What Is The Dividend Policy in Business?

The Dividend Policy in Business:- The dividend decision is one of three major corporate finance decisions, such as investment selection – choice of financing – dividend decision. Dividends result from a decision of the ordinary general meeting of shareholders (AGM) and are not mandatory.

Therefore, they do not appear in charge but as a reduction in reserves on the balance sheet.

Dividend Policy and Share Price Performance

The following formula indicates that shareholder return is based on two sources of enrichment: the payment of a dividend and the increase in the value of the share.

Annual rate of return = [(Price 1 – Price 0) + Dividends] / Price 0

The payment of a dividend logically results in an immediate decrease and the same amount of the share value. The value of a share is in fact the value of equity equal to the enterprise value less the net financial debt. However, the debt is increased by the dividends paid. Consequently, the payment of dividends does not constitute remuneration; it does not increase the shareholders’ assets but only changes their distribution.

Values ​​for Yield and Growth

The return is obtained differently according to the category of the share:

The yield values ​​pay a high dividend because they are generally in a mature sector with a stabilized amount of investments. The predominant part of the return comes from dividends. A high dividend dampens the change in the stock’s return in the event of sharp stock market fluctuations.

Growth values ​​are, as their name indicates, in a developing sector. They pay a zero or low dividend to devote most of their profits to financing high investments. The return comes mainly from the rise in the share price.

The listed company must display a “readable” dividend policy vis-à-vis its shareholders to enable them to select the shared profile that corresponds to their expectations. This policy is essentially expressed according to the following indicators:

The Payout Ratio: Dividends paid year N | Net profit year N-1

In practice, executives often define the dividend by going up from a percentage applied to future results. A distribution rate below 20% is considered low, a rate higher than 60% is considered high, knowing that some groups do not pay dividends as was the case for the American group Apple until the death of its former leader.

The rate of increase of the dividend in absolute value

Business executives in a cyclical sector favor certain stability of the dividend by amounting by integrating a large margin of maneuver in the level of the distribution rate which is consequently fluctuating.

Of course, the distribution rate is not immutable, it does not fluctuate solely according to past results, and it is also a “signal” for the future: the decline in the dividend may be due to the anticipation of lower earnings or the need for future investment financing. In this second case, the group must clearly communicate to the shareholders the cause of the reduction of the dividend under the pain of having its share price decrease.

Thus, before being bought by SAP, the software company Business Object had convinced its shareholders not to pay dividends despite high profits and a large surplus cash position. It was to accumulate resources to finance the buyout of companies in a sector of activity in the concentration phase.

On the other hand, a rise in the dividend indicates an expectation of a rise in earnings or a decline in future investments.

Several years ago, the chief financial officer of a large listed group expressed himself to justify an exceptional dividend and share buybacks:

The Profitability Requirement of the Shareholders

The total profit after tax is distributable (in France, after the constitution of the legal reserve). The choice of shareholders to leave a portion in reserves is therefore equivalent to a new investment for which he has an expectation of return. The company “creates shareholder value” if it reinvests profits at a rate higher than the weighted average cost of capital (WACC).

On the other hand, the “Piggy Bank” company accumulates reserves which year after year contributes to increasing a cash surplus placed at the money market rate, which is currently a zero or even negative rate. The return on equity ratio is therefore progressively closer to this monetary rate. This can be the case of the shareholder director who gives priority above all to the sustainability of his company to return on equity.

The requirement for shareholder dividends in comparison with full self-financing (as far as it is feasible!) are: Has a virtuous effect on the management of the company. It forces the manager to invest in projects whose profitability provides a loan repayment capacity to convince banker’s lenders and attracts new investors.

Other Ways to return Money to Shareholders

Different techniques make it possible to return the money only to the shareholders who wish it:

• Listed groups may buy back shares up to 10% of their shares. Under IFRS, these shares are negative for their purchase price in equity;
• A company can buy the shares of a shareholder wishing to withdraw to cancel them, thus reducing the capital. It is a decision of the extraordinary general assembly (AGE) taken by a majority of 2/3, the reduction of the capital modifying indeed the statutes.
• Some listed groups propose to their shareholders to pay them a dividend in shares. The number of shares offered in substitution for the dividend paid in cash is defined in relation to the current share price minus a maximum discount of 10% compared to the average of the last two prices. Shareholders have the choice between receiving their dividend in shares or in cash. Note a particular case. At the end of 2014, the LVMH group decided to make an exceptional distribution in the form of Hermes shares after renouncing its takeover bid for this group.

The Exceptional Dividends

An enterprise may decide to pay an “exceptional” dividend representing several years of income or an exceptional annual result. A group realizing a significant capital gain on the sale of an asset or a subsidiary may return it to the shareholders. This non-recurring dividend is not a signal for the future.

The exceptional dividend can be motivated by the shareholder’s objective of accelerating its deleveraging. With the “debt push-down, “a parent company borrows its subsidiary to pay an exceptional dividend, at the risk of degrading its financial structure. In 2015, PICARD Frozen has paid its shareholder, the Lion Capital investment fund, an exceptional dividend of 602 million Euros representing 4.5 times its annual profit. This payment caused an 88% increase in PICARD’s financial debt and a sharp deterioration of its rating.

The Payment of Dividends

The date of payment of dividends is decided by the AGO, traditionally, the payment is annual. However, more and more groups are splitting this payment by installments. For example, a group decides in July 2018 an interim dividend payable in December 2015, for the result of the same year.