Factors affecting the dividend policy

There are two factors affecting the dividend policy which are external and internal factors.

a) External factors:

General state of economy: In case of uncertain economic and business conditions, the management may like yo retain the whole or part of the firm's earnings to build up reserves to absorb shocks in future. Similarly in the period of the depression, the management may also withhold dividend payment to retain large part of earnings to preserve the firm's liquidity position. In the period of prosperity the management may not be liberal in dividend payments because of availability of large profitable opportunity.

State of capital market: in case firm has an easy access to the capital market to raise funds, itcan follow a liberal dividend policy. Otherwise it is likely to adopt more conservative dividend policy.

Tax Policy: Prevailing corporate income tax and tax on dividend also effects the dividend policy.

b) Internal factors:

Desire of the shareholders: Shareholders are technically the owners of the company and therefore their desire cannot be outlooked while deciding the dividend policy. Shareholders expect two forms of return on their investment viz. dividend and capital gain. in most cases shareholders desire to get dividend gets priority over the desire to earn capital gain because of the following reasons.

- Indication of strength
- Reduction of uncertainity
- Need for current income

Financial needs of the company: The financial need of the company may be in direct conflict with the desire of the sharehlders to receive largedividends. However a prudent management should give more weight age to the financial needs of the company, rather than the desire of the shareholders.

Desire of control: Dividend policy is not only influenced by the desire of shareholders, but the management's desire to keep control over the company. Additional equity issue dilutes the control. in case of strong desire for control, the management will not pay substantial dividends and prefer a lower dividend pay-out ratio. However where the management is strongly in control either because of substantial share holding or because of the shares being widelyheld, the firm may offer a high dividend payout ratio.

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