Different types of dividend policies

The different type of dividend policies would be

1. Residual dividend policy - In this policy, the company would pay out all income as dividends which is left after meeting the capital needs of the firm. In such a policy the dividend amount paid would vary year in year and would depend on the net income of the firm and the amount needed for capital expenditure. We know that changes in dividends have signaling effect in relation to how the firm would perform in the future. A policy which changes dividends every year would not provide any signal to the investors and so would not be a good policy. The share price would not adjust to the changes in dividends since the market would not understand what the change implies.

2. Constant dividend payout policy - In this policy, the firm pays out a constant percentage of the net income. In this policy also, the payout would vary depending on the income of the firm and so again would not provide any signals to the investors. This may also not be a good policy to follow. Also there is a clientele effect which states that investors invest depending on the dividends paid. If dividends vary then the investors would not know if they should invest or not and so that would depress the share price.

3. Stable dividend policy - In this policy the firm maintains a stable dividend and increases the dividends gradually as the firm feels that the net income is stable at higher levels. This is a good policy to follow since it provides correct signals to the market. The clientele effect is also taken care of and investors know how much of dividend to expect. Also changes in dividend would provide signal to the market about the future performance of the firm and so the share price would also adjust accordingly.

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