Dividend policy decisions - meaning and significance , kinds of dividends, bonus shares.

Dividend Policy Notes

I. Dividend Policy Decisions: Meaning and Significance

Definition: Decisions by a company's board on the amount, form, and timing of cash distributions to shareholders from profits. Determines how much of earnings is paid out versus retained for reinvestment.

Significance:

• Shareholder Value: Impacts shareholder wealth and perceptions. Regular dividends signal financial health.
• Investment Decisions: Used to assess profitability and risk. Income source for some investors.
• Capital Budgeting: Retained earnings are a funding source for new projects.
• Signaling: Signals management's confidence in future earnings. Dividend increases are usually positive.
• Market Valuation: Influences the market value of shares.

II. Kinds of Dividends

• Cash Dividend: Most common, paid in cash. Requires sufficient cash.
• Stock Dividend (Bonus Shares): Paid in additional shares. No cash outflow. Increases outstanding shares, reduces per-share price.
• Property Dividend: Paid in assets other than cash. Rare due to valuation/tax complications.
• Scrip Dividend (Deferred Dividend): Promissory note to pay dividend later. Used when cash is currently lacking but expected in the future.
• Liquidating Dividend: Return of capital to shareholders during liquidation. Distribution of assets, not earnings.
• Composite Dividend: Partly cash and partly in kind.

III. Bonus Shares (Stock Dividends)

Meaning: Distribution of accumulated profits as free additional shares to existing shareholders, proportionally to their holdings.

Merits:

• Preserves Cash: Conserves cash for reinvestment.
• Signaling Effect: Signals confidence in long-term prospects.
• Increased Marketability: Reduces per-share price, making stock affordable, potentially increasing trading volume.
• Enhanced Investor Confidence: Shareholders can profit from price rise after announcement.
• May Prevent Hostile Takeovers: Expands ownership base.

Demerits:

• Dilution of Earnings per Share (EPS): Increases shares outstanding, potentially reducing EPS.
• Psychological Impact: Negative if underlying performance is not strong.
• Tax Implications: Sale of bonus shares subject to capital gains tax.
• No Real Value Creation: Divides existing equity among more shares. Market price should adjust.

Accounting Treatment: Issued by capitalizing reserves (retained earnings, general reserve, security premium).

Legal Requirements (India):

• Fully paid-up shares only.
• Authorization from Articles of Association.
• Shareholder approval in a general meeting.
• No default in payment of interest or principal on fixed deposits or debt securities.
• Issued from free reserves, security premium account, or capital redemption reserve account.