Question

What are the principal considerations of a board of directors in making decisions involving dividend declarations? Discuss briefly.

Short answer

The board of directors must consider both the legal and economic implicationsof a dividend when determining whether one should be declared.

Step-by-step solution

Meaning of Dividend

Whether paid in cash or in-kind, dividends are a payment made by an organizationto its shareholders. It is measured as the return of the investment made by the stockholders.

In general, when considering the validity of a dividend declaration, directors should examine the following factors

1. The correct foundation for dividend distribution is normally retained earningsunless they are legally bound in some way.

2. Additional paid-in capitalmay be utilized for dividends in some states, while preferred stock payments may be limited.

3. Any retained earnings deficits and debitsin paid-in capital accounts must be repaired before any dividends are paid.

4. In some areas, dividends may not be enough to bring retained earnings below the cost of treasury shares maintained.

The board of directors should evaluate the following factors to ensure that dividends are financially sound

1. The availability (liquidity)of assets for distribution

2. Creditor agreements

3. The impacts of a dividend on investor perceptions(e.g., maintaining a projected "payout ratio")

4. The dividend size is evaluated in relation to the possibility of paying dividends in future bad years. It's also worth considering whether or not existing facilities can be expanded or replaced.