Dividend Policy-Stability Homework Help

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What is Dividend policy? 

Dividend policy is the set of strategies a company practices to decide how much of its earnings it will pay as dividend to the shareholders.The three main approaches of dividends are-

  • Residual dividend policy
  • Stability dividend policy
  • Hybrid dividend policy

How dividends distribution is important?

A company’s dividend policy has the effect of dividing its net income into two parts-

  • Dividends
  • Retained earnings

Dividend policy of the firm affects both long term financing and shareholder’s wealth. This is why company’s decision to pay dividends is considered as a long term financing decision and as a maximization of wealth decision.

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What is Dividend stability policy? 

The dividend variations caused by residual dividend policy significantly dissimilar with the certainty of the dividend stability policy. With this type of dividend policy, quarterly dividends are fixed at a portion of yearly income. Shareholders are generally favors this type of policy and it has a positive impact on the market price of share.

Types of Dividend stability policy-

  • Constant dividend per share- 

Many companies follow this kind of stability policy. They pay a fixed amount every year per share as dividend. This policy does not signify that the dividend per share will never rise. When the company reaches a new level of income and expects to maintain such level, the annual dividend per share may get increased.

  • Constant percentage of net earnings

In this type of stability policy, dividend is decided by calculating payout ratio. Payout ratio is ratio of dividends to earnings. We can say that with this policy amount of dividend will change in direct proportion to incomes. This type of policy is supported by the management as it is related to the ability of company to pay dividends.

  • Constant dividend per share plus extra dividend

In this policy, a small amount of dividend is fixed to cut the possibility of missing a dividend payment and extra dividend is paid in periods of profits. This policy ensures payment of dividend constantly without failure in payment.

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Advantages of Dividend stability policy-

  • Resolution of uncertainty of investors.
  • Investors who are old and retired depends upon the dividend, by this type of policy they get regular dividends without any default.
  • Financial institutions prefer the company who follows dividend stability policy as company has a record of paying dividend regularly without failure.
  • It helps in raising finances for the company.

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Disadvantages of Dividend stability policy-

  • Once this policy is adopted by a company, it cannot be changed.
  • Stability has to maintain by the company during lean periods also.
  • If company fails to pay dividend it will be a depressing effect on investors.

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