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Corporate finance
Eighth Edition
Chapter 10
Dividend policy
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Dividends and earnings
•The dividend decision is closely linked to the
financing decision of a company.
•The dividend decision must take account of the
views and expectations of shareholders.
•Retained earnings are preferred as a source of
investment funds (pecking order theory).
•Dividend payments reduce the earnings
available for investment, increasing the need for
external funds to meet investment plans.
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Operational issues
•Dividend is a distribution of after-tax profit made
on a cash basis.
•Interim plus final dividends = total dividend.
•Shareholders must approve final dividend.
•When dividend is announced, share price goes
‘cum dividend’, meaning buyer of share also
buys right to receive next dividend payment.
•When share price goes ‘ex dividend’, buyer no
longer gains the right to receive next dividend.
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Cum dividend and ex dividend
share prices
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Cum dividend and ex dividend
share prices (continued)
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Practical issues
Legal constraints
•Dividend can only be paid from accumulated
net realised profits (distributable profits).
•Regulations such as accounting standards
define the meaning of distributable profits.
•Governments may impose restrictions on
dividend payments.
•Restrictions may be imposed on dividend
payments by loan agreements or covenants.
Practical issues (continued)
Liquidity
•Dividends are cash payments so managers
must consider effect on liquidity of proposed
dividend payments.
