The view that dividends are irrelevant is not correct, once we modify the assumptions underlying this view to consider the realities of the world. In practice, every firm follows some kind or dividend policy. The typical dividend policy of most firms is to retain between one third to half of the net earnings and distribute the remaining amount to shareholders. Companies generally specify dividends in terms of a dividend rate. They also tend to increase dividend rate if their profits increase substantially.
The questions, which relate to the dividend policy of a firm, are:
- What are the preferences of shareholders? Do they want dividend income or capital gains?
- What are the financial needs of the company?
- How much should be paid out as dividends? What are the constraints on paying dividends?
- Should the company follow a stable dividend policy?
- What should be the form of dividends?
It is not easy to answer these questions. A number of factors will have to be evaluated to analyze each of these questions to evolve a long-term dividend policy for the firm. Broadly speaking, to develop a long-term dividend policy, the directors should aim at bringing a balance between the desires of shareholders and the needs of the company.
The factors, which generally influence the dividend policy of the firm, are as discussed below: