By William Cao. Edited by Arjun Chandrasekar and Swastik Patel.
Overview/Introduction
As you may know, a dividend, in short, is a company distributing cash to its shareholders for a certain amount of time. Though companies are not required to actually pay out dividends, investors can rely on them to see the company’s financial status. So, what happens when you add the word “policy” after it? It is quite simple, to say the least. A dividend policy is a policy that a company uses to structure its payout towards its investors. In other words, it is the backbone for the payout structure.
Types of Policies
The dividend policy is an important process of a company’s corporate strategy since this includes the fact that management has to decide on a certain amount of dividends to pay out, the timing, and other factors influencing dividend payments such as inflation. There are three types of dividend policies: constant, stable, and residual. A company’s constant dividend policy, like its name suggests, is a set number of percentages that the company annually pays from its earnings to dividends. This can be quite volatile as it is dependent on whether or not the company does or does not do well on their earnings report. Investors usually gravitate towards a stable dividend policy, which is a more stable and straightforward dividend policy. The overarching fact the dividend policy is being aligned to the long-term growth of the company allows it to be more predictable. On the other hand, a residual policy is the capital left after a company pays off its working capital and capital expenditures.
Conclusion
A dividend policy is a policy that a company uses to structure its payout towards its shareholders. There are three types of dividend policies: constant, stable, and residual. Some tend to lean more off basing the company’s dividends off earnings, while others base it off of future growth.
