Domestic Dividend Policy

ACCA P4考試：Domestic Dividend Policy

A parent company must decide whether group profits should be returned to investors as a dividend or retained in the business for reinvestment into new projects. Many different policies and theories are available:

1 Stable Dividend

■ Stable level of dividends or constant level of growth to avoid sharp movements in share price.

■ Maintains the level of dividends in the face of fluctuating earnings.

■ A common approach for quoted companies (as the financial markets like a stable dividend profile).

2 Constant Payout Ratio

■ Constant proportion of earnings paid out as dividend.

■ This is not particularly suitable for quoted companies as dividends will fluctuate (which can cause a volatile share price).

3 Residual Dividend Policy

■ Remaining earnings, after funding all attractive projects, are paid out as dividend:

■ dividend = operating cash flow – interest – tax – capital expenditure

■ This links to Pecking Order Theory (i.e. a dividend is only paid if more cash is available than required for reinvestment back into the business).

■ However, it is likely to lead to fluctuating dividends and may not be particularly suitable for quoted companies. Shareholders must fully understand the policy and have confidence in the investment criteria adopted by the company.

4 Clientele Theory

■ The company's historical dividend policy may have attracted particular investors to whom the policy is suited in terms of tax, need for current income, etc.

■ The company should then maintain a stable dividend policy or risk losing key investors.

■ Management should view shareholders as their "clientele".

5 Bird-in-the-Hand Theory

■ Shareholders may prefer higher dividends (and therefore lower potential capital gains) as a cash dividend today is without risk whereas future share price growth is uncertain.

■ This theory can be challenged, as when a share moves from cum-div to ex-div its price falls by a certain amount (i.e. the amount of dividend).