Function of Finance : Dividend Decision

Dividend decision is concerned with the amount of profits to be distributed and retained in the
firm.
Dividend: The term ‘dividend’ relates to the portion of profit, which is distributed to shareholders
of the company. It is a reward or compensation to them for their investment made in the firm.
The dividend can be declared from the current profits or accumulated profits.
Which course should be followed – dividend or retention? Normally, companies distribute
certain amount in the form of dividend, in a stable manner, to meet the expectations of
shareholders and balance is retained within the organisation for expansion. If dividend is not
distributed, there would be great dissatisfaction to the shareholders. Non-declaration of dividend
affects the market price of equity shares, severely. One significant element in the dividend
decision is, therefore, the dividend payout ratio i.e. what proportion of dividend is to be paid
to the shareholders. The dividend decision depends on the preference of the equity shareholders
and investment opportunities, available within the firm. A higher rate of dividend, beyond the
market expectations, increases the market price of shares. However, it leaves a small amount
in the form of retained earnings for expansion. The business that reinvests less will tend to
grow slower. The other alternative is to raise funds in the market for expansion. It is not a
desirable decision to retain all the profits for expansion, without distributing any amount in the
form of dividend.
There is no ready-made answer, how much is to be distributed and what portion is to be
retained. Retention of profit is related to
• Reinvestment opportunities available to the firm.
• Alternative rate of return available to equity shareholders, if they invest themselves