1. Legal rulesFactors to consider in paying dividends
(factors influencing dividend)
a) Net purchase rule: States that dividend
may be paid from company’s profit either past or present.
b) Capital impairment rule: prohibits
payment of dividends from capital i.e. from sale of ssets. This is liquidating the firm.
c) Insolvency rule: prohibits payment of
dividend when company is insolvent.
Insolvent company is one where assets are less than liabilities. Insolvent company is one where assets are
less than liabilities. In such a case
all earnings and assets of company belong to debt holders and no dividends is
paid.
2. Profitability and liquidity
A company’s capacity to pay
dividend will be determined primarily by its ability to generate adequate and
stable profits and cash flow.
If the company has liquidity
problem, it may be unable to pay cash dividend and result to paying stock
dividend.
3. Taxation position of shareholders
Dividend payment is influenced by
tax regime of a country e.g in Kenya cash dividend are taxable at source, while
capital are tax exempt.
The effect of tax differential is
to discourage shareholders from wanting high dividends. (This is explained by tax differential
theory).
4. Investment opportunity
Lack of appropriate investment
opportunities i.e. those with positive returns (N.P.V.), may encourage a firm
to increase its dividend distribution.
If a firm has many investment opportunities, it will pay low dividends
and have high retention.
5. Capital Structure
A company’s management may wish to
achieve or restore an optimal capital structure i.e. if they consider gearing
to be too high, they may pay low dividends and allow reserves to accumulate
until a more optimal/appropriate capital structure is restored/achieved.
6. Industrial Practice
Companies will be resistant to
deviation from accepted dividend or payment norms within the industry.
7. Growth Stage
Dividend policy is likely to be
influenced by firm’s growth stage e.g a young rapidly growing firm is likely to
have high demand for development finance and therefore may pay low dividend or
a defer dividend payment until company reaches maturity. It will retain high amount.
8. Ownership Structure
A dividend policy may be driven by
Time Ownership Structure e.g in small firms where owners and managers are same,
dividend payout are usually low.
However in a large quoted public
company dividend payout are significant because the owners are not the
managers. However, the values and
preferences of small group of owner managers would exert more direct influence
on dividend policy.
9. Shareholders expectation
Shareholder clientele that have
become accustomed to receiving stable and increasing div. Will expect a similar
pattern to continue in the future.
Any sudden reduction or reversal of
such a policy is likely to dissatisfy the shareholders and may result in a fail
in share prices.
10. Access to capital markets
Large, well established firms have
access to capital markets hence can get funds easily
They pay high dividends thus,
unlike small firms which pay low dividends (high retention) due to limited
borrowing capacity.
11. Contractual obligations on debt
covenants
They limit the flexibility and
amount of dividends to pay e.g. no payment of dividends from retained earnings.
