IntroductionDividends play a major role in the financial operations of any given Company particularly on the shareholders wealth. Dividends can either increase the shareholders wealth or decrease it depending with it effects. The dividend policy of a company relates to the form of dividends and the retention of profits for the future use in the business. The two objectives of dividend policy distribution of the dividends and retention of earnings for growth are in conflict. Dividend policy of a company affects: -Long term financial decisionsShareholder’s wealth. (Michaely, 1999)DiscussionThe dividend policy can be formed in view of the following considerations. Where are shareholders preferences?
Do they want dividend income or capital gains? What are the financial needs of the company? How much should be paid out of dividendsShould a company follow a stable dividend policy What should be the form of dividend? The dividend policy of a company is decided on the basis of the above considerations. The efforts should be made to bring a balance between the desires of the shareholders and the needs of the company. Shareholders may be interested either in dividend income or capital gains.
For example a wealthy shareholder in a high income tax bracket may be interested in capital gain instead of dividend income. On the other hand the retired shareholders may be more interested in cash dividends. Similarly, the majority shareholders like unit trust, insurance companies among others also prefer cash dividends because they have to pay a return to their deposition. The small shareholders mostly do not have specific objective to buy shares. They may buy shares to receive dividend income or get capital gain. The directors should therefore adopt a dividend policy, which fulfils the requirements of different classes of people.
(Starks, 2000)A high dividend pay out might be harmful to the long term because in this case, profits cannot be used for the further expansion of the company. However, this policy will be beneficial to raise the share prices in the short run. If the dividend policy is decided in view of the long-term financing requirements then the company will pay high dividends only when the firm does not have profitable investment opportunities. A policy of low dividends and higher retained earnings can utilize long-term earnings and dividends. A company’s dividend policy may be also restricted by the availability of liquid fluids.
If only a limited amount of cash can be made available, a high dividend policy is not possible. Sometimes the shareholders give a higher value to the near dividends than the future dividends. Higher dividends increase the value of shares, while lower dividends reduce the value of shares. (Rozeff, 2002)In case of stock split where ordinally shares are sub-divided, the nominal value of these shares is reduced and a shareholder will receive more shares for each share held previously, For example the nominal value per share is $20 at present and it may be decided to split it into four ordinally shares of $5 each.
In this case four ordinally shares will be issued for every share held previously.