Question

Discuss the key factors a corporation must consider when establishing its dividend policy. How does a company decide whether cash dividends, stock dividends, stock repurchases, or no dividends at all are the appropriate course of action? Why might investors prefer one of these options over others?

Answer 1

The key factors, is the profitability of the company. If the company chooses a fixed dividend payment, then the company has to pay dividend even when there are losses. On the other hand, if the company wants to keep the net income for future growth, then there are no dividend payments. Some factors to consider are:

1. Profitability of the company on a long term basis

2. The shareholder's wealth maximization - if company can maximize wealth by keeping the cash it can choose not to pay dividends.

3. If the business cannot make full use of the cash, then it’s better to pay the dividends to the shareholders.

Based on the current scenario, the company decides the manner of dividends. If there is a lot of cash sitting idle in the books of account, the business can decide to pay cash dividends. On the other hand, if the cash reserves are running low, the company may decide a stock dividend.

Investor's preference to dividends depends on the individual. If the individual investor is in the higher income tax bracket, he may prefer a stock dividend and on the other hand if an investor relies on dividends for living expenses, he may prefer regular cash dividends. So based on the individual needs of the investors, they choose a particular option.