What is a dividend policy?
A dividend policy dictates how much cash is returned to shareholders. When deciding what dividend to pay, if any, a company must look at the profits it has made and weigh up how much should be retained in the business to fund future growth and how much should be returned to investors. If it has had a bad year and it doesn’t have enough profit to cover its investment needs and the dividend, but expects the poor performance to be a one-off, then it may still make a payout to investors by either dipping into any surplus cash it has or using debt.
The dividend policy dictates how the value of the dividend is calculated and when it is paid. It also clarifies who gets what if a business has multiple share classes. For example, preference shares are usually entitled to dividends before common shareholders while American depositary receipts (ADRs) often earn a different dividend to other investors. Some share classes may not be entitled to dividends at all.
Some companies also choose to add what is known as a ‘scrip alternative’ dividend programme, which allows shareholders to receive the value of their dividends in new shares in the business rather than cash. Dividend policies may also include clauses that detail how bonus payments may work, such as special dividends or share buybacks.
Types of dividend policies
There is no definitive way of forming a dividend policy but there are four main types that are used by most publicly-listed businesses. However, there are additional ways to return cash to shareholders too.
- Residual dividend policy
- Stable dividend policy
- Progressive dividend policy
- Regular dividend policy
- Irregular dividend policy (special dividends)
- Share buybacks
- Scrip dividends