Dividend Decisions

The financial manager must take careful decisions on how the profit should be distributed
among shareholders. It is very important and crucial part of the business concern, because
these decisions are directly related with the value of the business concern and shareholder’s
wealth. Like financing decision and investment decision, dividend decision is also a major
part of the financial manager. When the business concerns decide dividend policy, they
have to consider certain factors such as retained earnings and the nature of shareholder of
the business concern.
Meaning of Dividend
Dividend refers to the business concerns net profits distributed among the shareholders. It
may also be termed as the part of the profit of a business concern, which is distributed
among its shareholders.
According to the Institute of Chartered Accountant of India, dividend is defined as
“a distribution to shareholders out of profits or reserves available for this purpose”.

Dividend may be distributed among the shareholders in the form of cash or stock. Hence,
Dividends are classified into:
A. Cash dividend
B. Stock dividend
C. Bond dividend
D. Property dividend

Irrelevance of Dividend
According to professors Soloman, Modigliani and Miller, dividend policy has no effect
on the share price of the company. There is no relation between the dividend rate and
value of the firm. Dividend decision is irrelevant of the value of the firm. Modigliani and
Miller contributed a major approach to prove the irrelevance dividend concept.
Modigliani and Miller’s Approach

According to MM, under a perfect market condition, the dividend policy of the company is
irrelevant and it does not affect the value of the firm.
“Under conditions of perfect market, rational investors, absence of tax discrimination
between dividend income and capital appreciation, given the firm’s investment policy, its
dividend policy may have no influence on the market price of shares”.
MM approach is based on the following important assumptions:
1. Perfect capital market.
2. Investors are rational.
3. There are no tax.
4. The firm has fixed investment policy.
5. No risk or uncertainty.

According to this concept, dividend policy is considered to affect the value of the firm.
Dividend relevance implies that shareholders prefer current dividend and there is no direct
relationship between dividend policy and value of the firm. Relevance of dividend concept
is supported by two eminent persons like Walter and Gordon.

Profitable Position of the Firm
Dividend decision depends on the profitable position of the business concern. When the
firm earns more profit, they can distribute more dividends to the shareholders.
Uncertainty of Future Income
Future income is a very important factor, which affects the dividend policy. When the
shareholder needs regular income, the firm should maintain regular dividend policy.
Legal Constrains
The Companies Act 1956 has put several restrictions regarding payments and declaration
of dividends. Similarly, Income Tax Act, 1961 also lays down certain restrictions on payment
of dividends.

Liquidity Position
Liquidity position of the firms leads to easy payments of dividend. If the firms have high
liquidity, the firms can provide cash dividend otherwise, they have to pay stock dividend.
Sources of Finance
If the firm has finance sources, it will be easy to mobilise large finance. The firm shall not
go for retained earnings.
Growth Rate of the Firm
High growth rate implies that the firm can distribute more dividend to its shareholders.
Tax Policy
Tax policy of the government also affects the dividend policy of the firm. When the
government gives tax incentives, the company pays more dividend.
Capital Market Conditions
Due to the capital market conditions, dividend policy may be affected. If the capital market
is prefect, it leads to improve the higher dividend.