Going public and the dividend policy of the company

higher rate of income tax (up to 40%). Thus higher-rate taxpayers may prefer comparatively low dividend payouts to minimize their tax burden.

Third, financial institutions confuse the taxation picture even more, through their major holdings in the shares of quoted companies. They are able to set off dividends received against dividends paid for tax purpose but some may be liable to capital gains tax if they sell shares to make dividends.

The effect of taxation on dividend decision is difficult to analyse. It may be argued that companies attract investors who can match their personal taxation regimes to company’s dividend policy, and that those who don’t join a particular ‘taxation club’ will invest elsewhere. If this were true, however, a change in company’s dividend policy would probably not find favour with its shareholders clientele. And would consequently affect share values, which seem to support the argument that dividend policy matters.

Other Arguments Supporting the Relevance of Dividend Policy.

Activity:

As a potential investor, how would you react to the following questions?

Would you prefer cash dividends now, against the promise of future, perhaps uncertain, dividends?

Would you prefer a stable, growing dividend to one that fluctuates in sympathy with company’s investment needs?

If a company, in whose shares you invest, increases or decreases its dividend, would it change your personal investment policy?

In answer in question (a) you probably opted for cash now rather than cash you may never see. The future is uncertain and most people take much convincing that it is in their interests to postpone income. Although the equity shareholder by definition is the risk-bearer, he is also entitled to a reasonable resolution of dividend prospects to compensate for the additional risk he carries. An investor will almost certainty pay higher price for earlier rather than later dividends.

In question (b), in definition, a fluctuating dividend is more risky than a stable dividend. Investors will pay more for stability, especially if it is linked with steady growth. Research has shown that, in general, dividends follow a pattern of stability with growth. Maintenance

of the previous year’s dividend is the first consideration, with growth added when directors feel that a higher plateau of profitability has been consolidated.

As regards question (c), you would no doubt be very happy about an increase, and might even be prompted to buy more shares – thus helping to put the market price up. Conversely a decreased dividend would cause to review your investment, perhaps even to sell your shares to take advantage of better investment opportunities elsewhere. Investors tend to believe that dividend changes provide information regarding a company’s futures prospects, and they react accordingly.

Practical Factors Affecting Dividend Policy

Whatever dividend policy is thought to be best for a company in theory, certain practical factors influence the decision.

Availability of profit The Companies Act 1985 provides that dividends can only be paid out of accumulated realized profit less realized losses, whether these are capital of revenue. Previous or current years’ losses must be made good before a distribution can be made. If an asset is sold, any realized profit or loss arising can be distributed; but any profit or loss arising from revaluation of an asset cannot be distributed – unless and until the asset is sold.

Availability of cash Profit may be earned during a year and yet it may hot be possible to pay a dividend because of lack of cash. This can arise for different reasons. It may already have been expected or be needed to replace fixed and working assets, perhaps at inflated prices. Large customers may not yet have paid their accounts or cash may be needed to repay a loan.

Other restrictions The company’s articles association may limit the payment of dividends or a lender by insert into a loan agreement to restrict the level of dividends. A company’s dividend policy cannot be so outrageously different from policies followed by similar companies in the same industry; otherwise the market price of its shares could fall. Dividends may be restricted by government prices and incomes polices.

Alternatives to Cash Dividends