Dividend policy determines the allocation of earnings payable to shareholders and earnings to be retained. The market value of shares of a company is greatly affected by its policy regarding the distribution of profits/surplus between pay-out (dividend) and plough-back (retained earnings).
Dividend policies can be of following types
- Constant Percentage of Earnings: a company may distribute dividends to its shareholders on the basis of a definite percentage of earnings. In this kind of policy, the shareholders are benefited if the earnings are increasing every year. But shareholders may not prefer this policy in case of declining earnings.
- Constant dividend rate: A certain percentage of paid-up capital may be adopted as a dividend policy. The merit of this policy is that the shareholders are fully assured as to how much dividend they are going to get.
- Conservative Dividend Policy: Conservative dividend policy is one where the management distributes only a few portions of the profit as dividend in spite of excessive profits earned. Under this policy major part of the profit is retained and shareholders are paid minimum divided. This policy is suitable for those companies which need extra funds for improvement and development programs.
- Liberal Dividend Policy: When the management distributes major part of the profit as dividend and retains very less amount, it is called liberal dividend policy. Only that part of the profit is retained which is urgently required.
- Sound or Stable dividend policy: This policy attaches equal importance to the company’s future requirements and shareholder’s current expectations and tries to balance both reasonably. Normally the amount of dividend and retained earnings are more or less the same. This policy is a middle path and is helpful in maintaining the reputation of the company.