Factors Affecting Dividend Decision

The dividend decision is a difficult decision because of conflicting objectives and also because of lack of specific decision-making techniques. It is not easy to lay down an optimum dividend policy which would maximize the long-run wealth of the shareholders. The factors affecting dividend policy are grouped into two broad categories.

1. Ownership considerations
2. Firm-oriented considerations

Ownership considerations: Where ownership is concentrated in few people, there are no problems in identifying ownership interests. However, if ownership is decentralized on a wide spectrum, the identification of their interests becomes difficult.

Various groups of shareholders may have different desires and objectives. Investors gravitate to those companies which combine the mix of growth and desired dividends.

Firm-oriented considerations: Ownership interests alone may not determine the dividend policy. A firm's needs are also an important consideration, which include the following:

• Contractual and legal restrictions
• Liquidity, credit-standing and working capital
• Needs of funds for immediate or future expansion
• Availability of external capital.
• Risk of losing control of organization
• Relative cost of external funds
• Business cycles
• Post dividend policies and stockholder relationships.

The following factors affect the shaping of a dividend policy:

Nature of Business: Companies with unstable earnings adopt dividend policies which are different from those which have steady earnings.

Composition of Shareholding: In the case of a closely held company, the personal objectives of the directors and of a majority of shareholders may govern the decision. To the contrary, widely held companies may take a dividend decision with a greater sense of responsibility by adopting a more formal and scientific approach.

Investment Opportunities: Many companies retain earnings to facilitate planned expansion. Companies with low credit ratings may feel that they may not be able to sell their securities for raising necessary finance they would need for future expansion. So, they may adopt a policy for retaining larger portion of earnings.

Similarly, is a company has lucrative opportunities for investing its funds and can earn a rate which is higher than its cost of capital, it may adopt a conservative dividend policy.

Liquidity: This is an important factor. There are companies, which are profitable but cannot generate sufficient cash, since profits are to be reinvested in fixed assets and working capital to boost sales.

Restrictions by Financial Institutions: Sometimes financial institutions which grant long-term loans to a company put a clause restricting dividend payment till the loan or a substantial part of it is repaid.

Inflation: In period of inflation, funds generated from depreciation may not be adequate to replace worn out equipment. Under inflationary situation, the firm has to depend upon retained earnings as a source of funds to make up for the shortfall. Consequently, the dividend pay out ratio will tend to be low.

Other factors: Age of the company has some effect on the dividend decision.

The demand for capital expenditure, money supply, etc., undergo great oscillations during the different stages of a business cycle. As a result, dividend policies may fluctuate from time to time.

Q. What are the factors affecting dividend decisions of firm?