Dividend Policy

Dividend policy is the policy that the company adopts for paying out the dividends to the company’s shareholders, which includes the percentage of the amount at which the dividend is to be paid out to the stockholders and how frequently the amount is paid to the company.

Simply put, a dividend policy is a set of guidelines or rules that the company frames for distributing dividends in years of profitability. It enhances an investor's confidence during the dividend's distribution. Generally, listed companies draft their dividend policies and keep them on the website for the investors.

The above snapshot is an example of Telefonica.

1. Dividend policy refers to a set of principles or criteria the corporation defines for delivering dividends to its shareholders in years of profitability. It is a structure of rules that a company uses to distribute dividends to its shareholders.
2. A dividend policy is a public document and thus needs the following components, objective/vision while declaring the dividend, laws applicable concerning the dividends, utilization of retained earnings, etc. 
3. There are certain pros and cons to dividend policing. Perks are that the company’s intent becomes visible, and trends of dividends are readily available. However, some cons are that the constant dividend payout changes.

An ideal policy will give the following answers:

1. Why this policy?
2. What will the policy mean in practice?
3. What are the risks and constraints associated with this policy?
4. What was done in practice to deliver under the policy?

Under any law, there is no specified format provided that all companies have to follow.

It has the following components:

1. Objective, intention, and strategic vision while declaring the dividend
2. Laws applicable to companies concerning dividends
3. Discretion of the board for the declaration of dividends
4. The utilization of Retained earnings for distribution
5. The calculation process followed at the time of the declaration of the dividend.
6. Factors to be considered while calculating the profit and earnings available for shareholders
7. Revision and availability of the policy

An ideal policy should have the components mentioned above. Companies have to formulate the dividend policy based on their plans and policies, get it approved by investors, and keep it available for the public on their website.

Various dividend policies are based on the company's intent to distribute them. The payout ratio and intent to progress the dividend payment determine all the policies.

It can be a regular policy, stable policy, constant dividend per share, constant dividend payout ratio, etc. All the policies have their facts, which apply to suitable market scenarios.

“Dividends are only one part of the total return that investors receive, but for many, it is the most important part, and therefore good disclosure is fundamental.”

In the UK, in 2014, the Financial Reporting Council's Reporting Lab initiated Project Lab for the companies listed under UK stock exchanges. Under this, they urged all the listed companies to disclose the dividend policy and capacity adequately. It should also represent any constraints the company can face while declaring the dividend. Furthermore, they were required to disclose their strategic intent.

This project assists investors in the UK in understanding companies better, along with their current practices and future strategic aspects of the payout through the dividend. As per the project, about 40% of the companies covered gave information about distributable profits.

A dividend policy reflects management thinking. Based on this perception, investors can consider the given policy beneficial or detrimental.

However, the following are the advantages –

1. Investors will invest based on a company's fund requirements and earning strategy by checking the dividend policy. The intent of the company becomes visible: Suppose there is a company rigorously paying a dividend in the market. At the same time, there are companies whose primary intention is to plow back the funds and reinvest the same in their business.
2. Trends of the dividend payout will be readily available: Investors will need to verify the past movement of the company to declare the dividend. In this policy, it will be readily available. Hence, it will be a one-stop source of information about the dividends.

However, the following are the cons –

1. Deviation from the constant dividend payout: Any change in the dividend payout policy or trend will directly impact the company's market image. It guides an analyst, and any deviation may crash the prices of the shares.
2. Future borrowing of funds: As discussed above, this also guides the market and fund providers. Fund providers will always ensure that their funds are used for business purposes and not as dividends by getting distributed to promoters.

Any modification in the dividend policies will require the shareholders’ approval. In addition, if any material changes are undertaken from statutory requirements, it is necessary to intimate the concerned state department.

Such modifications affect the mindset of investors, analysts, and credit rating agencies. Hence, it is of utmost importance to remain alert and cautious while making changes in the policy. Moreover, such policy changes require strategic thinking duly supported by future business aspects.

In the market scenario, corporations will always try to provide policy guidelines in a highly generalized manner, giving insight to the investor. No specific transaction-related data is disclosed, and thus, no additional disclosure is needed to be added or modified in the future.

As per the Financial Reporting Council of the UK, dividend disclosures are fundamental to companies and investors as they are essential in demonstrating and assessing board stewardship and investment. In addition, such disclosures help comprehend the future strategic thinking and liquidity risks that companies can face. Also, investors can determine the fair value of a company’s shares concerning their market price. However, it is highly complex to determine the profit distributable by any company.

This article has been a guide to what Dividend Policy is. Here we discuss the critical components of dividend policy, practical examples, and its pros and cons. You can learn more about financing from the following articles –

• Final Dividend Meaning
• Homemade Dividends Definition
• Cash Dividend Meaning
• Dividends Ex-Date vs Record Date