Dividend Policy
Dividend Theory
1. Discuss the factors which may impact on a firm’s dividend policy? .Industry and Company Variations Payout ratios vary amongst different industries e.g. firms within the telecoms and utilities sectors may typically payout around 60% of earnings in dividends, whilst retailers and computer software companies may typically payout around 20% of earnings in dividends Legal Constraints 1. Legal constraints can be viewed in the context of three broad areas; 2. it is illegal to use the firm’s capital to make dividend payments, 3. dividends must be paid out of present and past net earnings, 4. dividends cannot be paid when the firm is insolvent Restrictive Covenants These tend to have more impact on dividend policy than legal constraints. The covenants effectively restrict the amount of dividend that can be paid to ensure that debt is serviced appropriately. They are included in loan agreements, lease contracts and bond agreements. They can often specify that dividends can only be paid once earnings reach an agreed Tax The tax laws which shareholders are subject to can determine whether they would prefer dividend income or capital gains. In some instances, the tax rate on dividend income may be higher than that on capital gains. Also, dividends tend to be taxed immediately, whereas capital gains tax may be deferred into the future. Liquidity and Cash Flow Considerations Clearly the more liquid a firm is the more able it is to pay dividends. Many rapidly growing firms faced with potentially profitable investment opportunities may have difficulties maintaining liquidity and paying dividends at the same time and may favour retention. Borrowing Capacity A company’s ability to borrow can give it flexibility in relation to the payment of dividends. The more access a firm has to the variety of borrowing opportunities available , the better able it will be to
1. Discuss the factors which may impact on a firm’s dividend policy? .Industry and Company Variations Payout ratios vary amongst different industries e.g. firms within the telecoms and utilities sectors may typically payout around 60% of earnings in dividends, whilst retailers and computer software companies may typically payout around 20% of earnings in dividends Legal Constraints 1. Legal constraints can be viewed in the context of three broad areas; 2. it is illegal to use the firm’s capital to make dividend payments, 3. dividends must be paid out of present and past net earnings, 4. dividends cannot be paid when the firm is insolvent Restrictive Covenants These tend to have more impact on dividend policy than legal constraints. The covenants effectively restrict the amount of dividend that can be paid to ensure that debt is serviced appropriately. They are included in loan agreements, lease contracts and bond agreements. They can often specify that dividends can only be paid once earnings reach an agreed Tax The tax laws which shareholders are subject to can determine whether they would prefer dividend income or capital gains. In some instances, the tax rate on dividend income may be higher than that on capital gains. Also, dividends tend to be taxed immediately, whereas capital gains tax may be deferred into the future. Liquidity and Cash Flow Considerations Clearly the more liquid a firm is the more able it is to pay dividends. Many rapidly growing firms faced with potentially profitable investment opportunities may have difficulties maintaining liquidity and paying dividends at the same time and may favour retention. Borrowing Capacity A company’s ability to borrow can give it flexibility in relation to the payment of dividends. The more access a firm has to the variety of borrowing opportunities available , the better able it will be to