SUBJECT : G.

E Commerce (Business organization)

Topic: Dividend Policy and stock split

Name : Shashank Prakash

Dept. Roll No : 24/42095
Course : B.A Economics(H)
 Assignment: Dividend Policy

1. Introduction to Dividend Policy

Dividend policy refers to the strategy a company uses to determine
how much of its profits will be distributed to shareholders in the
form of dividends and how much will be retained within the company
for future growth. This decision is crucial as it has direct implications
for investor satisfaction, a company’s share price, market reputation,
and financial flexibility. A clearly defined and consistent dividend
policy can attract different types of investors—those who prefer
regular income and those who seek capital appreciation.
Furthermore, a company’s dividend policy reflects its confidence in
generating future earnings and maintaining healthy cash flows. In the
modern business environment, an optimal dividend policy is essential
for aligning corporate growth with shareholder expectations.

Types of Dividend Policies

1. Stable Dividend Policy: Under this approach, a company pays a
fixed or steadily increasing dividend amount each year,
regardless of fluctuations in earnings. This policy appeals to
risk-averse investors who value predictable income. However, in
periods of low profitability, it can put financial strain on the
company as it strives to maintain the consistent dividend.
2. Constant Payout Ratio: This policy involves paying a fixed
percentage of net income as dividends every year. It results in
variable dividend payments that mirror the company’s
earnings. Although this policy provides transparency, it may not
 satisfy investors seeking consistent income, especially during
years of low profitability.
3. Residual Dividend Policy: In this method, dividends are
distributed only after all suitable investment opportunities have
been funded. The focus here is on retaining earnings to finance
internal projects. It is more suitable for high-growth firms with
numerous investment opportunities and aligns dividends with
residual earnings.
4. Hybrid Dividend Policy: This policy combines features of stable
and residual dividend strategies. Companies maintain a base
dividend level and offer extra dividends in profitable years. It
provides stability while allowing flexibility in aligning dividends
with performance.

Types of Dividends
1. Cash Dividend: The most prevalent form of dividend, it involves
the direct payment of money to shareholders. It is a clear sign
of profitability and strong cash reserves. However, large cash
payouts may restrict the company’s ability to invest in new
opportunities.
2. Stock Dividend (Scrip Dividend): Issued in the form of
additional shares rather than cash, stock dividends help
conserve cash while still rewarding shareholders. It increases
the number of outstanding shares, diluting EPS but maintaining
investor interest.
3. Property Dividend: This rare form involves the distribution of
non-cash assets such as real estate, inventory, or investments. It
is used when cash or share options are not feasible, though it
involves complex valuation and taxation issues.
 4. Interim Dividend: Declared and paid before the end of a fiscal
year, interim dividends are a sign of robust short-term
performance. Companies generally declare interim dividends
after half-yearly or quarterly financial reviews.
5. Final Dividend: Declared at the end of the financial year during
the Annual General Meeting (AGM), based on audited financial
statements. It represents the main component of the yearly
dividend distribution.

Factors Affecting Dividend Decisions

1. Profitability: The primary determinant. Only firms generating
sufficient profit can consider dividend payouts. Companies with
stable and growing profits are better positioned to offer
consistent dividends.
2. Liquidity Position: A firm must have adequate cash to distribute
dividends. Even profitable firms may refrain from paying
dividends due to cash flow constraints, especially in capital-
intensive industries.
3. Investment Opportunities: Companies with numerous high-
return investment projects prefer to reinvest profits instead of
distributing them. This is common in tech startups and
expanding firms.
4. Shareholder Preferences: Some shareholders, such as retirees,
prefer regular dividend income, while others prioritize long-
term capital appreciation. Understanding the shareholder base
influences the dividend policy.
5. Stability of Earnings: Firms with predictable and steady
earnings are more likely to maintain stable dividend payments.
 6. Taxation Policy: Tax policies governing dividend income and
capital gains may influence dividend decisions. For instance, in
high-dividend tax jurisdictions, firms might lean toward stock
repurchases.
7. Legal and Contractual Constraints: Legal restrictions, like
statutory reserves, and loan covenants may prohibit or limit
dividend payments.
8. Access to Capital Markets: Firms with easy access to external
funding may prefer to distribute more dividends, while others
may retain earnings to avoid financing costs.

Relevance and Irrelevance Theories of Dividend Policy

1. Relevance Theories:
o Walter’s Model: Emphasizes that dividend policy affects
firm valuation, especially when internal return on
investment (r) differs from the firm’s cost of capital (k). If r
> k, retaining earnings adds more value.
o Gordon’s Model: Argues that investors prefer a certain
dividend now over uncertain capital gains in the future.
Known as the ‘bird in the hand’ theory, it implies a
positive relationship between dividend payout and stock
valuation.
2. Irrelevance Theory:
o Modigliani and Miller (MM) Hypothesis: States that under
perfect market conditions (no taxes, transaction costs, or
information asymmetry), dividend policy is irrelevant.
Investors can create their own dividend stream by selling
shares.
Critics of MM theory point out that real markets are not perfect.
Taxes, signaling effects, and agency costs make dividend policy a
relevant consideration for management.

2. Stock Split - Concept, Purpose, and Example

A stock split is a corporate action that increases the number of a
company’s outstanding shares by dividing each share, while the total
market capitalization remains unchanged. For example, in a 2-for-1
stock split, a shareholder owning 100 shares at ₹1,000 each will now
hold 200 shares at ₹500 each.
Purpose of Stock Split:
 To make shares more affordable for small investors.
 To improve share liquidity by increasing the number of shares
available.
 To send a positive signal to the market regarding the company’s
growth and confidence in future performance.
Impact of Stock Split on Financial Ratios:
 EPS and share price are adjusted accordingly.
 Book value per share and dividend per share reduce
proportionally.
 No change in total shareholder equity or firm value.

Bonus Shares - Concept, Purpose, and Illustration

Bonus shares are free additional shares distributed to existing
shareholders from the company’s reserves. For instance, a 1:2 bonus
issue means for every two shares held, one new share is issued,
increasing the shareholding by 50%.
Purpose of Bonus Shares:
 To capitalize on accumulated profits without using cash.
 To increase the liquidity of the stock and attract retail investors.
 To reward shareholders and convey a strong financial position.
Example: A shareholder holding 300 shares receives 150 more in a
1:2 bonus issue. Their total shares become 450, and the share price
adjusts proportionally to maintain the total investment value.

Impact of Stock Split on Shareholders

 Share Price Adjustments: The per-share price falls
proportionally post-split, making the stock appear more
affordable to retail investors.
 Increased Liquidity: Lower share price and higher number of
shares often lead to increased trading volume.
 No Immediate Wealth Change: Although the number of shares
increases, the value of the total investment remains the same
initially.
 Positive Market Perception: Stock splits are often interpreted
as a signal of expected growth and may attract new investors.
 Accounting Adjustments: All per-share metrics, including EPS,
DPS, and book value per share, adjust downward, although the
aggregate values remain unchanged.
Impact of Bonus Shares on Shareholders
 Increased Shareholding: Shareholders receive more shares
without any investment.
 No Cash Inflow: Bonus shares do not result in any cash benefit
to shareholders immediately.
 Perception of Growth: Bonus issues are considered a sign of
strong fundamentals and can improve investor confidence.
 EPS Dilution: As the number of shares increases, earnings per
share decline unless the net income also rises proportionally.
 Tax Implications: In many jurisdictions, bonus shares are not
taxed at issue but may influence capital gains tax upon sale.

Conclusion
In conclusion, dividend policy is a critical aspect of a company’s
financial management strategy. It reflects the company’s
commitment to rewarding shareholders while balancing the need to
reinvest in growth. An appropriate dividend policy not only
strengthens investor relations but also impacts the company’s market
reputation and financial stability. The concepts of stock splits and
bonus shares are equally important as they influence market
perception, liquidity, and shareholder wealth distribution. Although
these actions do not change the intrinsic value of the investment,
they play a strategic role in corporate signaling and investor
psychology. Ultimately, companies must tailor their dividend policies
to align with shareholder expectations, market conditions, and long-
term corporate goals.