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. Accelerated Dividend

    Special dividends paid by a company ahead of an imminent change ...
  5. Dividend Yield

    A financial ratio that shows how much a company pays out in dividends ...
  6. Cash Dividend

    Money paid to stockholders, normally out of the corporation's ...
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

    The 3 Biggest Misconceptions of Dividend Stocks

    To find the best dividend stocks, focus on total return, not yield.
  5. Investing

    How Dividends Work for Investors

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

    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

    AAPL: Apple Dividend Analysis

    Apple's dividend has had healthy growth ever since its 2012 reinstatement, thanks to Apple's continuously rising revenue, earnings and operating cash flow.
  8. Investing

    Due Diligence On Dividends

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

    Fintech is a portmanteau of financial technology that describes an emerging financial services sector in the 21st century.
  2. Ex-Dividend

    A classification of trading shares when a declared dividend belongs to the seller rather than the buyer. A stock will be ...
  3. Debt Security

    Any debt instrument that can be bought or sold between two parties and has basic terms defined, such as notional amount (amount ...
  4. Taxable Income

    Taxable income is described as gross income or adjusted gross income minus any deductions, exemptions or other adjustments ...
  5. Chartered Financial Analyst - CFA

    A professional designation given by the CFA Institute (formerly AIMR) that measures the competence and integrity of financial ...
  6. Initial Coin Offering (ICO)

    An Initial Coin Offering (ICO) is an unregulated means by which funds are raised for a new cryptocurrency venture.
Trading Center