Introduction (Definition of dividend policy)
Dividend policy refers to the more principle approach taken by the company’s general meeting of shareholders or the board of directors related to the dividends. This is about whether the company issues dividends, how many dividends it allocates, and when it issues dividends. The main issue is whether the company allocates its earnings or retains it for reinvestment. For stock companies, issuing higher dividends will help increase the market price of corporate stocks. However, a higher dividend also means that the company can only keep fewer funds for reinvestment which obviously will limit the company’s development and will lower the stock market price. Therefore, formulation of dividend policy, the company should take into account the company’s development needs and shareholders’ demands for the current period of revenue in order to meet the goal of maximizing the value of their stocks.
Constant payout ratio as known as the stable dividend policy. Under this dividend policy, the annual dividends of listed companies are basically fixed at a certain level. When the company’s operating performance declines in a certain year, it will not reduce the dividend payment. Although the dividend level is relatively fixed, it will increase slightly as the company’s performance improves. That is, the dividend payment presents a linear upward trend. This kind of dividend policy is stable and its advantages in enhance the company’s cohesion to investors. Furthermore, this dividend policy conveys to the market information on the company’s steady development which helps stabilize the company’s stock price and establishes the company’s good market image. In addition, this kind of dividend policy is conducive to attracting many investors, especially risk-averse investors.
Residual dividend policy is a kind of policy means that listed companies use the after tax profits first for reinvestment and the remaining portion are used for dividend distribution. When a listed company has more profitable investment opportunities and the expected return is higher than the cost of capital, it will become a rational choice for listed companies. The reason is part of the cash flow used by the listed company for reinvestment is part of the profit after tax. It is an internal source of financing and does not need to pay interest and dividends externally also do not need to finance the transaction costs of financing. Obviously, this kind of dividend policy can reduce the total cost of capital which is conducive to optimizing the company’s capital structure and maximizing corporate profits.