DIVIDEND POLICY


The term dividend refers to that part of
profits of a company which is distributed by
the company among its shareholders. It is the
reward of the shareholders for investments
made by them in the shares of the company
1) The Irrelevance concept of dividend or the Theory of
Irrelevance .

2) The Relevance Concept of Dividend or the Theory of

Relevance.
 
RESIDUAL APPROACH (IRRELEVANT)
 According to this theory, dividend decision has no
effect on the wealth of the shareholders or the prices
of the shares, and hence it is irrelevant so far as the
valuation of the firm is concerned. This theory
regards dividend decision merely as a part of
financing decision because the earnings available may
be retained in the business for re-investment.
 MODIGLIANI AND MILLER APPROACH (MM MODEL)
 They maintain that dividend policy has no effect on
the market price of the shares and the value of the
firm is determined by the earning capacity of the
firm or its investment policy. The splitting of earnings
between retentions and dividends, may be in any
manner the firm likes, does not affect the value of
the firm.
 Assumptions of MM hypothesis
i. There are perfect capital markets.
ii. Investors behave rationally.
iii. Information about the company is available to all without
any cost.
iv. There are no floatation and transaction costs.
v. No investor is large enough to effect the market price of
shares.
vi. There are either no taxes or there are no differences in the
tax rates applicable to dividends and capital gains.
vii. The firm has a rigid investment policy.
viii.There is no risk or uncertainty in regard to the future of the
firm.(MM dropped this assumption later)
THE RELEVANCE CONCEPT OF DIVIDEND
OR THE THEORY OF RELEVANCE

WALTER’S APPROACH
Prof.Walters approach supports the doctrine that
dividend decisions are relevant and affect the value of
the firm. The relationship between the internal rate of
return earned by the firm and its cost of capital is very
significant in determining the dividend policy to
subserve the ultimate goal of maximizing the wealth of
the share holders. Prof.Walter’s model is based on the
relationship between the firms i) return on investment
ie, r and ii) the cost of capital or the required rate of
return,ie,k
If r ˃K ie,if the firm earns a higher rate of return on its
investment than the required rate of return, the firm
should retain the earnings.
where r ˂ k, the shareholders would stand to gain if the
firm distributes its earnings. For such firms, the
optimum pay-out would be 100%and the firms should
distribute the entire earnings as dividends.
where r=k,the dividend policy will not affect the
market value of shares as the shareholders will get the
same return from the firm as expected by them.
Assumptions
The investments of the firm are financed
through retained earnings only and the
firm does not use external sources of
funds.
The internal rate of return (r) and the
cost of capital (k) of the firm are
constant.
Earnings and dividends do not change
while determining the value.
The firm has a very long life.
 (ii) GORDON’S APPROACH
Myron Gordon has also developed a model on the
lines of Prof. Walter suggesting that dividends
are relevant and the dividend decision of the
firm affects its value. His basic valuation model
is based on the following assumptions:
 The firm is an all equity firm
 No external financing is available or used. Retained earnings
represent the only source of financing investment programmes
 The rate of return on the firm’s investment r, is constant
 The retention ratio, b, once decided upon is constant. Thus,
growth rate of the firm g=br, is also constant.
 The cost of capital for the firm’s remains constant and it is greater
than the growth rate, i.e., k>br.
 The firm has perpetual life
 Corporate taxes do not exist.
 DETERMINANTS OF DIVIDEND POLICY
 Legal restriction.
 Magnitude and trend of earning.
 Desire and type of shareholder.
 Nature of industry.
 Age of the company.
 Future financial requirements.
 Government’s economic policy .
 Taxation policy.
 Inflation .
 Control objectives .
 Requirements of Institutional Investors.
 Liquid Resources.
 Stability of dividends .
TYPES OF DIVIDEND POLICY
1)Regular dividend policy
Payment of dividend at the usual rate is
termed as regular dividend. The investors such
as retired persons, widows and other
economically weaker persons prefer to get
regular dividends.
Stable dividend policy.
The term stability of dividends means consistency or lack of variability in
stream of dividend payments. In more precise terms, it means payment of
certain minimum amount of dividend regularly. A stable dividend policy
may be established in any of the following three forms:
Constant dividend per share
Constant payout ratio
 Advantages Of Stable Dividend Policy
 Itis sign of continued normal operations of the
company.
 It stabilizes the market value of shares.
 It creates confidence among the investors.
 Itprovides a source of livelihood to those
investors who view dividends as a source of funds
to meet day-to-day expenses.
 Dangers of stable dividend policy
 In spite of many advantages, the stable dividend policy suffers from
certain limitations. Once a stable dividend policy is followed by a
company, it is not easier to change it. If the stable dividends are not
paid to the shareholders on any account including insufficient profits.
Irregular dividend policy
Some companies follow irregular dividend payments on account of the
following:
Uncertainty of earnings
Unsuccessful business operations
Lack of liquid resources
4 A company may follow a policy of paying no dividends presently
because of its unfavorable working capital positions or on account of
requirements of funds for future expansion and growth.
5.No dividend policy
A company may follow a policy of paying no dividends
presently because of its unfavorable working capital
positions or on account of requirements of funds for future
expansion and growth.
5)Cash dividend
A cash dividend is a usual method of paying dividends. Payment of dividend in cash
results in outflow of funds and reduces the company’s net worth, though the
shareholders get an opportunity to invest the cash in any manner they desire.
6)Scrip or Bond dividend
A scrip dividend promises to pay the shareholders at a future specific date. In case a
company does not have sufficient funds to pay dividends in cash, it may issue notes or
bonds for amounts due to the shareholders.
7.Property dividend.
Property dividend property dividends are paid in the form of some assets other than
cash. They are distributed under exceptional circumstances and are not popular in
India
8,Stock dividend.
Stock dividend means the issue of bonus shares to the existing shareholders. If a
company doesn’t have liquid resources it is better to declare stock dividend .stock
dividend amounts to capitalization of earnings and distribution of profits among the
existing shareholders without affecting the cash position of a firm.
 Bonus issue
 A company can pay bonus to its shareholders either in cash or in the form of
shares .many a times ,a company is not in a position to pay bonus in cash inspire of
sufficient profits because of unsatisfactory cash position or because of its adverse
effects on the working capital of the company so desires and the articles of
association of the company provide ,it can pay bonus to its shareholders in the
form of shares by making partly paid shares as fully paid or by the issue of fully
paid bonus shares .
 GUIDELIN1)Issue of bonus shares after any public rights issue is subject to the
condition that no bonus issue shall be made which will dilute the value or rights of
debentures convertible fully or partly
 2)The bonus issue is made out of free reserves built out of the genuine profits or
share premium collected in cash only.
 3)Reserves created by revaluation of fixed asset are not capitalized.
 4)The declaration of bonus issue, in lieu of dividend, is not made.
 5)The bonus issue is not made unless the partly paid shares, if any existing are
made fully paid.
 6)The company :
 i. has not defaulted in payment of interest or principal in respect of fixed deposits
and interest on existing debentures or principal on redemption there of and
 ii.Has sufficient reason to believe that it has not defaulted in respect of payment
of statutory dues of the employees such as contribution to provident fund,
gratuity, bonus etc
 7)A company which announces its bonus issue after the approval of the Board of
Directors must implement the proposals within a period of six months from the
date of such approval and shall not have the option of changing the decision.
 8)There should be a provision in the Articles of Association of the company for
capitalization of resources,etc,and if not ,the company shall pass a resolution at its
general body meeting making provision in the Articles of Association for
capitalization
 Issue of Bonus Shares
• As per Sec. 55 of the Companies Act
2013, Capital Redemption Reserve (CRR)
and Securities Premium can be used for
issue of fully paid bonus shares.
• Free reserves and surplus can be used to
pay bonus to shareholders either to issue
fully paid bonus shares or to make existing
partly paid shares as fully paid up.

18
 Calculation of Capital Redemption Reserve
(CRR) and Net Proceeds from Fresh Issue

• CRR required
= Nominal Value of Shares to be bought-back – Net Proceeds from
Fresh Issue of Shares
• Net Proceeds from Fresh Issue of Shares
= Nominal Value of Shares issued (Premium on such issue, if any,
is to be ignored)
If new shares issued are partly paid, then only the paid up nominal
amount should be considered.
• Fresh Shares to be issued
= Nominal Value of Shares to be bought-back – Profits available for
CRR.

19
 Journal Entries (Contd.)
8. For payment to Shareholders

Shareholders/Equity Share Buy-back A/c Dr.

To Bank A/c

As per Rule 17 (8) of the Companies (Share Capital and

Debentures) Rules, 2014, private companies and unlisted public
companies are required to open a separate bank account and
deposit therein, such sum, as would make up the entire sum due
and payable as consideration for shares tendered for buy-back.
Then entries will be
a. Share Buy-back Bank A/c Dr.
To Bank A/c

b. Shareholders/Equity Share Buy-back A/c Dr.

To Share Buy-back Bank A/c

20
 Journal Entries for Issue of Bonus Shares (Contd.)

3. When Bonus to shareholders is declared

Capital Redemption Reserve A/c Dr.

Securities Premium A/c Dr.
General Reserve A/c Dr.
Surplus OR Divisible Profits A/c Dr.
To Bonus to Shareholders A/c

2. For issue of fully paid bonus shares

Bonus to Shareholders A/c Dr.
To Equity Share Capital A/c

21
 Journal Entries for Issue of Bonus Shares

3. When Bonus to shareholders is used to make

existing partly paid shares as fully paid up:
(a) For making final call due
Equity Share Final Call A/c Dr.
To Equity Share Capital A/c
(b) For adjusting bonus to shareholders
against final call due:
Bonus to Shareholders A/c Dr.
To Equity Share Final Call A/c

22
Buy-back of Shares
 Meaning of Buy-back of Shares
• Buy-back of shares means purchase of its own
shares/securities by a company.
• After buy-back of its shares, the company has to cancel
them.
• A company cannot buy-back its own shares for the
purpose of investment.
• When a company has sufficient cash, it may like to buy-
back its shares, usually when prevailing market price is
lower.

24
 Advantages Of Buy-Back Of
Shares
• Companies having large amount of free reserves
are free to use funds to acquire shares and other
specified securities under the buy-back process.
• Buy-back of shares is helpful to a company to
reduce its share capital which is bloated
unnecessarily for the time being.
• Buy-back of shares results in lower capital base ,
enhances post-buyback earning per share and
appreciates the price-earning ratio .
 Disadvantages Of Buy-back Of
Shares
• The buybacks imply under valuation of
companies stock .the companies plough back
some of the outstanding shares thereby creating
a shortage of shares in the market .
• Companies go for announcing buyback when
they can’t find anything better to do with their
cash .
• Well timed buyback of share is a clever way for
managers to invest cheaply in a company they
know rather than expensively in a company they
don’t know .
 Conditions for Buy-back [Sec. 68]
• The buy-back of the shares listed on any stock
exchange, must be in accordance with SEBI regulations.
• The buy-back of the shares not listed on any stock
exchange, must be in accordance with Rule 17 of the
Companies (Share capital and debentures) Rules, 2014.
No company shall purchase its shares/other securities,
unless the following conditions are satisfied:
1. The buy-back of shares should be authorised by its
Articles of Association.
2. A special resolution should be passed in the general
meeting of the company authorising the buy-back of
shares.
3. All the shares to be bought-back must be fully paid.
27
 Conditions for Buy-back [Sec. 68]
However, buy-back of shares can be made without a
special resolution if the following conditions are
fulfilled:
4.The buy-back is upto 10% of the total paid-up capital
equity capital and free reserves of the company.
5.Such buy-back is authorised by passing a resolution in
the meeting of Board of Directors.
6.There is a gap of 365 days between two buy-back offers
sanctioned by the board.

28
 Conditions for Buy-back (Contd.)
Maximum number of shares that can be bought-back
7.The buy back must not exceed 25% of total paid up
equity capital of the company in a single financial year. This
limit is regarding the maximum number of equity shares
that can be bought-back in a single financial year.
Maximum Amount Available for Buy-back of Shares
8.The buy back cannot exceed 25% of the paid up capital
and free reserves of the company. This limit is in the
context of the maximum amount that can be paid by a
company in a buy-back offer.

29
 Conditions for Buy-back (Contd.)
Post buy-back conditions:
9.The ratio of secured and unsecured debt owed by the
company must not be more than twice the capital and its
free reserves after such buy-back. In other words, the debt-
equity ratio of the company should not be more than 2:1
after the buy-back.
Note: The maximum amount of share buy-back in a
financial year cannot exceed of the lowest of three figures
calculated as per point no. 7, 8 and 9.

30
 Conditions for Buy-back (Contd.)
Post buy-back conditions:
10.After buy-back of the shares, the company cannot issue
further shares of the same kind as bought back for a period
of 6 months.

31
 Sources of Funds for Buy-back
• Free Reserves:
According to Sec. 69 of the Companies Act 2013, where
buy-back is done out of the free reserves, then an
amount equal to nominal value of shares bought back
must be transferred to “Capital Redemption Reserve
(CRR) A/c.”
• Securities Premium Account
• Proceeds from fresh Issue
However, buy-back of shares cannot be made out of the
proceeds of an earlier issue of the same kind of shares
or same kind of other securities.

32
 What is the manner in which the
company can buy back its own shares?

The company can buy back its shares in any of the

following manners :
•From the existing shareholders on a proportionate
basis through the tender offer;
•From open market through:
– Book building process
– Stock exchange,
•From odd lot holders.

33
 Journal Entries
1. If shares to be bought-back are not fully paid,
then to make them fully paid. A final call should
be made and received:
(a) Share Final Call A/c Dr.
To Share Capital A/c
(b) Bank A/c Dr.
To Share Final Call A/c

2. If there is calls-in-arrear on some shares:

• EITHER such amount shall be received,
• OR such shares shall be forfeited and then re-issued before buy-
back,
• Such shares cannot be bought-back.

34
 Journal Entries (Contd.)
3. For sale of assets/investments to arrange cash for redemption

Bank A/c Dr.

To Assets or Investment A/c

* Any loss on sale of assets/investments shall be debited to

Surplus (Profit and Loss A/c).

* Any Profit on sale of assets/investments shall be credited

to Capital Reserve.
4. For issue of debentures, if any

Bank A/c Dr.

To Debentures Application A/c
Debentures Application A/c Dr.
To Debentures A/c

35
 Journal Entries (Contd.)
5. For issue of new shares, if any
Bank A/c Dr.
To Share Application & Allotment A/c

Share Application & Allotment A/c Dr.

To Share Capital A/c
To Securities Premium A/c (if any)

6. For making due buy-back

Share Capital A/c Dr.
*Premium on Buy-back of Shares A/c Dr.
To Shareholders/Equity Share Buy-back A/c
* If shares are to be bought-back at premium.

36
 Journal Entries (Contd.)
7. For writing off Premium on buy-back, if any

Securities Premium A/c Dr.

Capital Reserve A/c* Dr.
General Reserve A/c Dr.
Surplus A/c Dr.
To Premium on Buy-back of Shares A/c

* Above order or preference is not legally

required. It is desirable that minimum use of
free reserve or divisible profits is made for this
purpose.
* Capital reserve (profit) can be used only if it
was realised in cash.

37
 SHARE SPLIT

 A share split is a method to increase the number of outstanding through a

proportional reduction in the par value of the share.

 A share split affects only the par value and the total number of outstanding
shares, the shareholders total funds remains unaltered.

 The primary motives to make shares seem more affordable to small

investors even though the underlying value of the company has not
changed.
 REVERSE SPLIT

 Under the situation of falling price of a company’s share the company may
want to reduce the number of outstanding shares to prop up the market
price per share. The reduction of the number of outstanding shares by
increasing the per share value is known as reverse split.
DIVIDEND POLICY OF 5 IT
COMPANIES

1. TATA CONSULTANCY SERVICES (TCS)

Dividend Summary

 For the year ending March 2013, Tata Consultancy Services has
declared an equity dividend of 2200.00% amounting to Rs 22 per
share. At the current share price of Rs 2000.85 this results in a
dividend yield of 1.1%.
2. WIPRO

Dividend Summary

For the year ending March 2013, Wipro has declared an equity
dividend of 350.00% amounting to Rs 7 per share. At the current share
price of Rs 477.95 this results in a dividend yield of 1.46%.
3. INFOSYS

Dividend Summary

For the year ending March 2013, Infosys has declared an equity
dividend of 840.00% amounting to Rs 42 per share. At the current
share price of Rs 3347.60 this results in a dividend yield of 1.25%.
4. HCL TECHNOLOGIES

Dividend Summary

For the year ending June 2012, HCL Technologies has declared an
equity dividend of 600.00% amounting to Rs 12 per share. At the
current share price of Rs 1050.25 this results in a dividend yield of
1.14%.
5. LARSEN & TOUBRO INFOTECH

Dividend Summary

For the year ending March 2013, Larsen and Toubro has declared
an equity dividend of 925.00% amounting to Rs 18.5 per share. At
the current share price of Rs 964.15 this results in a dividend yield
of 1.92%.