of a company
Dividend Policy is a financial decision that refers to the proportion of the firm’s earnings to be paid out to the shareholders. A firm’s dividend policy is influenced by large numbers of factors. The goal of the policy is to aim for steady and predictable dividend payouts every year, which is what most investors are seeking. Some factors affect the amount of dividend and some factors affect the types of a dividend. It is also highly volatile, but for some investors, it is the only acceptable dividend policy that a company should have.
The following are some major factors which influence the dividend policy of the firm.
(1) Legal requirements
There is no legal compulsion on the part of a company to distribute a dividend. However, their certain conditions imposed by law regarding the way dividend is distributed. Basically, there are three rules relating to dividend payments. They are the net profit rule, the capital impairment rule, and insolvency rule.
(2) Firm’s liquidity position
Dividend payout is also affected by the firm’s liquidity position. In spite of sufficient retained earnings, the firm may not be able to pay cash dividend if the earnings are not held in cash.
(3) Repayment need
A firm uses several forms of debt financing to meet its investment needs. These debts must be repaid at the maturity. If the firm has to retain its profits for the purpose of repaying debt, the dividend payment capacity reduces.
(4) The expected rate of return
If a firm has a relatively higher expected rate of return on the new investment, the firm prefers to retain the earnings for reinvestment rather than distributing cash dividend.
(5) Stability of earning
If a firm has relatively stable earnings, it is more likely to pay a relatively larger dividend than a firm with relatively fluctuating earnings.
(6) Desire for control
When the needs for additional financing arise, the management of the firm may not prefer to issue additional common stock because of the fear of dilution in control on management. Therefore, a firm prefers to retain more earnings to satisfy additional financing need which reduces dividend payment capacity.
(7) Access to the capital market
If a firm has easy access to capital markets in raising additional financing, it does not require more retained earnings. So a firm’s dividend payment capacity becomes high.
(8) Shareholder’s individual tax situation
For a closely held company, stockholders prefer relatively lower cash dividend because of higher tax to be paid on dividend income. The stockholders in higher personal tax bracket prefer capital gain rather than dividend gains.