Dividend policy refers to how a company decides whether to pay dividends, how much to pay, and when to pay dividends to its shareholders.
It affects share price, investor expectations, and the company’s capital structure.
1. Types of Dividend Policies
A. Stable Dividend Policy
The company pays a fixed amount per share every year, regardless of profit fluctuations.
✔ Example
ABC Ltd pays $0.50 per share every year.
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Year 1 profit: $200,000 → Dividend still $0.50
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Year 2 profit: $120,000 → Dividend still $0.50
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Year 3 profit: $300,000 → Dividend still $0.50
Why?
Investors like stability → reduces uncertainty.
B. Constant Payout Ratio
A constant percentage (not amount) of profit is paid out.
✔ Example
Company pays 40% of earnings as dividends.
-
Year 1 profit = $1,000,000 → Dividend = $400,000
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Year 2 profit = $500,000 → Dividend = $200,000
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Year 3 profit = $750,000 → Dividend = $300,000
Dividend changes each year depending on profits.
C. Residual Dividend Policy
The company first decides how much it needs for investment projects, and leftover earnings are paid as dividends.
✔ Example
Profit this year = $1,000,000
Investment required = $700,000
Remaining profit = $300,000 → Paid as dividend
If next year investments need $1,200,000 and profit is only $1,000,000 →
No dividends paid.
D. Zero Dividend Policy
Company pays no dividends (usually high-growth firms).
✔ Example
Tesla, Amazon (for many years):
They reinvest profits into expansion, R&D, new factories, etc.
2. Factors Affecting Dividend Policy
A. Legal Constraints
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Some countries restrict dividends to be paid only from retained earnings.
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You cannot pay dividends if it will cause insolvency.
Example
Company has profits but cash is locked in receivables → cannot legally pay dividends.
B. Liquidity (Cash Availability)
Dividends are paid in cash, so even if profit is high, low cash = low dividends.
Example
Profit = $1 million
Cash = $10,000
→ Dividends cannot be paid.
C. Investment Opportunities
If the company has profitable projects, it may retain earnings.
Example
Expected return on new project = 20%
Shareholders expect return = 10%
→ Better to retain earnings → lower dividends.
D. Shareholder Preferences
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Older investors prefer cash dividends
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Younger investors prefer capital gains (share price growth)
Example
If majority shareholders want regular cash, company maintains stable dividend.
E. Tax Considerations
If dividends have high tax and capital gains are taxed lower → shareholders prefer low dividends.
F. Borrowing (Gearing) Levels
Highly geared companies pay lower dividends because cash must be used to repay debt.
Example
Debt-to-equity ratio = 80%
→ Company may suspend dividends to pay loan interest.
3. Dividend Policy & Market Theories
A. Dividend Irrelevance Theory (M&M)
Miller and Modigliani argue:
Dividends do not affect share value in a perfect capital market.
Example
If company pays $1 dividend, share price will reduce by $1 automatically.
B. Bird-in-the-Hand Theory
Investors prefer certain dividends today over uncertain future capital gains.
Example
Company paying regular dividends → share price increases because investors value certainty.
C. Signalling Theory
Dividends send a signal about the company’s financial health.
Example
If dividends increase → Market thinks “profits will rise” → Share price rises
If dividends are cut → Market thinks “company in trouble” → Share price falls
D. Clientele Theory
Different investors prefer different dividend policies.
Example
A high-dividend-paying company attracts retirees.
A low-dividend company attracts growth-focused investors.
4. Dividend Forms (How Dividends Are Paid)
A. Cash Dividend
Most common.
B. Stock (Scrip) Dividend
Company gives shareholders more shares instead of cash.
Example
10% stock dividend → A shareholder with 1,000 shares receives 100 additional shares.
C. Stock Split / Reverse Split
Not a dividend, but affects shareholder perception.
D. Share Buyback
Company buys back its own shares — a form of returning cash to shareholders.
5. Full Numerical Example
Company: XYZ Ltd
Profit this year: $1,200,000
Investment needed: $600,000
Dividend policy: 40% payout ratio
Shares: 300,000 shares
Step 1: Dividend Amount
40% of $1,200,000 = $480,000
Step 2: Dividend per share
= 480,000 / 300,000
= $1.60 per share
Result
Each shareholder receives $1.60 per share.