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. Forward Dividend Yield

    An estimation of a year's dividend expressed as a percentage ...
  2. Accelerated Dividend

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

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

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

    The dividend yield that a share of stock would return based on ...
  6. Stock Dividend

    A dividend payment made in the form of additional shares, rather ...
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

    The 3 Biggest Misconceptions of Dividend Stocks

    To find the best dividend stocks, focus on total return, not yield.
  4. 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.
  5. Investing

    Due Diligence On Dividends

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

    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.
  7. Financial Advisor

    How Mutual Funds Pay Dividends: An Overview

    The process by which mutual fund dividends are calculated, distributed and reported is fairly straightforward in most cases. Here's a look.
  8. Investing

    Dividend ETFs Sought for Solid Revenue Streams

    Dividends can be found with plenty of ETFs, but investors should study up before committing capital.
RELATED FAQS
  1. 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 >>
  2. Cash dividend or stock dividend: Which is better?

    The purpose of dividends is to return wealth back to the shareholders of a company. There are two main types of dividends: ... Read Answer >>
Hot Definitions
  1. Return On Equity - ROE

    The amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability ...
  2. Bond

    A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) that borrows ...
  3. Whole Life Insurance Policy

    A life insurance contract with level premiums that has both an insurance and an investment component. The insurance component ...
  4. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer ...
  5. Capital Asset Pricing Model - CAPM

    A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities. ...
  6. Internal Rate Of Return - IRR

    A metric used in capital budgeting measuring the profitability of potential investments.
Trading Center