Dividend policies and consequences of changing

Dividend policies are crucial to a company and the relations with their shareholders and investors. Investors and shareholders have a great interest in these policies as they relate directly to the returns on the capital they have invested in a company. In terms of what policy the company will use they must decide on the value they will pay out to shareholders; this decision must be taken with caution because a policy set too high and the company may not have the finances to satisfy the payments, too low and shareholders may recognise they are not being appropriately rewarded.

Residual Dividend Policy

This policy is concerned with debt and equity; a company using this method will have a strict debt to equity ratio that it must maintain and therefore will use internally generated equity to finance any new projects. The dividend amount in this case is decided by the leftover value of equity after the project's financial requirements have been met, the downside of this policy is that if there is no spare capital post project completion there will not be any dividend value to pay and therefore a company's ability to generate its own internal equity is extremely important to keeping good relations with investors and having a hopeful future in taking on new investors. This policy does however help a business with its long term dividend policy.

Constant Growth Dividend

This policy is popular with shareholders due to agreement of growth year on year hence a boost in returns for the shareholders. On the other hand, the company must be careful what they promise shareholders in terms of their capability to grow. A company may use this method which keeps shareholders happy, the problem arises if the company does not earn as much money as it hoped to in order to pay out the increasing dividends. Two problems arise from this lack of success in its own policy: firstly they can suffer financial problems as they pay out dividends which in reality they cannot afford and secondly, the shareholders may lose confidence in the company as they witness the problem of paying out an increasing rate of dividend, which may only worsen as the years go on. On the positive side of this agreement is the benefits it can have with shareholder satisfaction assuming the company can match the increasing payout.

Constant Payout Dividend

Similar to a constant growth in that it should guarantee a payout for the shareholders but this policy agrees a constant amount that will be paid to shareholders each year without having any arrangement of growth in dividends. This has the advantages of keeping shareholders happy with their payouts on investments and also does not put too much pressure on the company to keep growing their revenue in order to increase their dividends each year.

Consequences of changing a policy

Shareholders enjoy a consistent policy when it comes to dividends which creates certainty when it comes to receiving payouts on their investments, a successful dividend policy will create a confidence amongst new investors who will be interested in the company for the future. This is a delicate position though; if a company has promised an increase in dividends each year as part of a policy change and suddenly realise the funds are not there for that rate of payout it creates tension and uncertainty within the business. On the other side of this, if the new dividend payout rate is not high enough and not in line with earnings then the rate is too low and greater dividends could and arguably should be paid to shareholders. The recent financial crisis has caused some companies to hold back on dividend payouts and this trend can also be seen in companies engaged in a merger or takeover.