The terms dividend denotes that part of the company’s balance of profit (after the execution of its ‘Retained Earning’), which is available for equal distribution amongst the shareholders (investors) of the company. Dividends are a form of incentive to the shareholders for having invested in the company’s shares. This is the return out of the profit made by a company during a year, for its shareholders (beneficiaries).
According to the Institute of Chartered Accountant of India, “A dividend is a distribution to shareholders out of profits or reserves available for this purpose”.
Forms/Types of Dividend
Dividends may be classified into different categories on the basis of various parameters, e.g. ‘Profit Dividends’ are the dividends paid out of the profit in the normal conduct of business, and ‘Liquidation Dividends’ are those which are paid out of the capital of a company. Other categories of dividends and the underlying parameters are described in the following points:
1) On the Basis of Types of Shares
i) Equity Dividend:
Dividends distributed to the equity shareholders of a company are known as equity dividends. Their quantum and timing are decided on the recommendation of the Board of Directors. Rate of equity dividends is not fixed (unlike in the case of dividends on preference shares, which are fixed) and depend upon the profit earned by the company during a particular year and the company’s need for funds in the future.
ii) Preference Dividend:
Preference Dividends, as the nomenclature indicates, are the dividends distributed amongst the preference shareholders. The rate of preference dividend is fixed (pre-decided) and does not depend upon the profits earned by a company during a particular year. However, the decision with regard to the distribution of preference dividends is taken on the basis of the recommendation of the Board of Directors.
If the Board of Directors believes it to be fit, they recommend a higher rate on preference dividends; although, they do not have the power to reduce the pre-decided rate of interest on preference dividends. Dividend payment to preference shareholders gets primacy over the dividend payment to equity shareholders; in fact dividend payment on equity shares is considered only after the payment of dividends on preference shares.
2) On the Basis of Modes of Payment
i) Cash Dividend:
The decision regarding the declaration of dividends is taken in a Board Meeting, wherein the voting and consideration on the subject take place amongst the Board of Directors (BoD). After the declaration, the payment is not immediate, as the process of transfer of stock between the holders takes time and an up-to-date list of stockholders is required for the purpose. This is precisely the reason the dates for the following activities are fixed in advance:
- Date of the meeting of the Board of Directors for the declaration of dividend.
- Date of the closure of record for shareholder’s register.
- Date of the payment on which cheques are mailed to the shareholders.
Thus, during the Annual General Meeting, the recommendation of BoD is approved by the shareholders and the process of “declaration of cash dividends” is finished. A declared cash dividend is part of shareholder’s equity (and not a liability of the company), a decision in the matter may be reversed. On Treasury Stocks, no cash payments are made.
ii) Bonus Share/Stock Dividend:
Sometimes, when the profits made by a company are substantial, they may decide to retain a part thereof by capitalizing and retaining it in the business perpetually by issuing stock dividends (additional or bonus stocks/shares in lieu of cash) to the existing stockholders. Under this process, assets distribution is not involved and each shareholder’s interest in the company remains unchanged. The total shareholder’s equity also remains unaffected. The stock dividend is beneficial for a company as it has a positive effect on its ‘Liquidity Management’, due to the absence of cash-outflow. Shareholders also stand to gain, as there is an increase in the number of shares in proportion to the shares held by them without any payment.
iii) Scrip Dividend:
In a situation, wherein a company is:
- Suffering from a temporary liquidity crunch, and
- Has an adequate level of retained earnings. It may decide to issue ‘Scrip Dividends’ in lieu of ‘Cash Dividends’. ‘Scrip Dividends’ may be issued either as ‘Promissory Notes’ (which may be discounted before its ‘due date’) or ‘Ordinary Shares’. Issue of ‘Scrip Dividends’ may result in increase in the number of shares of the company, but them will be no increase in the value of the company. Issue of ‘Scrip dividends’ is, sometimes, opted by a company due to temporary liquidity problems. However, investors do not favor this type of dividend, as it may lead to reduction in the market value of the company’s shares.
iv) Bond Dividends:
‘Bond Dividends’ may be defined as ‘dividend distribution that is paid to shareholders in the form of a bond or debenture (debt instruments) instead of cash’. It has fixed rate of interest for a long duration. The issue of ‘Bond Dividends’ is opted by a company under the same situation as that of the issue of ‘Scrip Dividends’, and has the same impact.
v) Property Dividend:
‘Property Dividend’ is an alternative to ‘Cash Dividend’, ‘Scrip Dividend’ or ‘Bond Dividend’. It is rather an uncommon payout structure, in which there is a transfer of non-monetary assets between a company and its shareholders on a non-reciprocal basis. The non-monetary asset may be in the form of:
a) Inventory of the company,
b) Shares of a subsidiary company, and
c) Real estate (land or building), etc.
The dividend is recorded at the market/fair value of the asset provided. This mode of payout is employed by a company, when it does not want to dilute its existing share position or when it suffers from liquidity problems.
vi) Composite Dividend:
When dividend payment involves two or more types mentioned in the foregoing paragraphs, it is known as ‘Composite Dividend’. For example, a company may decide to distribute dividend partly in the form of cash and partly in other forms, i.e., scrip, bond or property.
3) On the Basis of Time of Payment
i) Interim Dividend:
The dividend is normally declared in the Annual General Meeting •(AGM) of a company after the formalization of the balance sheet at the end of a financial year. However, at times the dividend is declared and paid before the finalization of the balance sheet or before AGM of a company. Such a dividend is rightly termed as ‘Interim Dividend’ and is paid when the Management/Board of the company has reasons to believe that the company has already earned enough profits and at the year end the level of profit would be maintained or increased. At times the projections of a company’s profitability may prove to be wrong; as such the Management needs to be extra cautious in declaring the interim dividend.
Interim Dividend is declared by the Board and paid before the approval of the Annual General Meeting of a company. Subsequently, when the AGM takes place and the final dividend is declared in the normal course, the amount of Interim Dividend, already paid, is adjusted and approval of ‘Interim Dividend’ is also granted spontaneously. Interim Dividend is something like a part of dividend paid in advance.
ii) Regular Dividend:
The dividend declared in the Annual General Meeting, in the normal course of business, is known as ‘Regular Dividend’. Regular Dividend is declared and paid after the finalization of a company’s balance sheet every year.
iii) Special Dividend:
A well-founded ‘Dividend Policy’ needs to be framed with a provision to ensure that frequency m change of the dividend rate is kept at the minimum from year to year and the level of profitability is not same every year. Even during a year of huge profit, the company may consider declaring a ‘Special Dividend’ instead of declaring an extraordinary rate of dividend for that particular year.
This would check the expectation of shareholders to get a high rate of dividend during the subsequent years. Declaration of ‘Special Dividend’ by a company express to its shareholders that this is a ‘One-Time’ affair and may not necessarily be repeated during succeeding years.