The document discusses dividend policy and its influencing factors. It defines dividends as profits distributed to shareholders. Key factors that influence dividend policy include legal restrictions, earnings trends, shareholder desires, industry nature, company age, future needs, economic conditions, taxation, inflation, control objectives, and institutional investor requirements. The types of dividend policies a company can have and forms of dividend payments are also outlined.

2. Introduction
 The term dividend refers to that portion of profit
which is distributed among the shareholders of the
firm.
 It is the reward of the shareholders for investments
made by them in the shares of the company.
 The dividend policy of a firm determines what
proportion of earnings is paid to shareholders by way
of dividends and what proportion is ploughed back in
the firm for reinvestment purposes.

3. Factors Influencing Dividend Policy
 Legal restrictions: legal provisions require that dividend
can be paid only out of current profits or past profits after
providing for depreciation or out of the money provided by
Government for payment of Dividend in pursuance of
given by the Government.
 Magnitude and trend of earning: As the dividend can
be paid only out of present or past years profit, earnings of
the company fix the upper limits on dividend.
 Desire and type of share holder: Desire of share holder
for dividend depend upon their economic status.
Investors, such as retired persons, widows and other
economically weaker persons view dividend as a source of
fund to meet their day to day living expenses.

4. contd..
 Nature of industry: Nature of industry to which the company
is engaged also considerably affect the dividend policy.
 Age of the company: A newly established concern has to limit
the payment of dividend and retain substantial part of earnings
for financing its future growth and development. While older
companies which have established sufficient reserve can afford
to pay liberal dividend.
 Future financial requirement: It is not only the desires of the
share holder, but also future financial requirement of the
company that have to be taken into consideration while making
a dividend decision.
 Government’s economic policy: The dividend policy of a firm
has also to be adjusted to the economic policy of the
Government as was the case the temporary restrictions on
payment of dividend ordinance was in force.

5.  Taxation policy: A high or low rate of business taxation
affects the net earning of company and there by its
dividend policy.
 Inflation: Inflation acts as a constraint in the payment of
dividend.
 Control objective: When a company pays high dividends
out of its earnings, it may result in the dilution of both
control and earning for the existing share holders.
 Requirement of institutional investors: Dividend
policy of a company can be affected by the requirements of
institutional investors such as financial
institution, bank, insurance corporation etc.,

6.  Stability of dividend: Stability of dividend
simply refers to the payment of dividend regularly
and shareholders generally prefer payment of such
regular dividends.
 Liquid resources: If a company does not have
liquid resources, it is better to declare stock
dividend. i.e., issue of bonus share to the existing
share holders.

7. Types of dividend Policy
 Regular dividend policy: Payment of dividend at the
usual rate is termed as regular dividend.
 Stable dividend policy: The term “stability of dividends”
means consistency or lack of variability in the stream of
dividend payments.
a) Constant dividend per share: some companies follow a
policy of paying fixed dividend per share irrespective of the
level of earnings year after year
b) Constant payout ratio: means payment of a fixed
percentage of net earnings as dividends every year. The
amount of dividend fluctuates in direct proportion to the
earnings of the company.

8. Contd..
c) Stable rupee dividend plus extra dividend: some co’s
follow a policy of paying constant low dividend per share
plus an extra dividend in the years of high profits.
 Irregular dividend policy: some companies follow
irregular dividend payments on account of the foll-g
a)uncertainty of earnings.
b)unsuccessful business operations
c)lack of liquid resources.
 No dividend policy: a company may follow a policy
of paying no dividends presently because of its
unfavourable working capital position.

9. Forms of Dividend
 DIVIDENDS paid in the ordinary course of business are
known as PROFIT DIVEDEND, while dividends paid out of
capital are known as LIQUIDATION DIVIDENDS.
Dividends may also be classified on the basis of medium in
which they are paid:
 Cash dividend: payment of dividend in cash results in
outflow of funds and reduces the company’s net
worth, though the shareholders get an opportunity to
invest the cash in any manner they desire.
 Scrip or bond dividend: a script dividend promises to pay
the shareholders at a future specific date. In case a
company does not have sufficient funds to pay dividends in
cash, it may issue notes or bonds for amounts due to the
shareholders.

10. Contd..
 Property dividend: are paid in the form of some
assets other than cash. They are distributed under
exceptional circumstances & are not popular in India.
 Stock dividend: means issue of bonus shares to the
existing shareholders.

11. CORPORATE DIVIDEND PRACTICES
IN INDIA
 Because of liberalization of Indian economy in recent
years, the share holders/investors are aware of the
events of the industrial sectors of the company.
 The up surge of the capital market both primary and
secondary will bear testimony of such awareness.
 In India, capital market today is not a place for yield
and dividend payments do not make much of a dent as
far as returns are concerned.
 Only companies with conservative payout companies
which believe in ploughing profits back and

12. employing them productively will be in a position to issue
bonus shares by capitalizing reserves .
 In an era of high interest costs, it is conservation of resources
that is far more important than their dividend distribution .
 Moreover, even though there may be liberal distribution of
dividend, the real yield to the investor who has acquired the
share at their market value may be very negligible.
 For Example : Tata Tea , a renowned company may
distribute dividend at a percentage as high as 50% .

13. Approaches to Dividend Policy
 However, there are conflicting opinions regarding the impact
of dividend policy on the valuation of the firm.
 According to one School of thought, dividends are
irrelevant, so the dividends have no impact on the value of
the firm.
 According to second School of thought, dividends are
relevant to the value of the firm measured in terms of market
prices of the shares.

14. 1. The Irrelevance Concept of Dividend
or The Theory of Irrelevance.
A. Residual Approach
 According to this theory, dividend decision has no effect
on the wealth of the shareholders or the prices of the
shares, and hence it is irrelevant so far as the valuation of
the firm is concerned.
 This theory regards dividend decision merely as a part of
financing decision because the earnings available may be
retained in the business for re-investment.

15.  But, if funds are not required in the business they may be
distributed as dividends.
 Thus, the decision to pay dividends or retain the earnings
may be taken as a residual decision.
 This theory assumes that investors do not differentiate
between dividends and retentions by the firm.
B. Modigliani and Miller Approach
 Modigliani and Miller have expressed in the most
comprehensive manner in support of the theory of
irrelevance.

16. 
 They maintained that dividend policy has no effect on the
market price of the shares and the value of the firm is
determined by the earning capacity of the firm or its
investment policy.
 As observed by M.M, “under conditions of perfect capital
markets, rational investors, absence of tax discrimination
between dividend income and capital appreciation, given
the firm’s investment policy, its dividend policy may have
no influence on the market price of the shares.”

17. 2. The Relevance Concept of Dividend or
The Theory of Relevance
 The other School of thought on dividend decision holds that
the dividend decisions considerably affect the value of the
firm.
 The advocates of this school of thought include Myron
Gordon, Jone Linter, James Walter and Richardson.
 According to them dividends communicate information to
the investors about the firm’s profitability and hence
dividend decision becomes relevant.

18.  Those firms which pay higher dividends, will have
greater value as compared to those which do not pay
dividends or have a lower dividend pay out ratio.
 The following are the two theories representing this notion:
A. Walter’s Approach
 Prof. Walter’s approach supports the doctrine that
dividend decisions are relevant and affect the value of
the firm.
 The relationship between the internal rate of return
earned by the firm and its cost of capital is very
significant in determining the dividend policy to sub
serve the ultimate goal of maximizing the wealth of the
shareholders.

19.  Walter’s Model is based on the following
assumptions:
- The investment of the firm is financed through retained
earnings only and the firm does not use external sources of
funds.
- The internal rate of return and the cost of capital are
constant.
- Earnings and dividends do not change while determining
the value.
- The firm has a very long life.

20. B. Gorden’s Approach
 Myron Gorden has also developed a model on the lines of
Prof. Walter suggesting that dividends are relevant and the
dividend decision of the firm affects its value.
 His basic valuation model is based on the following
assumptions:
- The firm is an all equity firm.
- No external financing is available or used.
- The rate of return on the firm’s investment is constant.
- The retention ratio once decided upon is constant.

21. - The cost of capital for the firm is constant.
- The firm has perpetual life.
- Corporate taxes do not exist.