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How Is a Corporate Dividend Policy Determined?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 04 September 2016
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The process used to determine corporate dividend policy is typically a combination of several different factors. Any governmental laws and regulations relative to the issue of stocks must be taken into account, as well as the particular circumstances of the company, including the relationship between the profits generated and the investment opportunities open to that business. While the range of issues that must be considered before setting corporate dividend policy will vary somewhat, there is a core group of considerations that is likely to apply in any given situation.

One key consideration with setting corporate dividend policy has to do with an assessment of the earnings generated by the firm. Companies that enjoy a relatively stable flow of revenue are in a position to better project income for future periods. This makes it easier to also project what portion of those earnings can be set aside for dividend payments to investors. Businesses that experience more volatile situations with the flow of earnings, such as companies that are somewhat seasonal in the demand for their goods and services, may need to dedicate a lower percentage of their earnings for dividend payments as a means of keeping the operation solvent.

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Along with the type of earnings involved, setting corporate dividend policy also requires assessing the investment opportunities open to the company, and balancing the need to set aside reserves for those investments along with allocating a portion of earnings for the paying of dividends. Doing so protects the interests of investors in the long run, since wise investments increase cash flow to the company, which in turn means more earnings to be proportionately used for making those dividend payments.

Considering the financial leverage of the firm is also key to determining corporate dividend policy. Firms that are carrying more debt will need to balance that debt with the dividends paid to investors in order to remain financially viable. This means that if there is more debt currently carried by the firm, there will be lower dividend payments in many cases.

The range of capital sources is also relevant to corporate dividend policy. Simply put, when the business has several different streams of revenue that consistently provide cash flow, the dividend policy should reflect this set of circumstances. Assuming that the debt load is kept within reason, a business with several revenue streams should be in a position to provide larger dividend payments to the investors.

Creating a viable corporate dividend policy requires taking a number of factors into consideration, then coming up with a policy that is equitable for both investors and the company itself. Failure to do so will make it harder to attract investors, or may create a situation in which the company is unable to honor its debt obligations as the result of how the dividend policy is structured. Reviewing the policy from time to time makes it possible to work out adjustments that fit into the new economy, and in turn keep both company owners and investors happy with the arrangements.

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