Other Factors that can Impact the Dividend Policy Decision
In addition to the factors we have already considered, firms look at a host of other considerations when deciding on a real-world dividend strategy. Below we mention just a few of these considerations which will touch on some of the things we have described.
- The corporate charter and restrictions on paying dividends:Capital impairment restrictions imposed by the state where the firm is incorporated can establish an equity base to protect the firm's bondholders and other creditors.This base, called legal capital, restricts the firm from paying dividends greater than this base amount. For example, a base might equal the par value of the stock plus paid-in capital. In this case the firm could not pay dividends in excess of this dollar amount. (Please note that dividends are paid from cash and not from the par value of stock from paid-in capital—these are non-cash book entry accounts.) An example of another restriction might target earnings and read as follows: "Firm X cannot pay dividends if it has experienced two quarters of negative EPS". Another example might be found in the firm's bond indenture. This indenture is intended to protect the bondholders by helping to insure the firm will have the necessary cash to make interest payments. Other variations on capital impairment restrictions could be cited.
- Cash flow adequacy and stability: Dividends are paid out of cash. Therefore the firm's ability to generate a steady stream of cash flow (after other cash obligations are met) plays a major role in deciding upon a dividend policy. Firms that maintain a high level of cash and have cash flow stability (other things equal) will tend to have higher payouts than firms that do not meet these requirements.
- Investment and growth opportunities: As suggested above, firms with a large menu of profitable investment opportunities will tend to establish a dividend policy reflecting the fact that they will need cash to invest in plant and equipment. As described in Figure 5-2 we see an inverse relationship between dividend payouts and growth opportunities. A firm's dividend policy must respect the personal income tax status of it's stockholders. This idea is related to the clientele effect described earlier. For example, if the majority of a firm's investors are wealthy, the firm might tend to have a low payout so as to allow its stockholders to delay taxes until the stock is sold.
- Shareholders' desire for no surprises: In research by John Lintner ("Distributions of Income of Corporations Among Dividends, Retained Earnings, and Taxes". American Economic Review 46, May 1956, pp 97 – 113), he finds that the majority of stock investors that want dividends prefer a continuous stream of (slowly) increasing dividends. Such a policy reduces the effects of "dividend surprises."
