Dividend policy theory represents the different methods in which a company rewards investors financially. Dividends are often immediate rewards for investors rather than waiting some time for growth in the stock’s price to earn financial returns. Companies often engage in one of a few of different types of dividend policy theory, though three stand out the most: cash dividends, stock dividends, and stock repurchase. Other dividend types may also exist, though they may be less frequent than these mentioned. In most cases, a company pays out dividends on a quarterly basis, though an annual dividend payment is also common with certain investment types.
Cash dividends represent actual money paid to investors from a company’s retained earnings. This dividend policy theory simply states how much money a company pays out per shareholder and class of stock, such as preferred and common. The frequency of payouts and the type of growth associated with cash dividends are also part of this theory. Most companies engage in cash dividends that remain the same for each quarter or year, with slight increases over time. Other times, a company may initiate special, one-time cash dividends through its dividend policy.
Stock dividends work in mostly the same manner as cash dividends, though investors receive additional stock shares rather than money. The frequency and amount of shares each investor receives follows a similar pattern to cash dividends as well. In some cases, however, stock dividends may be less popular as issuing new stock in large numbers can dilute the worth of current shares outstanding. While investors may enjoy the idea of stock dividends, the overall value of all stocks held by the investors may go down in price or worth. The benefit of stock dividends to a company, however, is that the company retains cash from retained earnings.
Stock repurchases in terms of dividend policy theory do not actually mean a company gives investors anything. In reality, repurchasing stock from investors reduces the supply of stock in a given market. Under the basic economic principle of supply and demand, when supply goes down for a given item, the price of the item increases. With stock investments, price increases result in higher stock value to current shareholders, who can then sell the stock at a large profit in some cases. Additionally, a company who repurchases stock is often seen as a good investment, which increases demand and again increases the stock price under this dividend policy theory.