Question 4

Explain the factors affecting dividend decision?

Answer

The factors that affects the dividend decisions are:

Amount of Earnings: Dividends are paid out of current and past earnings. Thus, earnings are major determinant of dividend decision.
Stability in Earnings: A company having higher and stable earnings can declare higher dividends than a company with lower and unstable earnings.
Stability of Dividends: Generally, companies try to stabilize dividends per share. A steady dividend is given each year. A change is only made, if the company’s earning potential has gone up and not just the earnings of the current year.
Growth Opportunities: Companies having good growth opportunities retain more money out of their earnings so as to finance the required investment. The dividend declared in growth companies is, therefore, smaller than that in the non-growth companies.
Cash Flow Position: Dividend involves an outflow of cash. Availability of enough cash is necessary for payment or declaration of dividends.
Shareholders’ Preference: While declaring dividends, management must keep in mind the preferences of the shareholders. Some shareholders in general desire that at least a certain amount is paid as dividend. The companies should consider the preferences of such shareholders.
Taxation Policy: If the tax on dividends is higher, it is better to pay less by way of dividends. But if the tax rates are lower, higher dividends may be declared. This is because as per the current taxation policy, a dividend distribution tax is levied on companies. However, shareholders prefer higher dividends, as dividends are tax free in the hands of shareholders.
Stock Market Reaction: Generally, an increase in dividends has a positive impact on stock market, whereas, a decrease or no increase may have a negative impact on stock market. Thus, while deciding on dividends, this should be kept in mind.
Access to capital market: Large and reputed companies generally have easy access to the capital market and, therefore, may depend less on retained earnings to finance their growth. These companies tend to pay higher dividends than the smaller companies.
Legal Constraints: Certain provisions of the Companies Act, place restrictions on payouts as dividend. Such provisions must be adhered to, while declaring the dividend.
Contractual Constraints: While granting loans to a company, sometimes, the lender may impose certain restrictions on the payment of dividends in future. The companies are required to ensure that the dividend payout does not violate the loan agreement in this regard.

Explain the factors affecting dividend decision?

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