This article is written by R Tushara of 5th year of BBA.LLB(Hons) of Chettinad School of Law, Kelambakkam
ABSTRACT:
Dividends are an essential part of the financial and investment spheres. These disbursements of a company’s earnings to its stakeholders are determined by the board of directors. Usually, these are paid in currency but can also be given as extra common stock. In this article, we will delve into the intricacies of dividends, including their importance, how they are calculated, and why investors find them so appealing.
KEYWORDS: disbursements, stakeholders, stock, currency
INTRODUCTION:
Dividends serve as a means for firms to give back to their investors. When enterprises garner a profit, they may elect to keep the money to reinvest in the venture or distribute it to shareholders as dividends. Such disbursements are often performed on a persistent basis, such as monthly, and are usually seen as a token of appreciation for investing in the organization.
WHY ARE DIVIDENDS IMPORTANT?
Dividends have multiple roles to play for both corporations and shareholders. Primarily, they afford stockholders a material yield from their investment. Through dividend remittances, investors are allowed to access a portion of the enterprise’s earnings without having to liquidate their stake. This strategy is highly attractive to money-minded shareholders who depend on dividends for sustaining cash inflow.
Moreover, dividends can be viewed as indicative of a company’s economic soundness and stability. Corporations that persistently dispense dividends are commonly perceived as more dependable and deeply rooted. A background of paying out profits can give assurance to shareowners and draw in fresh investors.
HOW ARE DIVIDENDS CALCULATED?
[1]The computation of disbursements is contingent upon multiple elements, consisting of the enterprise’s revenue, its dividend policy, and the number of shares issued. The directors of the company are dutybound to ascertain the magnitude and frequency of dividends dependent on these variables. The dividend yield, denoted as a percentage, is determined by apportioning the dividend per share over the company’s stock price.
Types of Dividends
There are several types of dividends that companies can choose to distribute to their shareholders. The most common types include cash dividends and stock dividends.
Cash Dividends:
Cash dividends are a form of distribution of profits made by a company to its shareholders. These distributions are typically made in cash rather than other forms, such as stock or property. Cash dividends serve as a way for companies to share their financial success with their shareholders, providing them with a tangible return on their investment. The decision to issue cash dividends is typically made by the company’s board of directors, who consider various factors, including the company’s financial position and future growth prospects. Companies that consistently generate strong profits and have a stable financial position are more likely to pay regular cash dividends. However, it is important to note that not all companies pay cash dividends, especially those in the growth phase or in industries that require significant reinvestment of earnings for expansion and innovation. For investors, cash dividends can provide a steady income stream and increase the overall return on investment. Additionally, the payment of cash dividends can also be seen as an indicator of a company’s financial health and stability.
In summary, cash dividends are an important aspect of corporate finance that allows companies to reward their shareholders for their investment in the business. These distributions are usually made in cash and represent a portion of the company’s profits. The decision to issue cash dividends is based on various factors, including the company’s financial position and future growth prospects. While not all companies pay cash dividends, they can serve as a source of income for investors and indicate the financial health of a company. The most conventional method of dividend payout is cash dividends. These dividends are distributed to stockholders in cash, as the name would imply. The company’s earnings and the board of directors’ decision normally determine the cash dividend’s amount.
Stock Dividends:
Stock dividends, also known as bonus shares, are a form of distribution of company earnings to shareholders. Unlike cash dividends, which involve the payment of cash to shareholders, stock dividends are issued in the form of additional shares. This means that shareholders receive more shares in proportion to their existing holdings. Stock dividends are often used by companies to retain earnings and reinvest in the business rather than distributing cash to shareholders. By issuing stock dividends, companies can conserve their cash and use it for various purposes such as research and development, expansion plans, or debt reduction.
One advantage of stock dividends is that they can increase the liquidity of a company’s shares in the market. When a company issues additional shares as stock dividends, it increases the total number of outstanding shares. This can attract new investors who may be interested in purchasing shares at a lower price per share due to the dilution effect caused by the increased number of shares. [2]Additionally, stock dividends can also be seen as an indication of a company’s confidence in its future performance. By choosing to issue stock dividends instead of cash dividends, companies signal that they have enough faith in their ability to generate future profits and sustain growth.
However, it is important for investors to understand that receiving stock dividends does not necessarily result in immediate financial gain. While the number of shares held by shareholders increases, the value per share may decrease proportionally due to dilution. Investors who rely on regular income from their investments may prefer cash dividends over stock dividends since cash payments provide immediate liquidity and can be used for personal expenses or reinvested elsewhere.
In conclusion, stock dividends offer companies a way to reward shareholders without depleting their cash reserves. They provide additional shares to existing shareholders and can attract new investors with lower share prices. However, investors should carefully consider their investment objectives and preferences before deciding whether they prefer cash or stock dividends. Ultimately, the choice between these two types of dividend distributions depends on individual circumstances and investment strategies. As a result, owners get more shares of stock rather than cash.
Dates and Conditions for Dividends:
It is crucial to be aware of the significant dates and conditions for dividends in order to comprehend the timing and eligibility of dividend payments. They are the release date, the ex-dividend date, the record date, and the payment date.
Date of Announcement:
The dividend declaration and public announcement dates are determined by the board of directors of a corporation. The dividend procedure officially begins on this day.
Ex-Dividend Date:
For investors, the ex-dividend date is important. It is the day on or after when a stock purchase will exclude the buyer from the upcoming dividend payment. Investors must possess the stock prior to the ex-dividend date in order to be eligible for the dividend.
Record date:
The corporation establishes the record date to identify which shareholders are entitled to the dividend. The dividend payment will go to stockholders whose shares were owned on or before this date.
Payment date
The real dividend payment to eligible shareholders takes place on the payment day. Investors will see the dividend amount credited to their accounts on this day.
Dividend-Paying Companies
Not every business pays dividends. Some businesses, especially those in the technology or biotech sectors, can decide to keep their profits in-house rather than pay out dividends. However, some industries are renowned for paying dividends on a regular basis. These include of necessities, oil and gas, banks and other financial institutions, pharmaceuticals and medical care, and utilities.
Dividend Policy and Investor Perception
Investor perception of a company can be significantly impacted by its dividend policy. A high dividend payment is a good sign since it shows that the business is making good earnings and is in good financial shape. [3]On the other hand, a business that cuts or cancels its dividend might be thought to be having financial issues or lacking in room to grow.
It is crucial to remember that a company’s dividend policy might change over time and is not always fixed in stone. Depending on several variables, including market conditions, operational results, and potential future growth, companies may opt to increase, cut, or suspend dividend payments.
Tax Factors to Consider for Dividends
Dividends are taxed differently in different jurisdictions. Dividends may be subject to additional taxes in some states, [4]while in others they may be taxed at a different rate than other forms of income. Investors should be aware of how their local tax laws will affect their ability to deduct dividend income.
Investment strategies and dividends
Investment strategies play a crucial role in determining the success of any investment portfolio. By carefully selecting and implementing the right strategies, investors can maximize their returns while managing risk effectively. One popular investment strategy is dividend investing, which focuses on investing in companies that regularly pay out dividends to their shareholders. Dividends are a portion of a company’s profits that are distributed to its shareholders as a reward for owning the stock. This strategy is particularly appealing to income-focused investors who seek a steady stream of cash flow from their investments. Dividend investing offers several advantages, including the potential for capital appreciation and a regular income stream. However, it is important to note that not all dividend stocks are created equal, and careful analysis is required to identify the most suitable investment opportunities. Investors should consider factors such as the company’s financial health, dividend history, and sustainability before making any investment decisions. Additionally, diversification is key when implementing a dividend-focused strategy to minimize the impact of market volatility and protect against individual stock risk. Overall, incorporating dividend investing into an investment portfolio can be a beneficial long-term strategy for investors seeking both income and growth potential. In an investor’s overall investment strategy, dividends can be very significant. Dividends can offer a reliable cash flow for income-oriented investors and serve to supplement other forms of income. Investors wanting both income and the possibility of capital appreciation frequently pick dividend-paying equities.
CASE LAWS ON DIVIDEND:
- The court determined that a dividend payment paid with capital was illegal in Trevor v. Whitworth (1887), which is a significant case. The notion that dividends should only be paid out of profits and not from the company’s capital was highlighted by the court.
- The case of Hutton v. West Cork Railway Co. (1883), which pioneered the idea of distributable profits, is another noteworthy one. The court decided that in order to pay a dividend, there must be enough distributable profits.
- The court made it plain that directors have a responsibility to act in the best interests of the company and its shareholders when declaring dividends in the case of Howard Smith Ltd v. Ampol Petroleum Ltd (1974). Before paying dividends, directors must consider several variables, including the company’s financial situation and prospects, the court noted.
- In addition, the Dimbula Valley (Ceylon) Tea Co. Ltd v. Laurie (1961) case demonstrated the significance of keeping a suitable number of reserves before paying dividends. According to the court’s decision, a firm should have enough reserves to cover its liabilities and potential emergencies before paying dividends.
- The validity of dividend payments made by a firm was contested in the case of Tata Iron & Steel Co. Ltd. v. State of Bihar, which is a famous example. In this instance, the court determined that a company’s dividend payments are lawful if they are funded by earnings and adhere to the Companies Act’s requirements.
- In the case of CIT v. P.M.S. Diesels, the court stressed the significance of declaring dividends only from profits and not from capital reserves or borrowed money. This is another significant case. According to the court, the company’s actual profits should be used to determine dividend declarations.
- Furthermore, the issue of profit diversion through the distribution of excessive dividends was brought to light by the case of CIT v. Swadeshi Polytex Ltd. In this instance, the court determined that excessive dividends may be declared illegal since they may be viewed as a diversion of profits.
Conclusion:
Dividends are a key component of investment and have a big impact on both businesses and investors. They give businesses a way to reward shareholders and distribute earnings. Dividends can attract investors and create trust by acting as a symbol of a company’s financial health and stability. For investors looking to include dividends in their investment strategy, understanding the various dividend types, payout dates, and the consequences of dividend policy is essential. Investors can make wise selections and successfully navigate the challenging world of dividend investing by considering the role of dividends and their possible advantages.
REFERENCES:
- https://www.investopedia.com/terms/d/dividend.asp#:~:text=A%20dividend%20is%20the%20distribution,of%20reinvestment%20in%20additional%20stock.
- https://en.wikipedia.org/wiki/Dividend
- https://economictimes.indiatimes.com/definition/dividend
- https://www.nerdwallet.com/article/investing/what-are-dividends
[1] KALAY, A. (2014). International Payout Policy, Information Asymmetry, and Agency Costs. Journal of Accounting Research, 52(2), 457–472.
[2] Barclay, M. J., Holderness, C. G., & Sheehan, D. P. (2009). Dividends and Corporate Shareholders. The Review of Financial Studies, 22(6), 2423–2455.
[3] Hakansson, N. H. (1982). To Pay or Not to Pay Dividend. The Journal of Finance, 37(2), 415–428.
[4] Chaplinsky, S., & Seyhun, H. N. (1990). Dividends and Taxes: Evidence on Tax-Reduction Strategies. The Journal of Business, 63(2), 239–260.
