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DIVIDEND AND DIVIDEND POLICY

Presentation · January 2017

DOI: 10.13140/RG.2.2.13699.58401

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 DIVIDEND AND DIVIDEND POLICY

BY

GWASKA DASPAN MIKE

(UJ/2016/PGMS/0235)

BEING AN ASSIGNMENT ON: CORPORATE FINANCE (ACC 804)

SUBMITTED TO: PROFESSOR A. A. OKWOLI

In Partial Fulfillment of the Requirement for the Award of the Masters of Sciences
Degree (MSc.) in Accounting and Finance, Accounting Department, Faculty of
Management Sciences, University of Jos.

APRIL 2017

1
TABLE OF CONTENTS
1.0 Introduction--------------------------------------------------------------------2
1.1 Objectives of the study-------------------------------------------------------2
1.2 Definition of Dividend-------------------------------------------------------2
1.3 Definition of Dividend Policy ----------------------------------------------3
1.4 Types of Dividends-----------------------------------------------------------4
1.5 The Dividend Decision-------------------------------------------------------5
1.6 Dividend Payment Procedure------------------------------------------------7
1.7 Dividend Policy Theories----------------------------------------------------8
1.8 Dividend Models-------------------------------------------------------------11
1.9 Types of Dividend Policies--------------------------------------------------13
1.10 Stable dividend policy: A policy of dividend smoothing----------------15
1.11 Steps to be followed in setting dividends----------------------------------18
1.12 Dividend and a firm's life cycle---------------------------------------------18
1.13 Measures of Dividend Policy------------------------------------------------18
1.14 Determinants of Dividend Payout-------------------------------------------19
1.15 Conclusion---------------------------------------------------------------------20
1.16 References---------------------------------------------------------------------20

2
1.0 INTRODUCTION
Once a company makes a profit, it must decide on what to do with those profits. They
could continue to retain the profits within the company, or they could pay out the profits to the
owners of the firm in the form of dividends. The dividend policy decision involves two
questions:
i. What fraction of earnings should be paid out, on average, over time? And,
ii. What type of dividend policy should the firm follow? I.e. issues such as whether it should
maintain steady dividend policy or a policy increasing dividend growth rate etc.
On the other hand, Management has to satisfy various stakeholders from the profit. Out of the
Stakeholders priority is to be given to equity share -holders as they are being the highest risk.
1.1 OBJECTIVE OF THE PAPER
The basic objective of this study to look into:
i. What dividend is all about and its types, dividend decision and procedures
ii. The dividend policies, it theories and types
iii. The various models of dividend
iv. Dividend in relation to a firm's life cycle
v. The measures of dividend that can be used by companies
1.2 DEFINITION OF DIVIDEND
As per the section 9 (3) of the Company Income Tax Act,1 dividend defined as: -
a. In relation to a company not being in the process of being wound up or liquidated, any profits
distributed, whether such profits are of a capital nature or not, including an amount equal to
the nominal value of bonus shares, debentures or securities awarded to the shareholders and
b. In relation to a company that is being wound up or liquidated, any profits distributed whether
in money or money's worth or otherwise, other than those of a capital nature earned before or
during the winding up or liquidation.
"The term dividend refers to that portion of profit (after tax) which is distributed among the
owners/ shareholders of the firm." 2
"Dividend may be defined as the return that a shareholder gets from the company, out of its
profits, on his shareholdings." 3

3
 In other words, dividend is that part of the net earnings of a corporation that is distributed to its
stockholders. It is a payment made to the equity shareholders for their investment in the company.
Dividend is the payment received by a shareholder from a company after distribution of profit.
Dividend is a reward to equity shareholders for their investment in the company. It is a basic
right of equity shareholders to get dividend from the earnings of a company. Their share
should be distributed among the members within the limit of an act and with rational behavior of
directors.
1.3 DEFINITION OF DIVIDEND POLICY
"Dividend policy determines the ultimate distribution of the firm's earnings between retention (that
is reinvestment) and cash dividend payments of shareholders." 4
"Dividend policy means the practice that management follows in making dividend payout
decisions, or in other words, the size and pattern of cash distributions over the time to
shareholders." 5
In other words, dividend policy is the firm's plan of action to be followed when dividend
decisions are made. It is the decision about how much of earnings to pay out as dividends versus
retaining and reinvesting earnings in the firm.
Dividend policy means policy or guideline followed by the management in declaring of dividend.
A dividend policy decides proportion of dividend and retains earnings. Retained earnings are an
important source of internal finance for long-term growth of the company while dividend reduces
the available cash funds of company.
"As long as the firm has investment project whose returns exceed its cost of capital, it will use
retained earnings to finance these projects". 6
There is a reciprocal relationship between retained earnings and dividend i.e. larger the retained
earnings, lesser the dividend and smaller the retained earnings, larger the dividend.
James E. Walter (1963) says "Choice of dividend policy almost effects the value of the
enterprise” 7
"Dividend policy must be evaluated in light of the objective of the firm namely, to choose a
policy that will maximize the value of the firm to its shareholders" Financial Management
and Policy. 8

4
 As we know in corporation, owners are shareholders but management is done through Board of
directors. It is the Board of Directors to decide whether to pay dividend or retain earnings for future
projects. It is a matter of conflict between shareholders and directors. Shareholders expect a quick
return on their capital. On the other hand, directors have to consider a number of factors in
determining divided policy.
Investors must keep an eye on the company's dividend policy for most companies regular boosts
in the face of irregular earnings can be a warning signal. So can the refusal of Management to
lower dividends when earning fall or capital requirement rise. Companies with high dividend and
rising debt may be borrowing money to pay shareholders. For investors who are seeking stock that
will advance on their performance and earning and earnings per share, lower dividend may
mean high returns. (Adopted from the Quality of earnings - Thornton O. Glove 1987)
The dividend policy of a company reflects how prudent its financial management is. The
future prospects, expansion, diversification mergers are effected by dividing policies and for
a healthy and buoyant capital market, both dividends and retained earnings are important
factors.
Most of the company follows some kind of dividend policy. The usual policy of a company is to
retain a position of net earnings and distribute the remaining amount to the shareholders. Many
factors have to be evaluated before forming a long-term dividend policy.
1.4 TYPES OF DIVIDENDS
Classifications of dividends are based on the form in which they are paid. Following given below
are the different types of dividends:
A. Cash dividend
Companies mostly pay dividends in cash. A Company should have enough cash in its bank
account when cash dividends are declared. If it does not have enough bank balance, arrangement
should be made to borrow funds.
When the Company follows a stable dividend policy, it should prepare a cash budget for the
coming period to indicate the necessary funds, which would be needed to meet the regular dividend
payments of the company. It is relatively difficult to make cash planning in anticipation of
dividend needs when an unstable policy is followed.

5
 The cash account and the reserve account of a company will be reduced when the cash
dividend is paid. Thus, both the total assets and net worth of the company are reduced when the
cash dividend is distributed. The market price of the share drops in most cases by the
amount of the cash dividend distributed.
B. Bonus Shares : (or Stock -dividend in USA)
An issue of bonus share is the distribution of shares free of cost to the existing shareholders, In
India, bonus shares are issued in addition to the cash dividend and not in lieu of cash dividend.
Hence, Companies in India may supplement cash dividend by bonus issues. Issuing bonus shares
increases the number of outstanding shares of the company. The bonus shares are distributed
proportionately to the existing shareholder. Hence there is no dilution of ownership.
The declaration of the bonus shares will increase the paid-up Share Capital and reduce the
reserves and surplus retained earnings) of the company.
The total net-worth (paid up capital plus reserves and surplus) is not affected by the bonus issue.
Infect, a bonus issue represents a recapitalization of reserves and surplus. It is merely an
accounting transfer from reserves and surplus to paid up capital.
The following are advantages of the bonus shares to shareholders:
i. Tax benefit: One of the advantages to shareholders in the receipt of bonus shares is the
beneficial treatment of such dividends with regard to income taxes.
ii. Indication of higher future profits: The issue of bonus shares is normally interpreted
by shareholders as an indication of higher profitability.
iii. Future dividends may increase: if a Company has been following a policy of paying a fixed
amount of dividend per share and continues it after the declaration of the bonus issue, the
total cash dividend of the shareholders will increase in the future.
iv. Psychological Value: The declaration of the bonus issue may have a favorable psychological
effect on shareholders. The receipt of bonus shares gives them a chance sell the shares
to make capital gains without impairing their principal investment. They also associate it
with the prosperity of the company.

6
 C. Special dividend
In special circumstances Company declares Special dividends. Generally company declares special
dividend in case of abnormal profits.
D. Extra- dividend
An extra dividend is an additional non-recurring dividend paid over and above the regular
dividends by the company. Companies with fluctuating earnings payout additional dividends
when their earnings warrant it, rather than fighting to keep a higher quantity of regular
dividends.
E. Annual dividend
When annually company declares and pay dividend is defined as annual dividend.
F. Interim dividend
During the year any time company declares a dividend, it is defined as Interim dividend.
G. Regular cash dividends
Regular cash dividends are those the company exacts to maintain every year. They may be paid
quarterly, monthly, semiannually or annually.
H. Scrip dividends
These are promises to make the payment of dividend at a future date, Instead of paying the
dividend now, the firm elects to pay it at some later date.
The ‘scrip’ issued to stockholders is merely a special form of promissory note or notes payable
I. Liquidating dividends
These dividends are those which reduce paid-in capital: It is a pro-rata distribution of cash or
property to stockholders as part of the dissolution of a business.
J. Property dividends
These dividends are payable in assets of the corporation other than cash. For example, a firm
may distribute samples of its own product or shares in another company it owns to its stockholders.
1.5 THE DIVIDEND DECISION
Who Makes Dividend Decision?
The company's Board of Directors makes dividend decisions. They are faced with the decision to
pay out dividends or to reinvest the cash into new projects.9

7
 The tradeoff between paying dividends and retaining profits within the company The dividend
policy decision is a trade-off between retaining earnings v/s paying out cash dividends.
Dividend policies must always consider two basic objectives:
i. Maximizing owners' wealth
ii. Providing sufficient financing
While determining a firm's dividend policy, management must find a balance between current
income for stockholders (dividends) and future growth of the company (retained earnings).
In applying a rational framework for dividend policy, a firm must consider the following two
issues: 10
i. How much cash is available for paying dividends to equity investors, after meeting all
needs-debt payments, capital expenditures and working capital (i.e. Free Cash Flow to
Equity - FCFE)
ii. To what extent are good projects available to the firm (i.e. Return on equity -ROE > Required
Return).
1.6 DIVIDEND PAYMENT PROCEDURES
The firm's board of directors normally meets quarterly to evaluate financial performance and
decide whether, and in what amount, dividends should be paid. If dividend is to be paid the
declaration date, record date etc. have to be established.
Significant dates

Declaration Record payment Cum-dividend Ex- dividend

Figure: 3.2 Dividend Payment Dates

Declaration date: This is the day on which the board of directors declares a payment of dividend.
Date of Record: This is the day on which all persons whose names are recoded as
stockholders will receive the dividend.
Payment date: The dividend checks are mailed to shareholders of record.
Cum Dividend date: This is the last day on which the buyer who buys the stock is entitled
to get the dividend.

8
 Ex-Dividend date: Shares become ex dividend on the date seller is entitled to keep the dividend.
This is the first date on which the buyer who buys the stock is not entitled to dividend.
1.7 DIVIDEND POLICY THEORIES:
Over the time various theories of dividend policy have emerged; some of the main theories are as
follows:
A. THE RESIDUAL THEORY OF DIVIDEND POLICY:
The residual theory of dividend policy holds that the firm will only pay dividend from residual
earnings, that is dividends should be paid only if funds remain after the optimum level of
capital expenditures is incurred i.e. all suitable investment opportunities have been financed.
With a residual dividend policy, the primary focus of the firm is on investments and hence
dividend policy is a passive decision variable. The value of a firm is a direct function of
its investment decisions thus making dividend policy irrelevant.
B. DIVIDEND IRRELEVANCY THEORY, (Miller & Modigliani, 1961)11
The dividend irrelevancy theory asserts that dividend policy has no effect on either the price of the
firm or its cost of capital.
Dividend Irrelevance Arguments
Dividend policy does not affect share price because the value of the firm is a function of its
earning power and the risk of its assets. If dividends do affect value, it is only due to:
a. Information effect: The informational content of dividends relative to management's
earnings expectations.
b. Clientele effect: A clientele effect exists which allows firms to attract shareholders whose
dividend preferences match the firm's historical dividend payout patterns.
A study conducted by Aswath Damodaran12 found that:
a) Older investors were more likely to hold high dividend stocks and
b) Poorer investors tended to hold high dividend stocks hence, firms with older investors pay
higher dividends and firms with wealthier investors pay lower dividends.
The Clientele Effect

High Net Firm A - No Dividends

9
 Worth

Individuals
Tax Exempt
Individuals
Firm - B - Dividends

Lower Tax Bracket

Figure 3.3: The Clientele Effect.

c. Signaling Effect: Rise in dividend payment is viewed as a positive signal whereas a
reduction in dividend payment is viewed as a negative signal about the future earnings prospects of
the company, thus leading to an increase or decreases in share prices of the firm. Managers use
dividends as signals to transmit information to the capital market.
Theoretical models by Bhattacharya (1979)13, Miller and Rock (1985)14 and John and Williams
(1985)15 and Williams (1988)16 tell us that dividend increases convey good news and dividend
decreases convey bad news.
However, this theory is based on the following assumptions:
i. There is an existence of perfect capital markets i.e. No personal or corporate taxes and
no transaction costs.
ii. The firm's investment policy is independent of its dividend policy.
iii. Investors behave rationally and information is freely available to them
iv. Risk or uncertainty does not exist.
The above-mentioned assumptions exclude personal and corporate taxes as well as any linkage
to capital investment policy as well as other factors that limit its application to real world
situations.
C. THE BIRD IN THE HAND THEORY, (John Lintner 1962 and Myron Gordon, 1963)17, 18
The essence of this theory is not stockholders are risk averse and prefer current dividends due to
their lower level of risk as compared to future dividends.
Dividend payments reduce investor uncertainty and thereby increase stock value. This theory is
based on the logic that ' what is available at present is preferable to what may be available in the
future'. Investors would prefer to have a sure dividend now rather than a promised dividend

10
 in the future (even if the promised dividend is larger). Hence dividend policy is relevant and
does affect the share price of a firm.
D. THE TAX DIFFERENTIAL THEORY, (B. Graham and D.L. Dodd)
This theory simply concludes that since dividends are taxed at higher rates than capital gains,
investors require higher rates of return as dividend yields increase. This theory suggests that a
low dividend payout ratio will maximize firm value.
E. PERCENT PAYOUT THEORY, (Rubner 1966)19
Rubner (1966) argued that shareholders prefer dividends and directors and managers requiring
additional finance would have to convince the investors that proposed new investments
would increase their wealth.
However to increase their job security and status in the eyes of the shareholders companies
can adopt 100 percent payout. However this policy is not followed in practice.
F. PERCENT RETENTION THEORY (Clarkson and Eliot 1969)20
Clarkson and Eliot (1969) argued that given taxation and transaction costs dividends are a
luxury that is not afforded by shareholders as well as by companies and hence a firm can follow
a policy of 100 percent retention.
Firms can thus avail of new investment opportunities that would be beneficial to shareholders too.
G. AGENCY COST THEORY (Jenson) 21, 22
Since Jenson and Meckling (1976), many studies have provided arguments that link agency costs
with the other financial activities of a firm. It has been argued that firms payout dividends in order
to reduce agency costs.
Dividend payout keeps firms in the capital market, where monitoring of managers is
available at lower cost. If a firm has free cash flows (Jensen (1986), it is better off sharing
them with stockholders as dividend payout in order to reduce the possibility of these funds
being wasted on unprofitable (negative net present value) projects. This modern view of
dividend policy emphasizes the valuable role of dividend policy in helping to resolve agency
problem and thus in enhancing shareholder value.

11
 H. A SUMMARY VIEW OF DIVIDEND POLICY THEORIES
The dividend policy theories focus on the issue of the relevancy of dividend policy to the
value of a firm.
Dividend Irrelevance
 Dividends do not make any difference (M & M theory)
 If there are no taxes disadvantages associated with dividends.
Dividend Relevance
 Dividends are relevant and have positive impact on firm value
 If stockholders like dividends, or dividends operate as a signal of future prospects. (Lintner
& Gordon)
 Dividends help to resolve agency problem and thus enhancing shareholder value. (Jenson)
 Dividends are not good (Graham and Dodd)
 If dividends have a tax disadvantage and increasing dividends reduce value.
There are therefore, conflicting viewpoints regarding the impact of dividend decision on value of a
firm.
1.8 DIVIDEND MODELS
The various models that support the above-mentioned theories of dividend relevance and
irrelevance are as follows:
A. MODIGLIANI MILLER APPROACH
According to them the price of a share of a firm is determined by its earning potentiality and
investment policy and not by the pattern of income distribution. The model given by them is
as follows: 22
Po = D1 + P1/ (1/Ke)
Where, Po = Prevailing market price of a share
Ke = Cost of equity capital
D1 = Dividend to be received at the end of period one
P1 = Market price of a share at the end of period one

12
 According to the MM hypothesis, market value of a share before dividend is declared is
equal to the present value of dividends paid plus the market value of the share after dividend is
declared.
B. WALTER'S APPROACH 23
According to Prof. James E. Walter, in the long run, share prices reflect the present value
of future+ dividends. According to him investment policy and dividend policy are inter
related and the choice of a appropriate dividend policy affects the value of an enterprise.
His formula for determination of expected market price of a share is as follows:
P = D + r/k(E-D)
K
Where, P = Market price of equity share
D = Dividend per share
E = Earnings per share
(E-D) = Retained earnings per share
r = Internal rate of return on investment
k = cost of capital
C. GORDON'S APPROACH/ DIVIDEND YIELD BASIS 24
The value of a share, like any other financial asset, is the present value of the future cash flows
associated with ownership. On this view, the value of the share is calculated as the present value of
an infinite stream of dividends.
Myron Gordon's Dividend Growth Model explains how dividend policy of a firm is a basis of
establishing share value. Gordon's model uses the dividend capitalization approach for stock
valuation. The formula used is as follows:
Po = E1 (1-b)
K-br
Where, Po = price per share at the end of year 0
E1 = earnings per share at the end of year 1
(1-b) = fraction of earnings the firm distributes by way of dividends
b = fraction of earnings the firm ploughs back

13
 k = rate of return required by shareholders
r = rate of return earned on investments made by the firm
br = growth rate of dividend and earnings
The models, provided by Walter and Gordon lead to the following implications:
If r > k Price per share increases as dividend payout ratio decreases
If r = k Price per share remains unchanged with changes in dividend
Payout ratio
If r < k Price per share increases as dividend payout ratio increases.
This further implies that:
Type of firm Optimum Payout Ratio

For a growth firm Nil

For a normal firm Irrelevant

For a declining firm 100 per cent

Figure 3.4: Optimum Payout Ratio.

1.9 TYPES OF DIVIDEND POLICY
How do firms view their dividend policies?
In a classic study, Lintner surveyed a number of managers in the 1950's and asked how they
set their dividend policy. Most of the respondents said that there were a target proportion of
earnings that determined their policy. One firm's policy might be to pay out 40% of earnings as
dividends whereas another company might have a target of 50%. On the basis of interviews with
corporate executives, Lintner concluded that firms select target payout ratios to which they
gradually adjust actual dividend payments over time. This would suggest that dividends change
with earnings.

14
 However, dividend policies may vary between various firms as every firm sets its own policy for
dividend distribution.
Firms may pursue any one of the following dividend policies:
A. GENEROUS OR LIBERAL DIVIDEND POLICY
Firms that follow this policy reward shareholders generously by stepping up dividend over the
time.
B. STABLE DIVIDEND POLICY
Firms may follow the policy of:
Stable dividend payout ratio: According to this policy, the percentage of earnings paid out of
dividends remains constant. The dividends will fluctuate with the earnings of the company.
Stable Naira (inflation adjusted) dividend policy: As per this policy the Naira level of dividends
remains stable.
C. LOW REGULAR DIVIDEND PLUS EXTRA DIVIDEND POLICY
As per this policy, a low, regular dividend is maintained and when times are good an extra
dividend is paid. Extra dividend is the additional dividend optionally paid by the firm if earnings
are higher than normal in a given period. Although the regular portion will be predictable, the total
dividend will be unpredictable.
D. RESIDUAL DIVIDEND POLICY
Under this policy, dividends are paid out of earnings not needed to finance new acceptable
capital projects. The dividends will fluctuate depending on investment opportunities available to
the company.
E. MULTIPLE DIVIDEND INCREASE POLICY
Some firms follow the policy of very frequent and small dividend increases. The objective is
to give shareholders an illusion of movement and growth.
F. ERRATIC DIVIDEND POLICY:
Dividends are paid erratically when the management feels it will not strain the resources of the
firm. Interests of the shareholders are not taken care of while making the dividend decisions.
It has been observed by various researchers that firms generally prefer to follow a stable or a
gradually rising dividend policy.

15
 G. UNIFORM CASH DIVIDEND PLUS BONUS POLICY
Under this policy, the minimum rate of dividend per share is paid in cash plus bonus shares are
issued out of accumulated reserves. However bonus shares are not given compulsorily on an annual
basis. They may be given over a period of a certain number of years, for example 3-5 years
depending on the accumulated reserves of the company that can be utilized for the purpose of
issuing bonus.
1.10 STABLE DIVIDEND POLICY: A POLICY OF DIVIDEND SMOOTHING
Lintner (1956)25 had observed that managers tend to value stable dividend policies and
corporations tend to smooth dividends relative to earnings. That is, dividends are increased
gradually and rarely cut, resulting in a much lower variability of dividends as compared to the
variability in earnings.
Most Companies adapt a basic policy of maintaining its internal reserves to ensure stable
income far into the future, while at the same time seek to distribute a sufficient amount of
earnings to shareholders in accordance with business results. with a decrease in EPS, DPS has
decreased and with increase in earnings the dividend per share has increased .However increase in
dividends is lagging behind increase in earnings in order to ‘smoothen’ or ‘stabilize’ dividend
payments over the time. Firm may adapt any of the following stable dividend policies: 26
 Stable dividend payout ratio
 Stable dividends per share
 A regular plus extra dividend policy

16
A. STABLE DIVIDEND PAYOUT RATIO:
As per this policy the percentage of dividends paid out of earnings remains constant.

EPS
DPS

Time (Years)

Figure 3.5: Stable Payout Ratio Policy

B. STABLE DIVIDENDS PER SHARE:
According to this policy, the firm pays a certain fixed amount of dividend per share every year.
Annual dividend per share is increased only when the company reaches a new level of earnings and
expects to maintain it.

DPS
EPS

Time (Years)

Figure 3.6: Stable Dividend per Share Policy

C. A REGULAR PLUS EXTRA DIVIDEND POLICY:
According to this policy a certain fixed percentage or a minimum amount of dividend is paid every
year, which is referred to as regular dividend. The firm pays ‘additional’ or ‘extra’ dividend if
earnings are higher than normal in any year.

17
 Earning

Extra

Regular
Dividend
Time (Years)

Figure 3.7: Regular and Extra Dividend Policy

D. RATIONALE FOR STABLE DIVIDEND POLICY:
Most firms adapt a stable dividend policy. If a firm’s earnings are temporarily depressed or if it
needs a substantial amount of funds for investment, then it might well maintain its regular
dividend using borrowed funds to meet its needs, until things returned to normal. The logic
or rationale for stable dividend policy is: Stockholders like stable dividends--many of them
depend on dividend income, and if dividends were cut, this might cause serious hardship to
them. A stable dividend policy is desirous for many investors such as retired persons, who
take dividends as a source to meet their current living expenses.
 A stable dividend policy would reduce investor uncertainty, and reductions in uncertainty are
generally associated with lower capital costs and higher stock prices, other things being
equal.
 Institutional investors generally prefer to invest in companies having stable dividend records.
 Adoption of stable dividends is advantageous for a company interested in raising funds from
external sources as shareholders willingly invest in companies having stable dividends as they
have more confidence in such companies.
The disadvantage is that such a policy might decrease corporate flexibility. Once a company has
adapted a stable dividend policy, any change in such a policy may have adverse effects on the
company image and may result in creating serious doubts in the minds of investors about

18
 financial standing of the company, which might prove to be very dangerous for the
company at a later stage.
1.11 STEPS TO BE FOLLOWED IN SETTING DIVIDENDS:
The dividend payment procedure involves determination of a firm’s profitable investment
opportunities over a reasonable time horizon; projection of the firm’s operating cash flows
necessary for financing the projects; estimation of the residual funds which can be made
available for distribution; finalizing the target payout rates keeping in view industry trends,
financial soundness of business, future prospects, borrowing capacity etc. among other factors; and
finally setting a feasible payout rate for the current year.
The steps to be followed by a firm in setting dividends are briefly listed as follows:
Determine the investment opportunities with high NPV

Project the firm’s investment financing needs

Set out a long term target ratio for dividend payment

Set feasible current year’s target ratio

Set (annual/half yearly/quarterly (preferable) dividend rates

Figure 3.8: Steps for setting dividends
1.12 DIVIDEND AND A FIRM’S LIFE CYCLE:
The payout policy of firms undergoes systematic changes over their life cycle. New firms or firms
that are in the growth stage pay very low or no dividends as during this initial growth period
firms retain funds to finance investment. Mature firms that are no longer in a growth phase often
pay high and increasing dividends. Thus, dividend payout keeps increasing as firms grow more
mature and finally d stage arises where a firm’s cash flow exceeds its capital needs, and during this
liquidation stage, excess cash is distributed generously in the form of cash dividends to the
shareholders.

19
 Stage of Growth
Stage I Stage II Stage III Stage IV
Introduction Rapid Growth Maturity Decline
Dividend Policy
No Dividend Low Dividend Payout Policy Growing or Increasing Payout Generous Dividend Payout
Policy Policy

Figure3.9: Dividend and a firm's life cycle

1.13 MEASURES OF DIVIDEND POLICY:
A. Dividend Payout: measures the percentage of earnings that the company pays in dividends. The
Dividend payout ratio of a firm indicates the percentage of earnings that is distributed to the
owners in the form of cash; calculated by dividing the firm’s cash dividend per share by its
earnings per share.
Dividend Payout = Dividends per share/ Earnings per share
B. Dividend Yield: measures the return that an investor can make from Dividends alone.
Dividend Yield = Dividends / Stock Price
C. Dividend Cover: indicates the vulnerability or margin of safety, of dividend payments to a drop in
earnings.27 The dividend cover ratio is used to assess a company’s ability to pay dividends to its
ordinary shareholders from its distributable earnings.
Dividend Cover = Earnings per Share / Dividends per share.
1.14 DETERMINANTS OF DIVIDEND PAYOUT:
Prof. A. A. Okwoli (2008), 28 states that in spite of the beautiful theories of dividends, the practice
is that the amount of dividend declared in any one year in any firm is governed by one or more of
the following determinants:
a. Profit earned by the firm and its revenue reserves
b. Government regulations restricting dividend
c. Market expectation
d. Liquidity
e. Ability to borrow
f. Control
g. Nature of shareholders
h. Restrictions in bond and debenture
i. inflation
20
1.15 CONCLUSION:
Dividend is that part of the net earnings of a corporation that is distributed to its stockholders. It is
a payment made to the equity shareholders for their investment in the company.
The policy to be adopted in dividend payout is determined by the Board of Directors who takes
note of the Firms investment needs.
The dividend policy adopted by any firm will definitely have an effect on the firm's future as well
as investors' interest in the firm.

21
1.16 REFERENCES
 1CITA ACT, CAP.60 LFN: 1990
 2R.P. Rustagi, Financial Management, Galgotia Publishing Company, 2001.
 3Dr. S.N. Maheshwari, Elements of Financial Management, Sultan Chand and Sons, 1999.
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