Question

Dividend policy is influenced by (1) the desire of a company for growth; (2) the difficulty of obtaining funds from other sources; and (3) the perceived preference of shareholders for dividend income. Discuss.

Answer 1

Answer:

Dividend policy is influenced by :

1. The desire of a company for growth : the growth of any company is directly related to the retention ratio of earnings and the return on equity. Growth = (1 - dividend payout) x return on equity; (1 - dividend payout) = retention ratio; Therefore, a lower amount of dividend paid will result in higher retention ratio and thus higher growth.

2. The difficulty of obtaining funds from other sources :

A company, for the new project or investment would prefer its retained earnings as a source of capital rather than obtaining funds from other sources which has element of high cost and risk. Thus, retained earnings are important source of capital and it increases by lowering the dividend payout.

3. The perceived preference of shareholders for dividend income :

Regular dividend payout brings trust in shareholders and other stakeholders. A good dividend policy will attract more investors as it stimulates the market and the share price. Investors who are dependent on dividend income, shall invest in regular dividend paying stocks.

Hence, it is evident that all the above factors influences the dividend policy of a company.

Hope the above clarifies. Thanks!