CORPORATE FINANCE

ASSIGNMENT NO. 1
TOPIC: FACTOR AFFECTING DIVIVDEND PLICY

SUBMITTED TO:
MISS SHAISTA
SUBMITTED BY:
ANUM FATIMA
ROLL NO.
61651003
CLASS:
BBA-8

DEPARTMENT OF MANAGEMENT SCIENCES

 Dividend is money that is regularly paid by a business to its shareholders using profits, cash
reserves or even debt. Dividends can be paid each quarter, at the end of every half of the
financial year, or annually, and are paid on a per share basis. Dividend payments are regarded
as rewards or profit for investors that have put money into the business to help it grow.

 DIVIDEND POLICY

Dividend policy is the policy a company adopt to structure its dividend payout to
shareholders. Most companies view a dividend policy as a vital part of the corporate strategy.
Management must decide on the dividend amount, timing, method, process and various other
factors that impact dividend payments.

FACTORS AFFECTING DIVIDEND POLICY

Company needs to analyze certain factors before framing their dividend policy.
The following are the various factors/determinants that impact the dividend policy of a
company:

 INDUSTRY NATURE

The nature of the industry to which the company belongs has a prime effect on the dividend
policy. Industries, where earnings are steady, may adopt a constant dividend policy as
opposed to the industries where earnings are uncertain and unstable. They are better off in
having a conservative approach to dividend payout.

 OWNERSHIP STRUCTURE

The ownership structure of a company also effects the policy. A company with a higher
promoter’ holdings will favor a low dividend payout as paying out dividends may cause a
decline in the value of the stock. Whereas, a high institutional ownership Determinants of
Dividend Decisions will favor a high dividend payout as it helps them to increase the control
over the management.

 CORPORATION’S AGE

Newly developed companies will have to retain major part of their earnings for future growth
and expansion. Thus, they have to follow a conservative policy unlike well established
companies, which can pay higher dividends from their reserves.

 NUMBER OF SHARE HOLDERS

A company with a large number of shareholders will have a difficult time in getting them to
agree to a conservative dividend policy. On the other hand, a closely held company has more
chances of succeeding to finalize conservative dividend payouts.

 DIFFERENT SHAREHOLDERS’ EXPECTATIONS

Another factor that effects the policy is the diversity in the type of shareholders a company
has. A different group of shareholders will have different expectations. A retired shareholder
will have a different requirement as compare to wealthy investor. The company requires to
clearly understand the various expectations and formulate a balanced dividend policy. In
general, cash dividend will give more satisfaction to shareholder in comparison to capital
appreciation.

 DEBT CONTRIBUTION
A company having more debt contribution in their financial structure and consequently, more
interest payments may to decide for a low dividend payout, so as to increase their net worth
and to make sure that it can make payment of financial charges even in case of earning of the
company is falling. Whereas a company utilizing more of own financing will prefer high
dividends.

 REINVESTMENT OPPORTUNITY

Dividend payout will also depend on the future requirements for the additional and more
capital. A company having profitable investment opportunities has justification in retaining
the earnings. However, a company with no capital requirements should adopt for a higher
dividend.

 BUSINESS LIFE CYCLES

When the company experiences a boom, it is advisable to save up and make reserves for dips.
Such reserves will help a company to maintain dividend even in recession markets to retain,
sustain and attract more shareholders.

 ALTERATION IN GOVERNMENT POLICIES

There could be the change in the dividend policy of a company due to the forcefully imposed
changes by the government.

 PROFITABILITY

The profitability of a firm is reflected in net profit ratio and ratio of profit to total assets. A
highly profitable company have a capacity to pays higher dividends and a company with less
profits will adopt a conservative dividend policy.

 TAXATION POLICY

The corporate taxes will impact dividend policy, either directly or indirectly. The taxes
directly reduce the residual earnings after tax available for the shareholders. If dividend
income is taxable in the hands of investor and capital gain is exempt, then company may
retain its earning so as to increase price per share, which ultimately gives higher return to
investors’ and vice versa. Further if it is possible that divide all shareholders into high tax
bracket or low tax bracket, accordingly dividend policy can be framed. Finally, objective is to
give maximum return to shareholders.
 PROFITABILITY TREND

Even if the company has been profitable over the years, the trend should be properly
analyzed to find the average earnings of the company. This average number should be then
studied in relation to the prevailing economic conditions. This will help in adopting for a
conservative policy if a depression is approaching.

 LIQUIDITY

Liquidity has a direct relation with the dividend policy. Suppose acompany having high
profit, may have majority of profit blocked in working capital. In that case its liquidity is
poor. In that case company should pay less dividend. High dividend payment is possible
only if company has sound earning and good liquidity.

 LEGAL RULES

There are certain legal restrictions on the companies for dividend payments. It is legal to
pay a dividend only if the capital is not reduced post payment. These rules are in place to
protect creditors’ interest. Most importantly providing depreciation is mandatory before
making payment of dividend. Depreciation is to be provided at minimum rates provided.
Providing depreciation is very important because with that company is able to retain an
amount of profit for replacement of fixed assets in future.

 INFLATION

Inflationary environments force companies to retain major part of their earnings and reduce
dividends. As the prices rise, the companies need to increase their capital reserves for their
purchases of fixed assets. In case of inflationary situation, same quantity of closing stock
will have more valuation, so payment of tax also increase.

 CONTROL OF SHAREHOLDERS

The firms aiming for more control in the hands of current shareholders prefer a conservative
dividend payout policy. It is imperative to pay fewer dividends to retain more control and
the earnings in the company.

 REPAYMENT OF DEBT

If a substantial amount of debt is required to paid, in that case even though the company has
high amount of earning, it may pay less dividend.
 FINANCING POLICY OF THE COMPANY

Dividend policy may be affected and influenced by financing policy of the company. If the
company decides to meet its expenses from its earnings, then it will have to pay less dividend
to shareholders. On the other hand, if the company feels, that outside borrowing is cheaper
than internal financing, then it may decide to pay higher rate of dividend to its shareholder.
Thus, the internal financing policy of the company influences the dividend policy of the
business firm.

 DIVIDEND POLICY OF COMPETITORS

Another factor which influences, is the dividend policy of other competitive concerns in the
market. If the other competing concerns, are paying higher rate of dividend than this concern,
the shareholders may prefer to invest their money in those concerns rather than in this
concern. Hence, every company will have to decide its dividend policy, by keeping in view
the dividend policy of other competitive concerns in the market.

 PAST RATES

If the firm is already existing, the dividend rate may be decided on the basis of dividends
declared in the previous years. It is better for the concern to maintain stability in the rate of
dividend and hence, generally the directors will have to keep in mind the rate of dividend
declared in the past.

 ABILITY TO BORROW

Every company requires finance both for expansion programs as well as for meeting
unanticipated expenses. Hence, the companies have to borrow from the market, well
established and large firms have better access to the capital market than new and small, firms
and hence, they can pay higher rate of dividend. The new companies generally find it difficult
to borrow from the market and hence they cannot afford to pay higher rate of dividend.

 GROWTH NEED OF COMPANY

Another factor which influences the rate of dividend is the growth needs of the company. In
case the company has already expanded considerably, it does not require funds for further
expansions. On the other hand, if the company has expansion programmes, it would need
more money for growth and development. Thus when money for expansion is not, needed,
then it is easy for the company to declare higher rate of dividend.
 POLICY OF CONTROL

Policy of control is another important factor which influences dividend policy. If the
company feels that no new shareholders should be added, then it will have to pay less
dividends. Generally, it is felt, that new shareholders, can dilute the existing control of the
management over the concern. Hence, if maintenance of existing control is an important
consideration, the rate of dividend may be lower so that the company can meet its financial
requirements from its retained earnings without issuing additional shares to the public.

 TAX POSITION OF SHAREHOLDERS

The tax position of shareholders is another influencing factor on dividend decisions. In a

Instead of receiving the dividend in the form of cash (whatever may be the per cent), the
shareholders would like to get shares and increase their holding in the form of shares. This
has certain benefits to shareholders. They get money by selling these extra shares received in
proportion to their original shareholding.

This will be a capital gain for them. Of course, they have to pay tax on capital gains. But the
capital gains tax will be less compared to the income-tax that they should have paid when
cash dividend was declared and added to the personal income of the shareholders.

THE END