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Home > Balance Sheets Checklists > Setting Up a Dividend Policy

Balance Sheets Checklists

Setting Up a Dividend Policy


Checklist Description

This checklist describes how to set up and maintain a dividend policy.

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Definition

A dividend is a payment made to a stockholder by a company from any earned profits (i.e. not from any other surplus). Companies generally use profit for two things—to reward stockholders for investing in the company or to reinvest in the business (known as retained earnings). Most companies generally reinvest a portion of the profit and pay out the rest in dividends. From the company’s perspective, the payment of dividends is the division of an asset among stockholders.

Dividends are paid out on after-tax income, although the dividends received by stockholders are usually treated as taxable income for tax purposes, depending on their country of residence. Dividends are usually settled on a cash basis, although payment often is in the form of a check. However, many companies pay dividends in the form of additional shares or offer a dividend reinvestment program that enables stockholders to use the cash dividend to buy more shares in the company.

The dividend is normally paid out as a fixed amount per share. Thus, each stockholder receives a dividend in proportion to his or her holding. Most companies pay dividends on a fixed schedule, such as quarterly, half-yearly, or annually. However, a company can declare a dividend whenever it chooses—this is usually known as a special dividend to distinguish it from the regular payouts.

When setting up your dividend policy, key decisions will be how frequently to pay out, what percentage of profit to distribute among stockholders, and whether you will offer them other options, such as stocks in lieu of cash. Once the policy is in place, it needs to be communicated clearly to all stockholders so that they know how often and in what form dividends will be distributed. Policies can always be amended. For example, if the company’s profits are badly hit one year, the board may decide not to pay dividends but to reinvest all the profit in the hope of better subsequent profits.

It is usual to publish the policy as a distinct corporate document for distribution in printed form. Many companies also publish the dividend policy on their websites. Amendments to the policy should be distributed in the same way.

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Advantages

  • Having a clear and transparent policy is essential for attracting stockholders. They are putting trust into a company by investing in it, and the company returns that trust by being open about what investors can expect to receive in return.

  • It is also important that any changes to the dividend policy, whether temporary or permanent, are communicated clearly and in a timely fashion to stockholders.

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Disadvantages

  • The only real disadvantage of a dividend policy is that some stockholders may be exposed to double taxation. In such a situation, stock repurchases may be more efficient if the tax rate for capital gains is lower.

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Action Checklist

  • Determine how frequently you will pay out dividends. Be realistic about this—don’t announce quarterly dividends if you know the cash flow patterns mean that a payout can only be made half-yearly.

  • Have your policy written up professionally by someone experienced in the field.

  • Ensure that the policy document is checked for compliance with all relevant financial regulations and laws in your territory of jurisdiction.

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Dos and Don’ts

Do

  • Keep the dividend policy up to date and ensure that stockholders receive regular mailings about any changes.

  • Inform stockholders well in advance of each payment date what percentage of profit the payout will be.

Don’t

  • Don’t amend dividend policy without good reason or telling your stockholders why.

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Further reading

Books:

  • Baker, H. Kent. Dividend Policy: Its Impact on Firm Value. Hoboken, NJ: Wiley, 2009.
  • Frankfurter, George M., and Bob G. Wood, with James Wansley. Dividend Policy: Theory and Practice. San Diego, CA: Academic Press, 2003.
  • Manos, Ronny. Capital Structure and Dividend Policy: Evidence from Emerging Markets. Saarbrücken, Germany: VDM Verlag, 2008.

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