15: Payout PolicyThe following sections describe three basic payout dividend policies; but bear in mind that the
constant dollar payout dividend policy dominates in every major economy. A particular company’s cash
dividend payout policy may incorporate elements of each policy type.
Constant Payout Ratio Policy
One type of dividend policy rarely adopted by companies is a constant payout ratio. As noted earlier, the
dividend payout ratio indicates the percentage of each dollar earned that is distributed to the owners.
With a constant payout ratio dividend policy, the company establishes that a certain percentage of earnings
is paid to shareholders in each dividend period. The problem with this policy is that, if the company’s
earnings drop or if a loss occurs in a given period, the dividends may be low or even non-existent, making
them as volatile as the company’s earnings.
Constant Dollar Payout Policy
Another type of dividend policy, the constant dollar payout dividend policy, is based on the payment of a
fixed-dollar dividend in each period. Using this policy, companies often increase the regular dividend
once a proven increase in long-term earnings has occurred. Under this policy, companies almost never
cut dividends unless they face a true crisis.
Companies that pay a steady dividend may build their policy around a target dividend payout ratio.
Under this policy, the company attempts to pay out a specified percentage of earnings. Rather than let
dividends fluctuate, however, it pays out a stated dollar dividend and slowly adjusts it toward the target
payout as proven earnings increases occur. This is known as a partial-adjustment strategy, and it implies
that at any given time, companies may be in a transition between two dividend payout levels.
Low-Regular and Extra Payout Policy
Some companies establish a low-regular and extra payout policy that pays out a low regular dividend,
supplemented by an additional cash dividend when earnings warrant it. If earnings are higher than
normal in a given period, the company may pay out this additional dividend, which is designated an
extra dividend, or special dividend. By designating the amount – by which the current dividend exceeds the
regular payment – as an extra dividend, the company avoids giving shareholders false hopes. The use of
the ‘extra’ or the ‘special’ designation is more common among companies that experience temporary shifts
in earnings.
exampleAn exception is National Presto Industries (NPI) in
the US, primarily a housewares and small appliance
manufacturer with an unbroken 66-year dividend
history, which regularly pays ‘extra’ dividends. Every
year, NPI pays a base US$1 per share dividend plus
an extra dividend based on profits. In 2011, NPI
announced its US$1.00 per share regular dividend plus
an extra dividend of US$7.25 per share, resulting in a
total annual dividend of US$8.25 per share. Its resulting
dividend yield for 2011 was a very attractive 7.4%.15 -1c BONUS SHARES AND SHARE SPLITS
In addition to paying cash dividends, companies sometimes issue bonus shares (in the US, these are referred
to as stock dividends). A transaction that is essentially identical to issuing a bonus share is a share split.
constant payout ratio
policy
Dividend policy in which a
company establishes that a
certain percentage of earnings
is paid to owners in each
dividend periodconstant dollar payment
policy
Dividend policy based on the
payment of a fixed-dollar
dividend in each period
target dividend payout
ratio
A policy under which a
company attempts to pay
out a specified percentage of
earnings by paying a stated
dollar dividend adjusted slowly
toward the target payout as
proven earnings increase
low-regular and extra
payout policy
Policy of a company paying a low
regular dividend supplemented
by an additional cash dividend
when earnings warrant it
extra dividend, or special
dividend
An additional dividend that a
company may pay if earnings
are higher than normal in a
given period