CORPORATE FINANCIAL

MANAGEMENT

UNIT - 3
DIVIDEND
DECISION

Chethan.S
 Meaning of Dividend
The term dividend refers to that
part of the profits of a company
which is distributed amongst its
shareholders.
Dividend Process
 Dividend policy

The term dividend policy refers to

the policy concerning how much
profits to be distributed as dividend
and how much to be retained in the
business.
 Types of Dividend policy
1. STABLE DIVIDEND POLICY
2. REGULAR DIVIDEND
POLICY
3. IRREGULAR DIVIDEND
POLICY
4. NO DIVIDEND POLICY
 1. Stable dividend policy
The term ‘stability of dividend’ means consistency or lack of variability in the
stream of dividend payment. In more precise terms, it means payment of certain
minimum amount of dividend regularly. A stable dividend policy may be established in
any of the following forms:
a. Constant dividend per share: Some companies follow a policy of paying fixed
dividend per share irrespective of the level of earnings year after year. Such firms,
usually, create a ‘Dividend Equalization Reserve’ to enable them pay the fixed dividend
even in the year when the earnings are not sufficient or when there are losses. A policy
of constant dividend per share is most suitable to concerns whose earnings are expected
to remain stable over a number of years.
b. Constant payout ratio: It means payment of a fixed percentage of net earnings as
dividends every year. The amount of dividend in such a policy fluctuates in direct
proportion to the earnings of the company. This type of policy is suitable to concerns
whose profits are expected to increase over a number of years.
c. Stable rupee dividend plus extra dividend: Some companies follow a policy of
paying constant low dividend per share plus an extra dividend in the years of high
profits. Such a policy is most suitable to the firms having fluctuating earnings from year
to year.
2. Regular dividend policy
 Payment of dividend at the usual rate is termed as regular dividend. The
investors such as retired persons, widows and other economically weaker
persons prefer to get regular dividends. A regular dividend policy offers
the following advantages:
 It establishes a profitable record of the company.
 It created confidence amongst the shareholders.
 It aids in long-term financing and renders financing easier.
 It stabilizes the market value of shares.
 The shareholders view dividends as a source of funds to meet their day-
to-day living expenses.
3. Irregular Dividend Policy
 Some companies follow irregular dividend
payments on account of the following:
 Uncertainty of earnings.
 Unsuccessful business operations.
 Lack of liquid resources.
 Fear of adverse effects of regular dividends
on the financial standing of the company.
4. No dividend Policy

A company may follow a policy of paying no

dividends presently because of its un favorable
working capital position or on account of
requirements of funds for future expansion and
growth.
 Forms of Dividend
Cash dividend
Property dividend
Stock dividend or Bonus shares
Scrip or Bond dividend
 Forms of dividend
Dividends can be classified in various forms. They are:
 Cash dividend: A cash dividend is a usual method of paying dividend. Payment
of dividends in cash results in outflow of funds from the firm. The firm should,
therefore, have adequate cash resources at it disposal so that its liquidity position
is not adversely affected due to cash dividend.
 Scrip or Bond dividend: In case the company does not have sufficient cash to
pay dividend it may issue bonds for the amount due to the shareholders by way of
dividends. The purpose of bond dividend is to postpone the payment of
immediate dividend in cash. The bond holders get regular interest on their bonds
besides payment of the bond money on the due date. Bond dividend is not
popular in India.
 Property dividend: In case of property dividend the company pay dividend in the
form of assets which are not required by the company or in the form of company’s
products. This type of dividend is also not popular in India.
 Stock dividend or Bonus shares: In case of this dividend, the company issues its
own shares to the existing shareholders in lieu or in addition to cash dividend.
Payment of stock dividend is popularly termed as “issue of bonus shares” in India.
Factors affecting dividend policy
External factors
1. General state of economy
2. State of capital market
3. Legal restrictions
4. Contractual restrictions
5. Tax policy
Internal factors
1. Desire of the shareholders
2. Financial needs of the company
3. Nature of earnings
4. Liquidity position
 Factors affecting dividend policy
The factors affecting the dividend policy are classified into external and internal:

External factors
Following are the external factors which affect the dividend policy of a firm:
1. General state of economy: The general state of economy affects to a great extent
the management’s decision to retain or distribute earnings of the firm.
In case of uncertain economic and business conditions - the management may like
to retain the whole or a part of the firm’s earnings to build up reserves to absorb
shock in the future.
In periods of depression - the management may also like to retain a large part of its
earnings to preserve the firm’s liquidity position.
In periods of prosperity - the management may not be liberal in dividend payments
though the earning power of a company warrants it because of availability of larger
profitable investment opportunities.
In periods of inflation - the management retain larger proportion of the earnings for
replacement of worn-out assets.
2. State of capital market: In case a firm has an easy access to the
capital market either because it is financially strong or because
favourable conditions prevail in the capital market, it can follow a
liberal dividend policy (retains less and distributes more). However, if
the firm has no easy access to capital market because either of weak
financial position or because of unfavourable conditions in the capital
market. It is likely to adopt a more conservative dividend policy
(retain more and distribute less profits to equity shareholders).

3. Legal restrictions: In India Companies Act 1956 has put several

restrictions regarding payment and declaration of dividends.
i) Dividends can only be paid out of current profits or past profits or money
provided by the central government or state government. Payment of
dividend out of capital is illegal.
ii) Dividend should be paid only out of profits after providing for
depreciation and transferring to reserves not less than 10%.

4. Contractual restrictions: Lenders of the firm generally put restrictions

on dividend payment to protect their interest and capital repayment in
periods when the firm is experiencing liquidity or profitability
problems. For example it may be provided in a loan agreement that the
firm shall not pay dividend of more than 12% so long the firm does not
clear the loan.

5. Tax policy: The tax policy followed by the Government also affects the
dividend policy. For example the Government gives tax incentives to
companies retaining larger share of their earnings.
Internal factors
1. Desire of the shareholders: Of course, the directors of the company have
considerable freedom in declaring the dividend but the shareholders are
the real owners of the company and therefore, their desires should not be
overlooked by the directors while deciding about the divided policy.
2. Financial needs of the company: Shareholders’ desire and financial
needs of the company are two conflict issues while determining the
dividend policy. If company retains more profits, it may not meet the
desires of the shareholders.
3. Nature of earnings: A firm having stable income may follow higher
dividend payout ratio. For example Public Utility Companies like
Electricity Boards and Air lines carrying business purely on cash system
may pay higher dividends. Similarly Liquor Companies can follow
liberal dividend policy since people used to drink liquor both in boom as
well as in recession. But the companies which are engaged in Luxury
Goods may follow conservative dividend policy because of stiff
competition and low profits.
4. Desire of control: The company which follows low dividend payout
ratio does not dilute the control of the existing shareholders whereas the
company following high dividend payout ratio dilutes the control of the
existing shareholders as it issues new shares to acquire funds to finance
future finance requirements.

5. Liquidity position: The payment of dividends results in cash outflow

from the firm. A firm may have adequate earnings but it may not have
sufficient cash to pay dividends. It is therefore important for the
management to take into account the cash position and the overall
liquidity position of the firm before and after payment of dividends
while making dividend decision.
 BONUS SHARE
Bonus shares are the additional shares given to the
current shareholders of the company free of cost, in
proportion to their existing shareholding. Such an
event is called a Bonus Issue. Bonus shares are given
to the current shareholders in lieu of a dividend pay-
out.
 Advantages of Bonus Share
Issue of bonus shares is beneficial both to the company as well as to the shareholders.
To the company
1. Conservation of Cash: Issue of bonus shares makes possible for the company to declare
a dividend without using the cash resources that may be needed for operation or expansion.
The company can thus retain earnings as well as satisfy the desire of the shareholders to
receive dividend.

2. Keeps EPS at a Reasonable Level: A company having a high EPS may have to face
problems both from the workers and consumers. Workers may feel that they are underpaid
while consumers think that they are overcharged for the company’s products. Issue of
bonus shares results in increasing the number of shares and reducing the earning per share.
Thus, EPS can be brought down to a reasonable level without affecting the interest of the
shareholders.

3. Wider Marketability of shares: Issue of bonus shares reduces the market price of the
company’s shares and thus even it reaches to the small investors who cannot afford for
bigger price shares.
To the investors
1. Tax Benefits: When dividend is received in cash, it is included in his income
and taxed at usual income rates. However, stock dividend is not so taxable. The
profit made on the sale of shares will be deemed as a capital gain and will be
subject to lower rate of income tax.

2. Indication of Higher Future Profits: Issue of bonus shares is generally an

indication of higher future profits. This is because a company declares a bonus
issue only when its earnings are expected to increase.

3. Increase in Future Dividends: The shareholders will get extra dividends in

future even if the existing cash dividend per share is continued.

4. High psychological Value: Issue of bonus shares is usually received

positively in the market. This tends to create greater demand for the company’s
shares. As a matter of fact, the share prices of the company may rise on the
stock exchange after bonus issue in place of falling.
 Disadvantages of Bonus Share

To the company
1. Issue of bonus shares leads to an increase in the capitalization of the company
2. Issue of bonus shares results in more liability on the company in respect of
future dividends.
3. It prevents new investors from becoming the shareholders of the company.
4. Control of the existing shareholders is not diluted and the present management
may misuse its position.

To the investors
1. Shareholders who prefer cash dividend may disappoint.
2. Issue of bonus shares lowers the market value of existing shares too.
 
 Provisions under
companies Act in
relation to dividends
 Dividend: – Sec – 2(35) provides the definition
of dividend which states that dividend includes
any “interim dividend”. Where in simple terms,
dividend can be defined as the sum of money paid
by a company, to its shareholders, out of the
profits made by a company, in the proportion to
the amount paid-up on the shares held by them
(Sec-51).
 Now the question is who can declare dividend? Is
it applicable to all the companies?
 Well, subject to the provisions of Companies Act, 2013, All
Companies, except those companies which are registered
under sec-8 (i.e. Non-profit organizations) can declare
dividend.
 Under Companies Act – 2013, Chapter VIII containing
sections, which deals with the provisions related
to declaration and payment of dividend. Section – 123 to
127 deals with the provisions related to the declaration and
payment of dividend.
Provisions under companies Act
in relation to dividends
1. Provisions related to Declaration of dividend (Sec-
123)
2. Payment of Dividend
3. Interim Dividend
4. Unpaid Dividend Account (Sec- 124)
5. Punishment for failure to distribute dividend (Sec-127)
6. Procedure of Declaration and Payment of Dividend
1. Provisions related to Declaration of
dividend (Sec- 123)
♠ Dividend is to be declared by the company at its Annual General meeting on such rate as
may be recommended by board, and it has no power to declare dividend exceeding the
amount recommended by the board. Once declared, it becomes debt payable by the
company to its shareholders, who can sue the company for the non-payment of the
dividend.
A company cannot pass a resolution for the declaration of dividend, without passing a
resolution for the adoption of accounts. Hence, a company shall adopt its books of
accounts first and then only, entitled to declare the dividend.
♠ Sources of Dividend

The basic principle of declaration of dividend is that it shall be paid out of profits only.
However as per companies act dividend can be paid out of-
1) Current year’s profit of the company, or
2) Undistributed or accumulated profits of the previous years, or
3) Out of money provided by the Central Government or a State Government for the payment
of dividend by the company in pursuance of a guarantee given by that Government.
2. Payment of Dividend
According to the provisions of Companies Act – 2013, No dividend shall
be payable except by way of cash, where dividend payable in cash
can also be paid through cheque, warrant or in any electronic mode,
to the shareholder who is entitled to the dividend.

Condition: – A company who has committed any default in compliance

with the provisions of sec- 73 and 74 relating to the acceptance and
repayment of deposits would be barred to declare dividend.
3. Interim Dividend
 According to the provisions of section – 123(3), Board of directors of
a company may declare interim dividend during any financial year,
out of the profits made by the company during such financial year or
out of previous year undistributed profits (subject to Companies
(Declaration and Payment of Dividend) Rules, 2014) .

 As per Section- 2(35) “dividend includes interim dividend” signifies

that the provisions of Companies Act 2013, applicable to the final
dividend to the extent possible, shall also applicable on interim
dividend.
 4. Unpaid Dividend Account (Sec-
124)
There are some cases wherein, dividend declared by the company has not
been paid or claimed and in case where such dividend remained
unpaid or unclaimed within 30 days from the date of declaration;
company shall take the following necessary steps-
(a) Open a special account with a scheduled bank to be called “ Unpaid
dividend account of …………………….(Company
Limited/Company( Private) Limited”
(b) Transfer the unpaid or unclaimed amount of dividend within a period
of 7 days from the expiry of such 30 days, to the special account.
In case of default- If the company committed any default, in transferring
such amount to the special account with in the specified time,
company shall be liable to pay interest @ 12% p.a. from the date of
such default.
5. Punishment for failure to
distribute dividend (Sec-127)
According to the provisions of sec- 127 of the companies act – 2013,
if a company fails to pay the dividend, within a period of 30 days
from the date of its declaration, to the shareholders who are entitled to
the dividend then-
 6. Procedure of Declaration and
Payment of Dividend
(a) Issue at least 7 clear days notice of the meeting of Board of directors in
accordance with the sec- 173 of the companies Act – 2013.
(b) In case of listed companies, notify stock exchange(s) where the securities of
the company are listed, at least 2 working days in advance of the date of the
meeting
(c) Hold Board meeting and pass resolutions for following purposes-
 Approving the annual accounts (balance sheet and profit and loss account of
the company for the year ended);
 Recommending the final amount of dividend;
 Determining the date of book closure;
 Fixing the Day, Date, Time and Venue of AGM;
 Approving the notice of AGM;
 Authorizing the Company Secretary/Director to issue the notice of AGM;
 (d) In case of listed companies, give 7 days’ notice of book closure to the stock
exchanges.
(e) In case of listed company, publish notice of book closure in a newspaper
circulating in the district in which the registered office of the company is situated
at least seven days before the date of commencement of book closure.
(f) Close the register of members and the share transfer register of the company.
(g) Hold a Board/committee meeting for approving registration of transfer/
transmission of the shares of the company, which have been lodged with the
company prior to the commencement of book closure.
(h) Hold the annual general meeting and pass an ordinary resolution declaring the
payment of dividend to the shareholders of the company as per recommendation
of the Board.
(i) Prepare a statement of dividend in respect of each shareholder.
(j) Ensure that the dividend tax is paid to the tax authorities within the prescribed
time.
(k) Open a separate bank account for making dividend payment and credit the said
bank account with the total amount of dividend payable within five days of
declaration of dividend.
(l) If the company is listed, then for payment of dividend it has to mandatorily
use, either directly or through its Registrars to an Issue and Share Transfer
Agents (RTI & STA), any Reserve Bank of India approved electronic mode
of payment such as Electronic Clearing Services (ECS), National Electronic
Fund Transfer (NEFT), etc.
(m) Make arrangements with the bank and in collaboration with other banks if
required, for payment of the Dividend Warrants at par.
(n) Dispatch dividend warrants within thirty days of the declaration of dividend.
In case of joint shareholders, dispatch the dividend warrant to the first named
shareholder.
(o) Arrange for transfer of unpaid or unclaimed dividend to a special account
named “Unpaid dividend Account” within 7 days after expiry of the period of
30 days of declaration of final dividend. (Section 124).
(p) Transfer unpaid dividend amount to Investor Education and Protection Fund
(IEPF) after the expiry of seven years from the date of transfer to unpaid
dividend A/c.