A dividend is a proportion of a company's earnings that is paid out to shareholders. The dividend policy is what determine this amount. Dividend policies can vary considerably between businesses, with one company adopting a very different strategy to the deployment of their excess capital than another. The policy will be affected by factors both internal and external to the company.
The general state of the national and international economy will impact upon a company's dividend policy. If the economy is good, with GDP rising, a company will have generated a good level of profits that it is willing to distribute to shareholders. Alternatively, with prospects looking good, shareholders may be more willing to leave their investment in the company to take advantage of future opportunities. When the economy is bad, dividend policy tends to favour reducing dividend payouts to preserve capital against further economic deterioration.
The state of the specific market in which a company operates can also affect dividend policy. If the market is good, with new customers secured and performance outdoing that of competitors, dividend policy favours higher payouts. If the market is tough, dividends are kept low to enable capital to be used to further the company's aims.
Different types of shareholders have different expectations of dividend policy when they invest in shares. This attitude to dividends will be a factor in determining which shares they hold in their portfolio. A retiree who is using the stock market to fund or augment a pension is likely to favour stocks that give high dividends. A young stockbroker will favour lower dividend companies as he will be looking for long-term capital growth and will likely have other sources of income. A cautious investor looks for high dividends as capital gains are less predictable.
Legal and governmental regulations can affect dividend policy. This is particularly true in highly regulated industries, where governments might restrict dividend payouts to ensure companies use capital to meet safety standards or to encourage certain types of research and growth. National taxation policies that affect how much tax a company pays will also have an impact upon dividend policy.
A company's management structure is another internal factor affecting dividend policy. If managers receive bonuses for company performance, or hold a large number of shares in the company, they tend to favour a policy that sees excess capital reinvested in the company to promote further growth. If managers have fewer incentives predicated on growth, shareholders might expect a higher dividend as a safeguard against managerial complacency.
Stability of income
If a company has a stable income, its dividend policy is likely to favour higher dividends. With a stable income, a certain amount of capital can be reserved to pay a dividend without impacting upon the capital needs of the company. This is particularly true if future earnings can be reasonably accurately predicted. Dividends can be paid without risking a cash shortage in the future.
A company may have a high profit margin on paper, but its liquidity position will affect its ability to pay a dividend. This could be due to the terms of repayment to its suppliers or in payment for the sale of its goods.