Dividend Law and Legal Definition
A dividend is a participation in the profit, usually based on the number of shares of stock in a corporation and the rate of payout approved by the board of directors or management, that is paid to shareholders for each share they own. Dividends may be paid in money, but can also be paid in shares of stock, known as a stock dividend. The stock dividend may be additional shares in the company, or it may be shares in a subsidiary being spun off to shareholders. Stock dividends are often used to conserve cash needed to operate the business.
There are three important dates to remember regarding dividends.
- Declaration date: The declaration date is the day the Board of Director’s announces their intention to pay a dividend. On this day, the company creates a liability on its books; it now owes the money to the stockholders. On the declaration date, the Board will also announce a date of record and a payment date.
- Date of record: This is the day upon which the stockholders of record are entitled to the upcoming dividend payment. Only the owners of the shares on or before that date will receive the dividend.
- Payment date: This is the date the dividend will actually be given to the shareholders of company.
A vast majority of dividends are paid four times a year on a quarterly basis.
Dividends and stock repurchases are the two major ways that corporations can distribute cash to shareholders. Dividends may also be distributed in the form of stock (stock dividends and stock splits), scrip (a promise to pay at a future date), or property (typically commodities or goods from inventory). By law, dividends must be paid from profits; dividends may not be paid from a corporation's capital. This law, which is designed to protect the corporation's creditors, is known as the impairment of capital rule. The law stipulates that dividend payments may not exceed the corporation's retained earnings as shown on its balance sheet.
Companies usually pay dividends on a quarterly basis. When the company is about to pay a dividend, the company's board of directors makes a dividend announcement that includes the amount of the dividend, the date of record, and the date of payment. The date on which the dividend announcement is made is known as the declaration date.
The date of record is significant for the company's shareholders. All shareholders on the date of record are entitled to receive the dividend. The ex-dividend date is the first day on which the stock is traded without the right to receive the declared dividend. All shares traded before the ex-dividend date are bought and sold with rights to receive the dividend (also known as the cum dividend). Since it usually takes a few business days to settle a stock transaction, the ex-dividend date is usually a few business days before the record date. On the ex-dividend date the trading price of the stock usually falls to account for the fact that the seller rather than the purchaser is entitled to the declared dividend.
Corporate dividend policy is a sometimes under-appreciated element of overall company strategy and financial planning. "It's difficult to generalize about dividend policy because it is usually very company-specific or industry-specific, [but] some general observations are possible," wrote Frederic Escherich in Directors and Boards. "Dividend policy's most important uses are to: 1) return excess cash to shareholders; 2) effectively manage the company's cash needs and capital structure; and 3) credibly signal shareholders about future earnings prospects." Indeed, when a company puts together its dividend policy, it must decide whether to distribute a certain amount of earnings to the company's shareholders or retain those earnings for reinvestment. Dividend policy is influenced by a number of factors that include various legal constraints on declaring dividends (bond indentures, impairment of capital rule, availability of cash, and penalty tax on accumulated earnings) as well as the nature of the company's investment opportunities and the effect of dividend policy on the cost of capital of common stock. Most firms have chosen to follow a dividend policy of issuing a stable or continuously increasing dividend. Relatively few firms issue a low regular dividend and declare special dividends when annual earnings are sufficient.
Opinions vary regarding the relationship between dividend policy and corporate taxation. "The usual argument is that since dividends are taxed as income, they have a tax disadvantage with respect to capital gains in a relatively light capital gains tax regime, especially for recipients in high tax brackets," wrote Francesca Cornelli in The Complete MBA Companion. "Therefore, other things being equal, companies that pay out high dividends should be valued less than companies that pay out low dividends. In response to this argument, however, economists have argued that the increasing domination of the market by tax-exempt institutions, the reduction of personal marginal income tax rates, the moves in both the UK and US to tax dividends and capital gains at the same rate and the abundance of tax shelters have all combined largely to neutralize the potential tax disadvantage of dividend payments."
SEE ALSO Stocks
Allen, F., and R. Michaely. Dividend Policy. N. Holland Handbooks.
Cornelli, Francesca. "The Thinking Behind Dividends." The Complete MBA Companion. Pitman Publishing, 1997.
Escherich, Frederic A. "Deliberating on Dividend Policy." Directors and Boards. Fall 2000.
Lazo, Shirley A. "The Dividends of Dividends: How Significant are Boosts and Cuts?" Barron's. 1 July 1996.
Peskett, Roger. "Deciding Dividends." Accountancy. September 1999.
Hillstrom, Northern Lights
updated by Magee, ECDI