Understanding Dividend Policy: Exploring the 3 Types and How They Operate

by

Types of Dividend Policy

Dividend policy refers to the decision-making process that a company uses to determine how much of its earnings it will distribute to shareholders in the form of dividends. There are several types of dividend policies that a company can adopt, each with its own advantages and disadvantages.

1. Regular Dividend Policy

The regular dividend policy is the most common type of dividend policy. Under this policy, a company pays a fixed amount of dividend at regular intervals, such as quarterly or annually. The amount of dividend paid remains relatively stable over time, regardless of the company’s earnings or financial performance. This type of policy provides shareholders with a predictable income stream and is often favored by income-oriented investors.

2. Stable Dividend Policy

The stable dividend policy is similar to the regular dividend policy, but with some flexibility. Under this policy, a company aims to maintain a stable dividend payout ratio, which is the percentage of earnings paid out as dividends. If the company’s earnings increase, it may increase the dividend payout accordingly. Conversely, if the company’s earnings decrease, it may decrease the dividend payout. This type of policy allows the company to share its success with shareholders while also providing some protection during periods of financial difficulty.

3. Residual Dividend Policy

The residual dividend policy is based on the idea that dividends should be paid only after all profitable investment opportunities have been pursued. Under this policy, a company first invests in projects that are expected to generate a return higher than the cost of capital. After funding these projects, any remaining earnings are distributed to shareholders as dividends. This type of policy is often favored by growth-oriented companies that prioritize reinvesting earnings to fuel future growth.