SEBI’s move that requires companies to develop and disclose the dividend distribution policy is yet another significant step to protect the minority shareholder interest

For long, payment of dividends to shareholders was the prerogative of companies and there was certainly not a proper justification for skipping dividend payments. In fact, companies never felt the need for any explanations. However, with the introduction of Regulation 43A of the SEBI (listing Obligations and Disclosure Requirements) Regulations, 2016, the top 500 (according to their market capitalisation) listed companies are required to formulate a dividend distribution policy. This will go a long way in helping minority shareholders to understand the dividend distribution policies of different companies and invest according to their investment objectives. Through this regulation, Securities and Exchange Board of India (SEBI) is more interested in bringing about transparency as to how companies distribute their profits and is more about proper disclosures than intruding into the financials (finances) of these companies. That is the reason why SEBI has not given any directives regarding the quantum of dividends and disclosure is primarily voluntary in nature.

There are many factors that determine the dividend payout decision of a company. Firstly, a company with strong growth prospects and an ability to reinvest back into the business maintains low payout ratio. In fact all the firms that experience above-average growth rates are expected to have low dividend payout ratios since, in line with the residual theory of dividends, a greater number of profitable investment opportunities should result (other things being equal) in a greater need for earnings retention. Since dividends represent a cash outflow, the liquidity position of a firm is often an important consideration in dividend decisions. The firm's ability to pay a cash dividend is judged by the cash position and overall liquidity of the firm. A growing, profitable firm may not be liquid since it needs funds for new capital expenditures and to build up its permanent working capital position. likewise, firms in cyclical industries may experience times when they lack liquidity due to general economic conditions. Hence, the degree of liquidity is a variable of concern when a firm’s dividend policy is being assessed. Dividend policy is also determined by the controlling stake of the promoter group in a company. Under these circumstances, the higher the payout ratio, the more likely that a subsequent issue of equity may be needed to finance capital expenditures and promoters might prefer to minimise the likelihood of an offering of equity to avoid any dilution in their ownership position. Hence, a low payout policy is preferred. On the other hand, a high institutional ownership will favour a high dividend payout as it helps them to increase the control over the management. Age of the company is also a major determinant of the dividend payouts. Newly formed companies will have to retain major part of their earnings for further growth and expansion. Thus, they have to follow a conservative policy unlike (against) established companies, which can pay higher dividends from their reserves. Another determinant of a suitable dividend policy of a firm is its ability to access short-term sources of funds. This may be achieved by the company negotiating for a bank overdraft limit or having access to other short-term sources of funds. However, if a company’s ability to make a new issue of shares or to issue debt is restricted, it is likely that it will retain a higher proportion of its profits than a company which has ready access to funds from the capital market.

Notifying the new regulations, SEBI has given certain guidelines to companies for developing the dividend distribution policy and ideally disclosing the same in their annual reports and on their websites. First, the companies have to be clear about the circumstances under which the shareholders of the listed entities may or may not expect a dividend. Second, the shareholders must be informed about the financial parameters while declaring a dividend. Third, the external factors like state of the economy, Government regulations and policies and business conditions; and internal factors like profits earned during the year, capital budgeting decisions for the coming years and investments in subsidiaries or associated businesses, that would be considered for declaring dividends need to be disclosed to the investors. Fourth, companies need to provide a clear strategy for utilising the retained earnings and finally disclose the parameters that would be adopted to pay dividends to different classes of shares. In a nutshell, the management of a company is completely free to frame the required dividend policy. There are no obligations to be adhered to. So, the company needs to judiciously weigh all the factors and formulate a balanced dividend policy. A dividend policy can also be revised in the wake of changes in any of the factors.

Traditionally, although India commands higher valuations in terms of earnings multiples, it has an inferior dividend payout ratio compared to many emerging and developed markets. Over the last years, Indian companies distributed about 30-40 per cent of their profits as dividends while some of the emerging market indices from Brazil. Taiwan, Malaysia, and Indonesia boasted payout ratios of anywhere between 93 per cent and 47 per cent. However, there might be an upswing in dividend distribution. According to a report by shareholder advisory firm Institutional Investor Advisory Services India limited (IiAS), 91 of the top 100 companies have a publicly available dividend distribution policy, and of these, 15 companies are likely to distribute a higher share of their profits as the dividend. However, who is the real beneficiary of high dividend payoutsIJ Dividend distribution policy is extremely relevant in the Indian context where most of the business is family- owned with closely held shares and because the agency problems between majority and minority shareholders, any increase in the dividend payments benefit the promoter group in a big way. For example, Tata Consultancy Services (TCS) saw the promoters’ share of dividends nearly double from Rs 3,615.95 crores in 2012 to Rs 6,293.10 crores in 2016. Similarly, Hindustan Zinc promoter earned a hefty dividend during the same year to the tune of Rs 7,625 crore  that increased exponentially from Rs 658.34 crore in 2012. The same is the case with Shiv Nadar, chairman of HCl who was paid a dividend of Rs 1,359.60 crore as compared to Rs 529.47 crore in 2012, a rise of about two and half times. But what about the small investorIJ Does he benefit in the same wayIJ Any return to shareholder comprises of two things — capital appreciation and dividends.  Therefore, on account of a small stake in the company, the retail investors or minority shareholders do not benefit by dividend distribution in absolute terms. On the other hand, when a dividend is paid, on the ex-dividend date, the stock price is adjusted downward by the amount of the dividend paid out. And as the dividends no longer belong to the company, this is reflected by a reduction in the company’s market capitalisation. So, a retail investor ends up losing in both ways.  The move by SEBI that requires companies to develop and disclose the dividend distribution policy is yet another significant step to protect the minority shareholder interest. In a country where only four per cent of the population invests in stock markets, it is the responsibility of the regulators to provide a transparent, deep and liquid market to ensure more retail participation and the policy for dividend distribution in helping small investors to make a conscious decision.

(The writer is Assistant Professor, Amity University)