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Stock Dividend

I. Procedure of paying dividend

The dividends can be declared only by the board of directors, which is subject to the ratification by the shareholders in the annual general meeting. Once declared the dividends become a current liability of the firm. They can be paid only out of profits of the current or past years.

The dividends are payable to those investors whose names appear in the shareholders list of the firm, on a particular date announced in advance for that purpose, which is normally called record date. The buyers can get the shares transferred in their name before the record date. Buyers get the dividend from the seller if the shares are bought cum dividends. If the shares are bought on ex dividend basis, the buyers should return the dividend, if they receive.

II. Types of dividends

Several types of dividends exist in practice. Companies usually pay regular cash dividends. These may be paid once a year or more times in a year splitting the amount. In some western countries, it is common to pay dividends quarterly. Here the word regular does not convey any legal obligation of the company to compulsorily pay dividends. It only connotes that the companies can maintain similar payments in future also. For that purpose, dividends are set such a level that a firm can pay even during the years of poor performance. In a particular year, if a company pays a higher dividend and it believes that such payment is not indicating that they are not liable to be repeated.

Companies also choose stock dividend instead of cash dividend. It is not uncommon in West to popular

the payment of regular stock dividend of around 5 percent. Stock dividends are very similar to stock splits. They increase the number of shares, but will not bring fresh funds to the firm, and will reduce values per share. But a stock dividend leads to capitalization of reserves equal to the sum of new shares at par value. In case of a stock split the face value will be reduced to increase the number of shares. So there will not be transfer of funds even in the books of accounts.

There are some other non cash dividends, corporate gifts and discounts fall in this category. In some countries companies encourages shareholders to reinvest their dividends continuously, by allowing some discount, on prevailing market price. By offering reinvestment opportunity to the shareholders, the company can fulfill both payment of stock dividend and issuing of new share for additional capital simultaneously. In the process the company can also save the floatation costs of issuing new shares.

III. Factors influencing the divident policy

A firm choosing a dividend policy will have to decide about the portion of earning to be distributed as dividends and the portion to be retained either for liquidity needs or for investments. Various factors should be considered while finalizing the dividend policy. They are firms expected rate of return on new investment opportunities, tax rates on dividends and capital gains legal considerations, access to the capital market and the implications of following a particular dividend policy.

New investments - If new investments are not available to the firm with attractive rates of return it is not willing to retire the debt, firm may use the earnings to distribute as dividends. In a growing economy, if the firm finds good investment opportunities, it may use major portion or all earnings to finance the new projects. This can be found in case of new and fast growing companies with profitable ventures. They may do so after considering the relative costs and benefits of internal and external financing. At times, firms may retain earnings in liquid assets, even if profitable investments are not available currently, with the hope of investing in future. In real life, companies neither follow 100 percent retention nor 100 percent distribution of their earnings, whether projects with good returns are available or not.

Expectation of shareholders - No doubt dividend decision is the prerogative of the company directors. However, they only represent the shareholders, who are the owners of the company, and they appoint the directors. Thus due importance will be given to the share holders expectations with regard to stock dividend. Shareholders preference for dividend or capital gains hinges on their economic status and tax rates applicable to dividends and capital gains. Share holders having sources of other regular income may not attach much weightage income. Similarly institutional investors who buy large blocks of stocks prefer regular divides to meet their own dividend obligations.

In case of closely held companies, it is easy to ascertain the expectations of the shareholders to adopt a dividend policy of their choice. But in case of companies with large number of shareholders distributed across the country, it is hardly possible to gather their views on expected dividend policy. Under the circumstances, the directors may tend the expectations of the dominant groups of the shareholders. The minority groups may switch over to other companies which meet their expectations. So, at times companies should formulate its dividend policies keeping the target groups of shareholders in mind.

Taxes * As explained in the dividend theories, the capital gains and dividend income are not related as same for tax purpose in most countries. In many countries capital gains are treated favourable with a lower tax rate when compared to dividends.

Legal restrictions on paying dividends * The companies have to follow certain legal norms while deciding the dividend payments. Some of the restrictions are:

a. The companies act provides that dividend shall be paid only out of the current profits or past profits after providing for depreciation. But, the central government is empowered to allow any company without providing for depreciation.

b. Lenders may pure restrictions on dividend payment to protect their interests when the firm is experiencing liquidity or profitability problems.

Control - The existing management group normally tries to continue their control on the company. When a company pays dividend and raises new equity capital, the shareholding of the management group may come down as a percentage, unless they increase their share holding proportionality. If they are unwilling to increase their shareholding they may retain more earnings to finance the projects. Thus, the control aspiration will affect the dividend policy.

Access to capital market - In spite of policy to distribute high dividends and raise new capital to finance the new investments, companies may fail to do so, when the capital markets are in a highly depressed state. The firms may prune the dividend rate in such periods until they are able to access the capital market as per their expectations.

IV. Dividend stability

Companies normally dislike changing their dividend policies too often. Even the share holders value stable dividends higher than fluctuating one. There are three forms of stable dividends. They are:

* Stable dividend per share or rate.

* Stable dividend pay out ratio, and

* Stable dividend per share plus extra dividend.

V. Diciding the dividend pay out ratio

Based on a survey of corporate managers join linter emphasized the following points with reference to dividend policies:

* Firms pursue long term target dividend pay out ratios.

* Managers do not attach much significance to dividend declarations, if they do not represent any change from the current dividend policy of the respective firms.

* Dividend changes indicate significant changes in the long term earnings. However, dividends will be smoothened over a period of time. Temporary shifts in earning will not reflect in dividend payments.

* Managers dislike reducing the dividends. So they tend to be overcautious in recommending dividend hikes.

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