Dividends are the vehicle a company uses to deliver its profit to shareholders. They are therefore an important aspect of how shareholders are rewarded for their investment and ownership in a company.
Put simply, if a company makes a profit it can issue a dividend to shareholders. Profit being the amount left over after a company has paid its business expenses and tax liabilities e.g. corporation tax. The amount of a dividend must not exceed the amount of profit (after tax) available to cover the dividend.
The directors of a company are responsible for determining the value of company dividends, as well as overseeing payment; however, shareholders themselves have voting rights, and they also approve dividends through their voting rights. There is no obligation on the directors to declare a dividend.
Dividends can be paid in a number of ways, such as through the additional distribution of stock shares or other property. The most common form dividend payments take, however, is still cash.
Retained earnings and dividend types
When a company makes a profit, the majority will often be classed as ‘retained earnings’ – namely money which is used to operate the business going forward.
Commonly, a company will use the remainder of its profit, after retained earnings have been accounted for, to form the basis of its dividend payments. Often a company will use retained earnings to continue to pay dividends in future years, even if it has not made the necessary profits, in order to keep shareholders happy.
The amount of a dividend payment is up to the discretion of a company’s board of directors, with final dividend amounts being subject to shareholder approval. Similarly, the time-frame of dividend payments can vary from company to company – they can be paid monthly, quarterly, bi-annually, or annually, depending on circumstances.
It is common for a company to issue two dividend types – interim (issued throughout the year) and final (at the end of the year).
Shareholder approval is usually required only on the final dividend, i.e. the end of year dividend.
In summary, interim dividends can be set and approved by directors. Final dividends are generally proposed by directors and approved by the members (shareholders).
Important dividend dates include the ‘announcement date’, which is when company management announces the nature of up-coming dividends.
The ‘ex-dividend date’, or ex-date, is the date after which shareholders buying stock will not qualify to receive the dividend.
The ‘payment date’ is the date on which the dividend payments are actually made.
Why are dividends paid?
There are a number of reasons a company would want to pay dividends to their shareholders – the primary one being as a reward for investment and ownership – in other words, as a reward for trust.
Shareholders display their trust in a given company by purchasing a number of that company’s shares, and it’s expected that this trust will be rewarded. The trust of a company’s investors is an invaluable commodity, and if a company continually avoids paying dividends, it may lead investors to sell their shares en-masse.
Dividend payments are generally taxed at a lower rate than salaried income, plus there is a £2,000 tax free dividend allowance, and there is no need to pay National Insurance Contributions (NIC) on dividend income. Hence, dividend payments are popular among shareholders.
There is also the benefit to a company’s image – if payments are made regularly, then that company is going to be considered reliable. This will help encourage more shareholders to invest over time. If the dividend payment increases year-on-year, it can also be a positive indicator that the company is in a good state of financial health.
Of course shareholders also invest in a company to retain specific controls over it. They have a number of rights and are able to ensure the directors do not overstep their delegated powers. The shareholders also retain the power to make major decisions affecting the business, which they typically exercise through voting on resolutions at general meetings. Therefore, it is important to understand dividend payments are not the only reason for investing in a company.