Dividend Policy

Loading the player...

What is a 'Dividend Policy'

A dividend policy is the policy a company uses to decide how much it will pay out to shareholders in the form of dividends. Some research and economic logic suggests that dividend policy may be irrelevant (in theory), but many investors rely on dividends as a vital source of income.

BREAKING DOWN 'Dividend Policy'

Because dividends represent a form of income for investors, a company's dividend policy is an important consideration for some investors. As such, it is an important consideration for company leadership, especially because company leaders are often the largest shareholders and have the most to gain from a generous dividend policy. Most companies view a dividend policy as an integral part of the corporate strategy. Management must decide on the dividend amount, timing and various other factors that influence dividend payments over time. There are three types of dividend policies: a stable dividend policy, a constant dividend policy and a residual dividend policy.

Stable Dividend Policy

The stable dividend policy is the easiest and most commonly used policy. The goal of the policy is to aim for steady and predictable dividend payouts every year, which is what most investors are seeking. When earnings are up, investors receive a dividend. When earnings are down, investors receive a dividend. The goal is to align the dividend policy with the long-term growth of the company rather than with quarterly earnings volatility. This approach allows the shareholder to have more certainty around the amount and timing of the dividend.

Constant Dividend Policy

The primary drawback of the stable dividend policy is that, in booming years, investors may not see a dividend increase. By contrast, under the constant dividend policy, a percentage of the company's earnings are paid every year. In this way, investors experience the full volatility of company earnings. If earnings are up, investors get a larger dividend; if earnings are down, investors may not receive a dividend. The primary drawback to the method is the volatility of earnings and dividends. It is difficult to plan when dividend income is highly volatile.

Residual Dividend Policy

A residual dividend policy is also highly volatile, but for some investors, it is the only acceptable dividend policy that a company should have. In a residual dividend policy the company pays out what's left after it pays for capital expenditures and working capital needs. This approach is volatile, but it makes the most sense in terms of business operations. Investors don't want to invest in a company that justifies its increased debt with the need to pay dividends.

RELATED TERMS
  1. Dividend

    A distribution of a portion of a company's earnings, decided ...
  2. Forward Dividend Yield

    An estimation of a year's dividend expressed as a percentage ...
  3. Dividend Rate

    The total expected dividend payments from an investment, fund ...
  4. Dividend Yield

    A financial ratio that shows how much a company pays out in dividends ...
  5. Accelerated Dividend

    Special dividends paid by a company ahead of an imminent change ...
  6. Indicated Yield

    The dividend yield that a share of stock would return based on ...
Related Articles
  1. Investing

    How And Why Do Companies Pay Dividends?

    If a company decides to pay dividends, it will choose one of three approaches: residual, stability or hybrid policies. Which a company chooses can determine how profitable its dividend payments ...
  2. Investing

    Why Dividends Matter

    Seven words that are music to investors' ears? "The dividend check is in the mail."
  3. Investing

    How And Why Do Companies Pay Dividends?

    The arguments for dividends include the idea that a dividend provides certainty about a company’s well being.
  4. Investing

    How Dividends Work For Investors

    Find out how a company can put its profits directly into your hands.
  5. Investing

    The 3 Biggest Misconceptions of Dividend Stocks

    To find the best dividend stocks, focus on total return, not yield.
  6. Markets

    How Dividends Affect Stock Prices

    Find out how dividends affect the price of the underlying stock, the role of market psychology and how to predict price changes after dividend declaration.
  7. Investing

    Due Diligence On Dividends

    Understanding dividends and how they work will help you become a more informed and successful investor.
  8. Managing Wealth

    The Importance of Dividends in Your Portfolio

    Learn some of the primary reasons why dividends constitute a critical factor in the overall performance of a stock investor's portfolio.
  9. Managing Wealth

    The Risks of Chasing High Dividend Stocks

    Dividend stocks offer enticing yields, but a lot can go wrong on the way to collecting that dividend payout.
  10. Markets

    The Top 5 Dividend Paying Oil Stocks for 2016

    Discover the top five dividend-paying oil companies for 2016 and what factors contribute to their ability to continue dividend payments.
RELATED FAQS
  1. Can dividends be paid out monthly?

    Find out if stocks can pay dividends monthly, and learn about the types of companies most likely to do so and how monthly ... Read Answer >>
  2. What is the difference between yield and dividend?

    Learn how to differentiate between dividend yield and dividend return, and see why dividend yield is the more popular rate ... Read Answer >>
  3. Which is better a cash dividend or a stock dividend?

    The purpose of dividends is to return wealth back to the shareholders of a company. There are two main types of dividends: ... Read Answer >>
  4. What is the difference between the dividend yield and the dividend payout ratio?

    Learn the differences between a stock's dividend yield and its dividend payout ratio, and learn why the latter might be a ... Read Answer >>
  5. How do dividends affect retained earnings?

    Find out how distribution of dividends affects a company's retained earnings, including the difference between cash dividends ... Read Answer >>
  6. Are dividends considered an asset?

    Find out why dividends are considered an asset for investors but a liability for the company that issued the stock, and learn ... Read Answer >>
Hot Definitions
  1. Quantitative Trading

    Trading strategies based on quantitative analysis which rely on mathematical computations and number crunching to identify ...
  2. Bond Ladder

    A portfolio of fixed-income securities in which each security has a significantly different maturity date. The purpose of ...
  3. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  4. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  5. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  6. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
Trading Center