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Dividend policy of a company is very crucial in order to maintain good relations with the investors (specially the shareholders) of the company. When a company makes a profit, the management decides on what to do with those profits.
They have the option of retaining the profits and reinvesting them so as to earn more profits and increase shareholder wealth in terms of increase in share prices or paying the profits earned as dividend to shareholders so that the shareholders can have some cash in hand.
However, once the company decides to pay dividends, it should establish a permanent dividend policy, which may impact on investors and perceptions of the company in the financial markets. Generally, companies paying dividends are respected by the shareholders given the liquidity preference theory. If the company thinks that it has enough investment opportunities and they would be able to substantially increase the value of the company for the shareholders, it should retain the profits. What they decide depends on the situation of the company now and in the future. It also depends on the preferences of investors and potential investors.
Graham and Dodd established the relationship between the market price and dividends and gave the following formula
P = m (D+E/3)
P = Price
m = multiplier
D = Dividend per share
E = Earnings per share
Different Concepts of Dividend Policy include
Dividend Payout Ratio
Dividend Discount Model
Zero Growth Dividend Discount Model
Constant Growth Dividend Discount Model
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