DIVIDEND POLICIES AND DECISIONS :HOW MUCH TO PAY: ALTERNATIVE DIVIDENDS POLICIES

 HOW MUCH TO PAY: ALTERNATIVE DIVIDENDS POLICIES

a) Constant payout ratio

This is where the firm will pay a fixed dividend rate e.g. 40% of earnings.  The DPS would therefore fluctuate as the earnings per share changes.

Dividends are directly dependent on the firms earnings ability and if no profits are made no dividend is paid.

This policy creates uncertainty to ordinary shareholders especially who rely on dividend income and they might demand a higher required rate of return.

b) Constant amount per share (fixed D.P.S.)

The DPS is fixed in amount irrespective of the earnings level.  This creates certainty and is therefore preferred by shareholders who have a high reliance on dividend income.

It protects the firm from periods of low earnings by fixing, DPS at a low level.

This policy treats all shareholders like preferred shareholders by giving a fixed return.  The DPS could be increased to a higher level if earnings appear relatively permanent and sustainable.

c) Constant DPS plus Extra/Surplus

Under this policy a constant DPS is paid every year.  However extra dividends are paid in years of supernormal earnings.

It gives the firm flexibility to increase dividends when earnings are high and the shareholders are given a chance to participate in super normal earnings

The extra dividends is given in such a way that it is not perceived as a commitments by the firm to continue the extra dividend in the future.  It is applied by the firms whose earnings are highly volatile e.g agricultural sector.

d) Residual dividend policy

Under this policy dividend is paid out of earnings left over after investment decisions have been financed.  Dividend will only be paid if there are no profitable investment opportunities available.  The policy is consistent with shareholders wealth maximization.