What is a “dividend”?

October 3, 2021

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3 min read

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Origins

A dividend is the distribution of profits by a company to its shareholders, usually in the form of cash. This is how the shareholders of a business, who are its owners, receive a reward for an investment they’ve made.

The first company on record to pay dividends to its shareholders was the Dutch East India Company. Throughout its 200 year operation from 1602 to 1800, the Dutch East India Company paid dividends of approximately 18% of the company’s shares every year to its shareholders. 

Overview

A company will pay dividends to its shareholders when it is performing well financially and therefore has the cash available to award those shareholders who invested in it. This will occur once corporation tax has been deducted from annual profits. Whilst dividends are usually paid in cash, they can also be given to shareholders in other forms such as shares or physical assets. These are known as “dividends in specie” or “dividends in kind”.

However, a company has no legal obligation to pay or declare dividends to their shareholders unless such a right has been attached to a share. In fact, many companies do not pay dividends at all. This might be because the business is in an early phase of development and therefore cannot afford to redirect resources away from research and development or general business expansion. Company directors have a duty to promote the success of the company, and therefore they must consider whether issuing dividends is a smart move for their company.

When a company does issue dividends, directors can either recommend a “final dividend” or an “interim dividend”. A final dividend is paid to shareholders at the end of the financial year once a company has assessed its annual turnover. Once directors recommend final dividends and these are approved by shareholders, they become a payable debt. In contrast, interim dividends can be paid at any time during the year, typically quarterly or biannually. They are calculated before a company’s annual earnings have been gauged and are usually smaller than final dividends. Unlike final dividends, a board of directors can revoke a resolution to pay such dividends.

Should a company want to pay dividends of different amounts to different shareholders, it has to create different classes of shares to which it allocates different dividend rights. The company must detail this in its articles of association which is essentially a company’s constitution.

It might seem that a company should be viewed in a positive light if it issues dividends. There is, however, an argument against this. Some perceive the distribution of significant dividends by a business as a negative indication of a company’s financial health. For example, if a business takes advantage of extra cash to pay its shareholders, this might be seen as a sign that it has no suitable projects to generate future returns on. 

Likewise, companies which are known for their reliable dividend payments have faced negative ramifications when announcing a decrease in dividends. For example, General Electric decreased its regular dividend payments by 50% which triggered a negative decline in its share price. Nevertheless, a company’s reduction in dividends might instead signal a redirection of capital to projects that could yield high returns in the long term.

Verdict

Clearly, businesses face multiple pressures when it comes to deciding when, how, to whom, and how often to pay dividends. Nevertheless, from those who receive dividends, there don’t appear to be many complaints.

Report written by Edie Essex Barrett

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