- This determines what portion of earnings will be paid out to stockholders and what will be retained in the business to finance long-term growth.
- Dividend constitutes the cash flow that accrues to equity holders whereas retained earnings are one of the most significant sources of funds for financing the corporate growth.
FORMS OF DIVIDEND:
- The most common type of dividend is in the form of cash
- Public companies usually pay cash dividend, sometimes a regular cash dividend and sometimes an extra cash dividend
- Paying a cash dividend reduces the corporate cash and retained earnings.
- It is also paid in the form of shares of stock and this is referred as stock dividend or bonus shares.
STABLE DIVIDEND POLICY THEORY:
The stability could take three forms:
- Keep dividends at a stable rupee amount but allow its payout ratio to fluctuate, or
- Maintain stable payout ratio and let the rupee dividend fluctuate, or
- Set low regular dividend and then supplement it with year-end “extras” in years when earnings are high. As earnings of the firm increase the customary dividend will not be altered but a year-end “extras” will be declared.
RESIDUAL THEORY OF DIVIDEND POLICY:
- Dividend policy is strictly a financing decision; the payment of cash dividend is a passive residual.
- The amount of dividend payout will fluctuate from period to period in keeping with fluctuations in the amount of acceptable investment opportunities available to the firm.
- If the firm unable to find out profitable investment opportunities, payout will be 100%.
- The theory implies that investors prefer to have the firm retain and reinvest earnings rather than pay them out in dividends if the return on re-invested earnings exceeds the rate of return the investors could themselves obtain on other investments of comparable risks.
IRRELEVANCE OF DIVIDEND:
- Investors are indifferent to dividends and capital gains and so dividends have no effect on the wealth of shareholders.
- They argue that the value of the firm is determined by the earning power of firms assets or its investment policy.
- The manner is which earnings are divided into dividends and retained earnings does not affect this value.
DETERMINANTS OF DIVIDEND POLICY:
- Legal: dividends must be paid out of firm’s earnings/ current earnings
- Financial: a firm can pay dividend only to the extent that it has cash to disburse
- Economic constraints
- Nature of business conducted by a company
- Existence of the company: length of existence of the company.
- Type of company Organisation: pvt. Or public
- Financial needs of the company.
- Market conditions
- Financial arrangements
- Change in government policies
LEGAL ASPECTS OF DIVIDENDS:
- Dividends to be paid only out of profits:
- It is necessary for a company to declare and pay dividend only out of profits for that year arrived at after providing for depreciation in accordance with the provisions of section 205(2) of the act.
- A dividend could be declared out of profits of the company for any previous financial year or years arrived after providing for depreciation in accordance with those provisions and remaining undistributed.
- The dividend can also be declared out of moneys provided by the central govt. or a state govt. for the payment of dividend in pursuance of guarantee given by that govt.
- The company is required to transfer to the reserves such percentage of its profits for that year not exceeding 10% in addition to providing for depreciation as required under section 205(2A) of the Act.
- Unpaid dividend to be transferred to special dividend account:
- Dividends are to be paid within 30 days from the date of the declaration
- If they are not paid the company is required to transfer the unpaid dividend to unpaid account within 7 days of the expiry of the period of 30 days.
- The company is required to open this account in any scheduled bank as required under section 205-A of the Companies Act, 1956
- Dividend is to be paid only to registered shareholders or to their order or their bankers
TRANSFER OF UNPAID/UNCLAIMED DIVIDEND TO INVESTOR EDUCATION AND PROTECTION FUND:
- Any money transferred to the unpaid dividend account of a company in pursuance of section 205A(5) which remains unpaid or unclaimed for a period of 7 years from the date of such transfer to unpaid dividend account, shall be transferred by the company to the investor education and protection fund established under sub-section (1) of section 205C
- Sub-section (1A) of section 205 stipulates that the board of directors may declare interim dividend and the amount of dividend including interim dividend is to be such deposited in a separate bank account within 5 days from the date of depreciation.
- Failure to do so, every director of the company, shall, if knowingly a party to the default, be punishable with simple imprisonment for a term which may extend to 3 years and shall also liable to a fine of rupees for everyday during which such default continues and
- The company shall be liable to pay simple interest at a rate of 18% p.a. during the period for which such default continues.