## Dividend Decision: Introduction and Forms
### The Three Key Financial Decisions
```
Financial Management
├── Financing Decision → How to raise funds?
├── Investment Decision → Where to invest funds?
└── Dividend Decision → How to distribute profits?
```
The Dividend Decision determines what portion of after-tax profit (PAT) is:
- Distributed to shareholders as dividend, or
- Retained as surplus for reinvestment
It appears simple but is complex in practice: too much dividend may cause future cash problems; too little may signal poor performance.
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### Two Schools of Thought
| Theory | Models | View |
|---|---|---|
| Irrelevance | Modigliani-Miller (MM) | Dividend policy doesn't affect firm value |
| Relevance | Walter's, Gordon's, Lintner's | Dividend policy does affect firm value |
---
### Forms of Dividend
#### 1. Cash Dividend
- Most common form.
- Paid via cash, cheque, demand draft, or ECS.
- Cannot be paid in kind.
#### 2. Share Repurchase (Buyback)
- Company buys its own shares using corporate cash.
- Treated as a form of dividend distribution.
- Repurchased shares are either:
- Treasury shares (held for future reissue), or
- Cancelled (reduces paid-up capital)
- Effect on shareholder wealth: same as cash dividend in theory.
#### 3. Stock Dividend (Bonus Shares)
- New shares issued free of cost to existing shareholders.
- Ownership proportion of each shareholder remains unchanged.
- Capitalises free reserves → reduces reserves but increases share capital.
- No change in net worth of the company.
SEBI Conditions for Bonus Issue:
- AOA must authorise the issue.
- All partly paid-up shares must first be converted to fully paid.
- No default in repayment of loan/interest or statutory dues.
- Can only be issued from free reserves or share premium (not from capital reserve).
#### Advantages of Stock Dividend
To shareholders:
- Not taxed as dividend income.
- Potential for higher future cash dividends.
- Improves liquidity by lowering per-share price (more affordable shares).
To company:
- Conserves cash for investment.
- Useful when lenders restrict cash dividend payouts.
#### Limitations of Stock Dividend
- For shareholders: No real change in wealth or ownership percentage—only a psychological benefit.
- For company: Costly to administer; inefficient if done frequently in small amounts.