CHAPTER TWENTY-EIGHT
Dividend Policy
Your company’s dividend policy is important for these reasons:
- It impacts the financing program and capital budget.
- It affects cash flow. A company experiencing liquidity problems may be forced to restrict its dividend payments.
- It influences investor attitudes. For example, stockholders do not like dividends cut because they associate it with corporate financial problems. Furthermore, in formulating a dividend policy, the CFO must determine and fulfill the stockowners’ objectives. Otherwise, the stockholders may sell their shares, which in turn may lower the market price of the stock. Stockholder dissatisfaction raises the possibility that an outside group may acquire control of the company.
- It lowers stockholders’ equity since dividends reduce retained earnings and so results in a higher debt–equity ratio.
If your company’s cash flows and investment requirements are unstable, the CFO should not recommend a high regular dividend. It would be better to establish a low regular dividend that can be met even in bad years.
TYPES OF DIVIDEND POLICIES
What dividend policy is best for your company?
The company’s dividend policy should maximize owner wealth while providing adequate financing for the business. When the company’s profitability increases, the CFO does not automatically raise the dividend. Generally, there is a time lag between increased earnings and the payment of a higher dividend. The CFO should be optimistic that the increased earnings ...
