question_answer 23)

Explain factors affecting the dividend decision.

Answer:

Dividend decision relates to distribution of profit to the shareholders and its retention in the business for meeting the future investment requirements. How much of the profits earned by a company will be distributed as profit and how much will be retained in the business is affected by many factors. 'Some of the important factors are discussed as follows (i) Earnings Dividends are paid out of current and past year earnings. Therefore, earnings is a major determinant of the decision about dividend. (ii) Stability of Earnings Other things remaining the same, a company having stable earning is in a position to declare higher dividends. As against this, a company having unstable earnings is likely to pay smaller dividend. (iii) Growth Opportunities Companies having good growth opportunities retain more money out of their earnings so as to finance the required investment. The dividend in growth companies, is therefore, smaller than that in non-growth companies. (iv) Cash Flow Position Dividends involve an outflow of cash. A company may be profitable but short on cash. Availability of enough cash in the company is necessary for declaration of dividend by it. (v) Shareholder Preference If the shareholder in general, desire that at least a certain amount should be paid as dividend, the companies are likely to declare the same. (vi) Taxation Policy If tax on dividend is higher it would be better to pay less by way of dividends. As compared to this, higher dividends may be declared if tax rates are relatively lower. (vii) Stock Market Reaction For investors, an increase in dividend is a good news and stock prices react positively to it. Similarly, a decrease in dividend may have a negative impact on the share prices in the stock market. (viii) Access to Capital Market Large and reputed companies generally have easy access to the capital market and therefore, depend less on retained earnings to finance their growth. These companies tend to pay higher dividends than the smaller companies which have relatively low access to the market. (ix) Legal constraints Certain provisions of the Company's Act place restriction on payouts as dividend. Such provisions have to be adhered, while declaring dividends. (x) Contractual Constraints While granting loans to a company, sometimes the lender may impose certain restrictions on the payment dividends does not violate the terms and conditions of the loan agreement in this regard.