Dividend Decisions^337
irrespective of fluctuating earnings also is beneficial because many institutions
take decisions based on the actual payout by the companies. Signalling effect of
this type has already been mentioned above.
This is the most favoured type of dividend policies adopted by the companies the
world over.- Target Payout Ratio: Although there is a reason to believe that stable dividends
have a positive effect on a company's share price, many firms set a bench-mark
target payout ratio (or range). They only deviate from this target to achieve relatively
stable dividends or stable and occasionaly increasing ones. Lintner contents that
companies seek to maintain a target dividend payout ratio over the long run, but
only with a lag. For example, a company may decide that it will pay around 40 per
cent of its earnings as dividends and only increase it when this ratio falls to 30 per
cent of the earnings that the company is reasonably sure of. This is especially
applicable in case of companies with stable earnings and earnings growth for only
they can sustain a target payout ratio in the long run. - Regular and extra dividends: Especially when a company earns above average
earnings because of any reason but which is non-recurring in nature, it proposes
a extra dividend over and above the regular dividend it pays. This extra earnings
could be due to divestment of a plant or business operations and the company has
no possible utilisation of the same. In line with the recommendations that investors
like to receive the money back from the company rather than the company utilising
that money in non-business activities, the companies usually return the money
back to the shareholders. This labelling of extra dividends or one-time dividends is
given to help the investors appreciate the fact that extra dividends are non-recurring
in nature and this is the only year this is being paid.
There are other ways of returning cash to shareholders and one of the biggest ones is
gaining ground in India recently. This is share buyback.
Stock Dividends and Stock Splits
An integral part of dividend policy of a firm is the use of bonus shares and stock splits.
Both involve issuing new shares on a pro rata basis to the current shareholders while
the firm's assets, its earnings, the risk being assumed and the investors percentage
ownership in the company remain unchanged. The only definite result from either a
bonus share or share split is the increase in the number of shares outstanding. Table
illustrates their effect on the capitalization of the firm. Part one of the table shows the
equity of the balance sheet before the bonus issue and part two after the issue. The
effect of share splits is shown in part three.