Dividend Policy: The way we bind ourselves, both the company and investor

Earnings for a long-term Investor:

As shareholders, we own a part of the company to reap the benefits of its business success. Investors, invest in those businesses that are potentially profitable and yield good returns. Barring the speculators of the secondary market, a long-term investor, stays invested in the company for taking a share of the profits earned periodically, which we call as dividends.

Future Investments for a company to run:

Similarly, the promoters also hold a large share in the company and most of the management holds shares acquired via equity stock options. Each of their interest also lies in the company’s performance, profits and then the dividends shared. More than their personal returns, they have a larger responsibility of running the company. And to do so, they have to decide on the future projects, savings, clearing debts and other such activities. It is imperative that the companies have to balance the interest of the investors as well as the company’s future plans when it comes to how much to pay-out as dividends.

Unlike investors, who wait only for the returns, companies have to take a cautious decision in distributing dividends. As mentioned earlier, the companies have to carefully plan and allocate the money for its future plans. Be it a residual dividend policy or a stable dividend policy, each time a dividend is paid out, both the investors and the promoters make some personal money added to their return on investment. However, the company loses some capital to re-invest in the future businesses.

Balancing both with a Dividend Policy:

To overcome such dilemma and to help the management decide on how much to pay as dividends, a framework of dividend policy is essential. In the past, there were possibilities that companies did not pay any dividends even though they were sitting on a huge piled up cash surplus. At the same time, there were possibilities for the companies to pay huge dividends, leaving nothing to run the company. This caused a severe investor dissatisfaction.

In the year 2016, SEBI made it mandatory for the top 500 companies to have a dividend policy, disclosing the philosophy, method, rate and other details regarding the dividend payouts. Of the three types of Dividend policies: Stable, Residual and Hybrid, investors choose companies that give a stable and periodic dividends. However, companies prefer a hybrid policy accommodating some flexibility for the business fluctuations.

While it is just a policy and actions can still have a deviations based on the business circumstances, investors consider this policy document as a promise. By having this policy in place, management is indirectly compelled to provision for future dividend payouts and plan the operations accordingly.

Conclusion:

Any company cannot be classified as a value creator or good or bad company, just by looking at their dividend policy. A stable dividend paying company can be bad also or a company that follows no dividend policy can be good also for the long-term value creation. Value of a company is determined by many parameters, both quantitative and qualitative. However a dividend policy gives a good indication of the management’s thought process in valuing the the investor’s interest and the company’s prospects. Not having any such policy, keeps the investors in the dark.