Question

Compare and contrast a sticky dividend policy with a residual dividend policy. Which policy is more widely used by large corporations? What advantages does that policy have over the other?

Answer 1

When we say sticky dividend policy it means that companies do not change their dividend policy very frequently and they stick with their dividend policy. Let’s say a company has been paying a dividend of $0.50 per share annually and every year it grows at 5%, the company would choose to stick with the dividend growth most of the time, even in certain years where its performance is not good. Residual dividend policy is when the company pays dividend after it had taken the capital expenditure from the net income and the residual is paid as dividend to the stock holders. The major difference between the sticky dividend policy and residual dividend policy is in sticky the dividend grows at a fixed rate and can be easily forecasted while in residual it can differ significantly from year to year. Most large corporation follow a sticky dividend policy because change in dividends affects the investors interest towards the company stock price and investor might perceive the company as riskier if there is sudden cut in the dividend. The Sticky dividend policy conveys that the company is generating enough cash flows each year so its business model is stable and not being disrupted. This dividend policy also assures the investors that company is doing well and not becoming riskier.