Types of dividend policy
Dividend policy is a policy determined by the company to pay out its earnings as a dividend to its shareholders. There are basically four types of dividend policy, they are as follows:
- Stable dividend policy or Constant dividend policy
- Stable dividend payout policy or constant dividend payout policy
- Regular plus extra dividend ratio
- Residual dividend policy
Let’s describe these types of dividend policy individually plus detail explanation,
# Stable/ Constant dividend policy
Under the stable dividend policy, dividend per share is fixed. Also, under this policy dividend per share should be constant. This policy may be stated as ‘Rs. 2 dividends per share’ or ‘Rs. 3 dividend per share’ and so on. This fixed amount of dividend per share is paid on an annual basis irrespective of earnings for the year. The earning may fluctuate from year to year but dividends per share remain stable. However, it does not mean that dividend per share remains fixed for all the periods to come. The amount of dividend per share is likely to increase over the years along with the increase in earnings. Once the dividend is increased, the firm tries to maintain the dividend stable at the new level.
# Stable/ constant dividend payout ratio
In this stable dividend payout policy of dividends, there is a dividend payout ratio is fixed. And, the dividend payout ratio should be constant e.g. 20%, 25%, 30%, etc. Similarly, under this dividend policy, a firm tries to maintain a constant dividend payout ratio over the years. For example, if the dividend payout ratio for the firm is set at 60 percent, the firm always pays 60 percent of its annual earnings as dividends. Because of the fixed payout ratio, dividends per share under this policy fluctuate from year to year as the earnings fluctuate. That is, if earnings increase, dividends also increases and if earnings decreases, dividends also decrease in exact proportion.
# Regular plus extra
The firm applying this policy determines minimum constant dividends plus some extra amount of dividends that depends upon the earnings. The minimum limit of dividend per share is fixed and the additional dividend is paid over the regular low dividends in the years of relatively high earnings. As soon as the earnings decline to a normal level, the firm cuts its extra dividend and pays only the normal or minimum dividend. In other words, in this dividend policy, a lower dividend per share is fixed and for the extra dividend per share, there are some conditions or criteria that are stated.
# Residual dividend policy
This is the latest dividend policy and widely applicable to various business firms. Under this policy, the dividend can be paid or can not be paid it depends upon the future investment opportunities of the firm.
Types of dividend policy are not limited to only on above-discussed policies. Rather than, many scholars are in the process of finding or developing the new dividend policies to adapt to the faster pace changing the business environment.