Page 3 - Lesson Note 3

The payment of dividend involves an outflow of cash. A company

may be earning profit but may be short on cash. Availability of
enough cash in the company is necessary for declaration of

dividend.

(f) Shareholders’ Preference:
While declaring dividends, management must keep in mind the

preferences of the shareholders in this regard. If the shareholders
in general desire that at least a certain amount is paid as dividend,

the companies are likely to declare the same. There are always
some shareholders who depend upon a regular income from their
investments.

(g) Taxation Policy:

The choice between the payment of dividend and retaining the
earnings is, to some extent, affected by the difference in the tax

treatment of dividends and capital gains.
If tax on dividend is higher, it is better to pay less by way of

dividends. As compared to this, higher dividends may be declared
if tax rates are relatively lower.

Though the dividends are free of tax in the hands of
shareholders, a dividend distribution tax is levied on companies.

Thus, under the present tax policy, shareholders are likely to
prefer higher dividends.

(h) Stock Market Reaction:

Investors, in general, view an increase in dividend as good news
and stock prices react positively to it. Similarly, a decrease in
dividend may have a negative impact on the share prices in the

stock market.