Dividend PolicyDefined with Examples & More

Written By:
Lisa Borga

A dividend policy determines the way in which a company pays dividends to its stockholders.

If a company has earned a profit, it can choose to put that profit back into the company, pay it all out in dividends, or split the profit between these options.

Companies can choose to form a policy to follow when making this decision.

Understanding Dividend Policies

Although some researchers may consider paying dividends unimportant, many companies make paying dividends an important part of their company strategy.

Often, investors see paying dividends as a sign of a company’s financial health.

However, it is important for a company to consider its liquidity as well as any goals it has for growth when deciding whether or not to pay a dividend or how much of a dividend to pay.

A dividend policy does more than just decide how much of a dividend to pay.

It also determines when to pay the dividend, as well as other issues that are important when deciding to pay dividends.

Dividend Policies

There are five basic types of dividend policies.

These are irregular, regular, residual, stable, and no dividends. Here is a description of each of these.

Irregular Dividend Policy

A company with this dividend policy states that it is not obligated to pay its stockholders a dividend.

This policy is often used in companies that have not had stable earnings and may have a lack of liquidity.

A company with this dividend policy could decide to pay out a dividend, but investors can’t be sure of this.

Even if the company does make a profit, it could decide to put the money back into the business in hopes of increasing growth.

Companies with this type of policy are often considered a more risky investment.

Regular Dividend Policy

When following a regular dividend policy, a company will have a policy they follow when  paying out a dividend to their stockholders each year.

Should the company earn unusually high profits, it will keep the additional profit.

Likewise, if the company earns unusually low profits or makes a loss, it will still pay this dividend to its stockholders.

This policy is generally used by companies that have stable earnings and a good cash flow.

These types of companies are usually considered to be a low risk even if the dividends they pay out are small.

This type of company is a good choice for investors who are retired or nearing retirement, as well as others who are averse to risk.

Residual Dividend Policy

In this dividend policy, the company pays out dividends using any earnings leftover after taking money out for any planned investments.

This type of dividend policy allows a company to fund its planned investments primarily with its own money, thus not having to raise much money through external funding.

Stable Dividend Policy

This is a very common dividend policy and is very easy for a company to use.

With a stable dividend policy, the company pays out a fixed percentage of its profits each year in dividends.

As an example, a company could choose a 5% payout rate.

The company would then pay out 5% of its profit in dividends to its stockholders regardless of the amount of profit.

This policy is more likely to be used by mature companies that are not involved in a strong growth strategy.

Companies with this dividend policy are a good choice for investors looking for a steady income.

No Dividend Policy

Companies with this dividend policy do not pay out dividends regardless of their profits.

These companies retain their profits and reinvest them in the company.

Companies that choose this policy generally want to expand quickly.

This type of policy can cause the value of the company’s stock to appreciate.

These companies are a good choice for investors that are more interested in the value of their shares than a regular income.

Final Thoughts

A company’s dividend policy is an important part of its strategy, even if its policy is to not pay dividends.

Investors often consider a company’s dividend policy when deciding whether or not to invest in a company.

A dividend policy can help an investor see what type of return they can expect on their investment.

Furthermore, many investors see a company’s dividend policy as a reflection of its financial health.

Key Takeaways

• Many companies choose to pay out dividends to their shareholders, but they are not required to do so.
• Irregular, regular, no dividends, residual, and stable are some different types of dividend policies.
• Although there is no requirement for companies to pay dividends, some investors see doing so as an important sign of the financial health of a company.