Oran Hall Who is responsible for paying dividends?
A dividend is the portion of the profits of a company that is paid to the shareholders. The dividend may be paid from the profit of the current year or from profits accumulated from previous years, which makes it possible for a company to pay dividends even if it does not make a profit in the current year.
The management of a company is responsible for running the company profitably so that it can pay dividends, but it is the board of directors which ultimately determines if a dividend is paid to the shareholders, and how much per unit of stock.
The two examples below illustrate:
o Access Financial Services Limited wishes to advise that a dividend payment of $0.12 per share was approved at its board of directors meeting held on August 10, 2023.
o Carreras Limited wishes to advise that, at a meeting of the board of directors held on August 10, 2023, the directors declared an interim dividend of $0.19 per stock unit.
Although the language varies slightly, the message is that it is the board of directors which determines if a company pays a dividend. Generally, the final dividend is paid after the end of the final year to which it applies.
The following are the main factors which determine if a company pays a dividend: net earnings for the financial year; the stability of earnings over several years; the amount of retained earnings and the rate of return thereon; the working capital position of the company; plans for expanding or contracting the operations of the company; restrictions in the trust deed of outstanding bond issues or preferred share covenants which may require working capital at a certain level before dividends are paid; and the policy of the board of directors, which is guided primarily by the goals set for the company.
The factors illustrate that a company does not have to pay a dividend, even if it makes a profit.
Some companies pay a dividend once per year. Others pay twice per year, even four times per year. This is primarily why Carreras mentions an interim dividend in its announcement. The last dividend for a year in which there are multiple payments is called the final dividend.
Although it may be possible to discern a pattern in the dividend payments of some companies, this does not apply in all cases. It is therefore difficult to project with any level of certainty the quantum of the dividend that will be declared on each unit of stock.
Each shareholder gets the same amount of dividend per unit of stock. So, naturally, large shareholders get significantly more than small shareholders.
Some investors do well from the dividends they earn. An acquaintance shared with me that she does not sell stocks when she buys them, and has been buying them for decades. The dividends she now receives are significantly more than what she paid for many of the stocks in her portfolio.
Investors who take this approach often benefit significantly in retirement, as dividends tend to provide a much better stream of income than interest.
But there are risks. A company may choose to follow a very conservative dividend policy and pay little or no dividends. Further, it may perform poorly and thus not appreciate meaningfully on the market.
There is value in companies not paying high levels of dividends. Profits not distributed to the shareholders are retained in the business. This increases what is called shareholders’ equity and helps to make the financial position of the company stronger, reduces the need to borrow, and gives it resources for expansion. This tends to cause the price of the shares to increase significantly over time.
In a general sense, though, dividends have some bearing on stock prices. The stock price of companies that pay high dividends may increase more than that of the stock of companies that do not. Additionally, high dividends may have a moderating effect on the price of a stock in a declining stock market.
So far, I have been discussing dividends on ordinary shares. But dividends are also paid on preference shares, which differ from ordinary shares. For example, preference share dividends tend to be a fixed amount, do not depend on the profitability of the company, have priority over dividends on ordinary shares, and do not generally influence the price of the shares. They, however, must be declared by the board of directors.
Dividends provide income to shareholders, but payment is not mandatory, as the board of directors has discretion to re-invest the profit in the corporation or to pay dividends.
The role of management is to cause the company to make a profit so that the directors can determine if they will declare a dividend.
Oran A. Hall, author of Understanding Investments and principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel.finviser.jm@gmail.com