Dividend policy
Policies in finance
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Key Takeaways
- Dividend policy , in financial management and corporate finance, is concerned with the policies regarding dividends; more specifically paying a cash dividend in the present, as opposed to, presumably, paying an increased dividend at a later stage.
- Management considerations In setting dividend policy, management must pay regard to various practical considerations, often independent of the theory, outlined below.
- investment needs and future prospects - it must also take into account shareholders' preferences, and the relationship with capital markets more broadly.
- projects where returns exceed the hurdle rate, and excess cash surplus is not needed, then management should return some or all of the excess cash to shareholders as dividends.
- Management may also wish to avoid "unsettling" the capital markets by changing policy abruptly; see below re signaling.
Dividend policy, in financial management and corporate finance, is concerned with the policies regarding dividends; more specifically paying a cash dividend in the present, as opposed to, presumably, paying an increased dividend at a later stage. Practical and theoretical considerations will inform this thinking.
Management considerations
In setting dividend policy, management must pay regard to various practical considerations, often independent of the theory, outlined below. In general, whether to issue dividends, and what amount, is determined mainly on the basis of the company's unappropriated profit (excess cash) and influenced by the company's long-term earning power: when cash surplus exists and is not needed by the firm, then management is expected to pay out some or all of those surplus earnings in the form of cash dividends or to repurchase the company's stock through a share buyback program. At the same time, although the decisioning must weigh the best use of those resources for the firm - i.e. investment needs and future prospects - it must also take into account shareholders' preferences, and the relationship with capital markets more broadly.
As regards the firm: If there are no NPV positive opportunities, i.e. projects where returns exceed the hurdle rate, and excess cash surplus is not needed, then management should return some or all of the excess cash to shareholders as dividends. However, potentially limiting any distribution, the firm's overall finances, liquidity, and legal / debt covenants in place will also be of relevance. Management may also wish to avoid "unsettling" the capital markets by changing policy abruptly; see below re signaling.
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