Bonus Shares and Dividend Policies: Impact on Companies
Advantages to the Company [Issue of Bonus Shares]
1. It makes available capital to carry a larger and more profitable business.
2. It is felt that financing helps the company to get rid of market influences.
3. When a company pays a bonus to its shareholders in the value of shares and not in cash, its liquid resources are maintained and the working capital of the company is not affected.
4. It enables the company to make use of its profit on a permanent basis and increases the creditworthiness of the company.
5. It is the cheapest method of raising additional capital for the expansion of the business.
6. Abnormally high rates of dividends can be reduced by issuing bonus shares which enables a company to restrict the entry of new entrepreneurs into the business and thereby reduces competition.
Disadvantages [Issue of Bonus Shares]
1. The issue of bonus shares leads to a drastic fall in the future rate of dividends, as it is only the capital that increases and not the actual resources of the company. The earnings do not usually increase with the issue of bonus shares. Thus, if a company earns a profit of Rs. 2,00,000 against a share capital of Rs. 5,00,000 and the issue of bonus shares to Rs. 8,00,000 raises the capital of the company, the rate of dividend falls from 40% to 25%.
2. The fall in the future rate of dividends results in the fall of the market price of shares considerably, this may cause unhappiness among the shareholders.
3. The reserves of the company after the bonus issue decline and leave lesser security to investors.
Types of Dividend Policies
- Regular Dividend Policy: Companies following this policy distribute dividends to their shareholders on a regular basis, regardless of their yearly profits or losses. It’s a consistent and predictable approach, ensuring shareholders receive a dividend at specified intervals.
- Irregular Dividend Policy: Under this policy, companies do not have a fixed pattern for dividend distribution. They distribute dividends only when they have surplus profits. The payouts are unpredictable and depend on the company’s financial health at any given time.
- Stable Dividend Policy: Companies with this policy commit to paying a certain amount as dividends every year, irrespective of their actual profits. This provides shareholders with a sense of reliability, knowing they’ll receive a set dividend amount annually.
- No Dividend Policy: Companies adopting this policy retain all their earnings and do not distribute any dividends to shareholders. They usually reinvest these earnings to fuel growth, expansion, or other business activities.
- Residual Dividend Policy: In this type, the company uses its earnings to pay for its expenses, investments, and savings. Whatever money is left (residual) is given as dividends.
Criticism of the MM Approach
- Perfect capital markets do not exist in reality.
- Information about the company is not available to all persons.
- Firms have to incur flotation costs while issuing securities.
- Taxes do exist and there is normally different tax treatment for dividends and capital gains.
- Investors have to pay brokerage, fees, etc., while doing any transaction.
Walter’s Approach
Professor Walter’s approach supports the doctrine that dividend decisions are relevant and affect the value of the firm. The relationship between the internal rate of return earned by the firm and its cost of capital is very significant in determining the dividend policy to subserve the ultimate goal of maximizing the wealth of the shareholders.
In this type, the company uses its earnings to pay for its expenses, investments, and savings. Whatever money is left (residual) is given as dividends.