Q:

How is dividend policy calculated?

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Quick Answer

The three primary models used to craft dividend policies are the stability, residual and hybrid approaches. Dividend policies are established by a company's board of directors or C-level executives. These plans establish a set of guidelines for determining a company's dividend pay out to its shareholders.

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Full Answer

When crafting a dividend policy, a company's executive team evaluates which approach to utilize for determining the dividend amount. The company's financial standing and outlook ultimately determine the approach.

A company that relies on internal equity to pay for new projects opts for the residual dividend policy. This approach provides dividend payments from the leftover or residual equity after all project capital needs are satisfied.

If a company wants a more predictable dividend model, it chooses the dividend stability policy. Under this approach, the company chooses a cyclical policy that establishes payments at a fixed fraction of its quarterly earnings or a fixed fraction of its annual earnings.

The final method for crafting a dividend policy combines aspects of the residual and stability approaches. With a hybrid approach, companies create two dividend amounts, one of which is fixed and based on its annual earnings, and then a subsequent or bonus dividend, which is paid-out only when the company exceeds their earnings expectations.

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