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Slide 1: 

What is Dividend Policy? Dividend Policy

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Dividend PolicyMeaning – Dividend refers to that part of net profits of a company which is distributes among shareholders as a return on their investment in the company. Dividend is paid on preference as well as equity shares of the company. On preference shares,dividend is paid at a predetermined fixed rate.

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CHAPTER 22 – Dividend Policy 22 - 3 Dividend PolicyWhat is It? Dividend Policy refers to the explicit or implicit decision of the Board of Directors regarding the amount of residual earnings (past or present) that should be distributed to the shareholders of the corporation. This decision is considered a financing decision because the profits of the corporation are an important source of financing available to the firm.

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CHAPTER 22 – Dividend Policy 22 - 4 Types of Dividends Dividends are a permanent distribution of residual earnings/property of the corporation to its owners. Dividends can be in the form of: Cash Additional Shares of Stock (stock dividend) Property If a firm is dissolved, at the end of the process, a final dividend of any residual amount is made to the shareholders – this is known as a liquidating dividend.

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Dividends and Corporate Financing Dividend Policy

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CHAPTER 22 – Dividend Policy 22 - 6 In the absence of dividends, corporate earnings accrue to the benefit of shareholders as retained earnings and are automatically reinvested in the firm. When a cash dividend is declared, those funds leave the firm permanently and irreversibly. Distribution of earnings as dividends may starve the company of funds required for growth and expansion, and this may cause the firm to seek additional external capital. Dividends a Financing Decision

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CHAPTER 22 – Dividend Policy 22 - 7 Dividends versus Interest Obligations Interest Interest is a payment to lenders for the use of their funds for a given period of time Timely payment of the required amount of interest is a legal obligation Failure to pay interest (and fulfill other contractual commitments under the bond indenture or loan contract) is an act of bankruptcy and the lender has recourse through the courts to seek remedies Secured lenders (bondholders) have the first claim on the firm’s assets in the case of dissolution or in the case of bankruptcy Dividends A dividend is a discretionary payment made to shareholders The decision to distribute dividends is solely the responsibility of the board of directors Shareholders are residual claimants of the firm (they have the last, and residual claim on assets on dissolution and on profits after all other claims have been fully satisfied)

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Dividend Decision and the Board of Directors Dividend Policy

Dividend Policy : 

Dividend Policy CHAPTER 22 – Dividend Policy 22 - 9 Dividend Policy Dividends, Shareholders and the Board of Directors There is no legal obligation for firms to pay dividends to common shareholders Shareholders cannot force a Board of Directors to declare a dividend, and courts will not interfere with the BOD’s right to make the dividend decision because: Board members are jointly and severally liable for any damages they may cause Board members are constrained by legal rules affecting dividends including: Not paying dividends out of capital Not paying dividends when that decision could cause the firm to become insolvent Not paying dividends in contravention of contractual commitments (such as debt covenant agreements)

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