Dividend

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Dividend is a payment by a corporation to shareholders that are given to shareholders and represent a return on the capital directly or indirectly contributed to the corporation by the shareholders.

Some important characteristics of dividends include the following:

  • The payment of dividends is at the discretion of the board of directors. If dividends are not declared it is not a liability of the corporation. A corporation cannot default on an undeclared dividend. As a consequence, corporations cannot become bankrupt because of nonpayment of dividends. The amount of dividend and even whether it is paid are decisions made by the board of directors.
  • The payment of dividends by the corporation is not a business expense. Dividends are not deductible for corporate tax purposes. In short dividends are paid out of the corporations after-tax profits.
  • Dividends received by individual shareholders are taxable. However, corporations that own stock in other corporations are permitted to exclude 70 percent of the dividend amounts they receive and are taxed only the remaining 30 percent. The 70/30 rule only applies when the recipient owns less than 20 percent of the outstanding stock in the corporation.
  • Dividend payments are made to holders of preferred stock before given to holders of common stock.

Forms of Dividends and How They are Paid

Dividends can come in multiple forms. The basic forms regarding corporate finance include Cash Dividends, Stock Dividends, and Stock Repurchase.

Cash Dividends(the basic forms)

1. Regular Cash Dividends

Regular Cash Dividend is defined as a cash payment made by a firm to its owners in the normal course of business, usually made four times per year. Cash dividends are also the most common type of dividends. Regular Cash Dividends are commonly seen with public companies. The cash payments are made directly to shareholders and on a regular basis.


2. Extra Dividends

In addition to the regular cash payments sometimes firms will pay an extra cash dividend. An extra cash payment is an additional dividend payment, that may or may not be repeated.


3. Special Dividends

Similar to the extra cash dividend is the special dividend, which is an uncommon or one time payment. Special dividends are usually not repeated. When special dividends are declared it is usually because of strong company earnings and is a way to share the profits with shareholders. [1]

4. Liquidating Dividends

The payment of a liquidating dividend usually means that some or all of the business has been sold off. A liquidating dividend is a reduction of paid in capital. [2]

Stock Dividends

A stock dividend is not a true dividend because it is not paid in cash. The effect of a stock dividend is to increase the number of shares that each owner holds. To recap stock dividends are an increase in the number of shares held, however the value of each individual stock goes down. The investor will still own the same amount of value in stock, but in more shares. A stock dividend is commonly expressed in terms of percentages. For example a 20 percent stock dividend means that a shareholder receives one new share for every five currently owned (a 20% increase).

Why would a company issue a stock dividend, if it decreases the value of their stock share? According to Investopedia, "companies may decide to distribute stock to shareholders of record if the company's availability of liquid cash is in short supply."

Their are two types of stock dividends, they are small and large dividends. Small dividends are less than 20 to 25 percent. Large dividends are greater than 20 to 25 percent.

Stock Repurchase

An alternative to cash dividends, is to repurchase the firm's own stock.

Dividend Dates

1. Declaration Date - the date on which a board of directors declare a payment of dividends

2. Ex-dividend Date - the date on which the seller is entitled to keep the dividend

3. Record Date - when the declared dividends are distributable to those who are shareholders

4. Payment Date - when the dividend checks are mailed to shareholders of record

Dividend Policy

Dividend Policy asks the question: Should the firm pay out money to its shareholders, or should the firm take money and invest it for the shareholders?

A low payout is favored by US Taxes, flotation costs, and possible dividend restrictions. With a low dividend payout, the money that is reinvested will increase the long-term value of the firm. This will lead to a higher expected capital gains return. A firm may also face certain restrictions that prevent it from paying out a certain amount of dividends.

A high payout is favored by a desire for current income and tax and legal benefits. Those corporations who own stock in another corporation or investors who are exempt from taxes might want a high dividend payout because it is more favorable to them.

Determining a Dividend Policy

Residual Dividend Approach - this is taken if a company wants to meet is desired debt-equity ratio before making any dividend payments.

Cyclical Dividend Policy - dividend payments will vary throughout the year

Stable Dividend Policy - all dividend payments are equal

Stock Dividends and Splits

Stock Dividend - is paid out in shares of stock instead of in cash and is usually expressed in terms of a percentage

Stock Split - resembles a stock dividend but is expressed as a ratio instead of a percentage; each share is divided to create more shares

Notes

  1. Special dividends can also occur when a company wishes to make changes to its financial structure or to spin off a subsidiary company to its shareholders.
  2. According to Investopedia, a liquidating dividend is not really a good thing. It would be preferable to have dividends come from earnings.