Dividend Policy - Common Stock - Andrew Jacobson (2024)

Last Updated on Thu, 09 Mar 2023 |Common Stock

A dividend policy is a firm's decision about the payment of cash dividends to shareholders. Looking at the dividends per share and the dividend payout at a point in time doesn't tell us much about the firm's dividend policy. We generally need somewhat more information than one quarter's or one year's dividend. If we look at dividends over a longer period, we can begin to get a better picture of the firm's dividend policy.

There are several basic ways of describing a firm's dividend policy:

■ No dividends

■ Constant growth in dividends per share

: Source: Value Line Investment Survey

Another pattern is the constant payout ratio, as exhibited in Exhibit 16.3 by the Sara Lee Corporation. Sara Lee's dividend payout is around 40% each year, with the most noticeable deviation occurring when it paid a special dividend in 1992. Many other companies in the food processing industry, such as Kellogg and Tootsie Roll Industries, pay dividends that are a relatively constant percentage of earnings.

Some companies display both a constant dividend payout and a constant growth in dividends. The dividends per share and dividend payout of General Electric common stock over the years 1980 through 2001 are graphed in Exhibit 16.4. Dividends per share grew steadily throughout much of this period. Looking at the dividend payout in this same figure, we see that it has been relatively constant throughout the period as well. This type of dividend pattern is characteristic of large, mature companies that have predictable earnings growth—the dividends growth tends to mimic the earnings growth, resulting in a constant payout.

U.S. corporations that pay dividends tend to pay either constant or increasing dividends per share. Dividends tend to be lower in industries that have many profitable opportunities to invest their earnings. But as a company matures and finds fewer and fewer profitable investment opportunities, a greater portion of its earnings are paid out in dividends.

EXHIBIT 16.4 Dividends per Share and Dividend Payout for the General Electric Corporation, 1980-2001

: Source: Value Line Investment Survey

Many firms are reluctant to cut dividends because the firm's share price usually falls when a dividend reduction is announced.14 For example, the U.S. auto manufacturers cut dividends during the recession in the early 1990s, as illustrated in Exhibit 16.5 by General Motors (Panel A) and Ford Motor Company (Panel B). As you can see in these graphs, as earnings per share declined the auto makers did not cut dividends until EPS were negative—and in the case of GM, not until it had experienced two consecutive loss years. But as earnings recovered in the mid-1990s, dividends were increased. Firms tend to only raise their regular quarterly dividend when they are sure they can keep it up in the future. By giving a special or extra dividend, the firm is able to provide more cash to the shareholders without committing itself to paying an increased dividend each period into the future. Let's look at an example. The fortunes of Longview Fibre, a timber growing and harvesting firm,

14 A number of studies have documented the fall in share price that accompanies a cut in dividends. See, for example, Richardson Pettit, "Dividends Announcements, Security Performance, and Capital Market Efficiency," Journal of Finance (December 1972), pp. 86-96; and Joseph Aharony and Itzhak Swary, "Quarterly Dividend and Earnings Announcements and Stockholders' Returns: An Empirical Analysis," Journal of Finance (March 1980), pp. 1-12]. But just how much the share price falls depends on the reasons for the cut; see J. Randall Woolridge and Chinmoy Gosh, "Dividend Cuts: Do They Always Signal Bad News?" Midland Journal of Corporate Finance (Summer 1985), pp. 20-32.

vary depending on construction demand and timber cutting availability on public land, both of which are quite uncertain. Longview Fibre pays a regular quarterly dividend around $0.10 a share, but also may pay special dividends that vary according to its earnings.

EXHIBIT 16.5 Dividends and Earnings per Share for General Motors and Ford Motor Company, 1980-2001 Panel A: General Motors

: Panel B: Ford Motor Company

: Source: Value Line Investment Survey

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