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8.2.3 Dividends

Explore the essential details about dividends in equity securities, including dividend policy, payment methods, ex-dividend dates, dividend reinvestment plans, and stock dividends.

Dividend Policy

Dividend policy is determined by a company’s board of directors and is guided primarily by the company’s size, goals, financial position, and the industry in which it operates. For example, a large, established company such as a bank may pay out a substantial percentage of its earnings as dividends to shareholders, whereas a growing tech company may retain a higher proportion of earnings to fund research and development.

Most companies retain a portion of their earnings each year to maintain operations and finance growth. In the long run, this policy benefits shareholders if it results in increased earnings. However, dividends may be reduced or halted, particularly during poor economic times, and investors should recognize this as one of the risks of common share investment.

Regular and Extra Dividends

Companies paying dividends on common shares may designate a specified amount to be paid each year as a regular dividend. The term “regular” indicates to investors that, barring a major collapse in earnings, those payments will be maintained.

Some companies may pay an extra dividend on the common shares, often at the end of the company’s fiscal year. The extra payment is a bonus paid in addition to the regular dividend, and the term “extra” indicates that investors should not assume the payment will be repeated the following year.

Declaring and Claiming Dividends

Companies may pay dividends once, twice, or four times a year. Unlike interest on debt, dividends on common shares are not a contractual obligation. The board of directors decides whether to pay a dividend, and if so, the amount and payment date. An announcement is made in advance of the payment date.

For shares registered in the name of the owner, dividend payment cheques are mailed directly to the owner. For shares registered in street certificate form, dividend payments are made to the securities firm whose name appears on the certificate, which in turn credits the accounts of clients owning the shares.

Ex-Dividend and Cum Dividend

Many companies place advertisements in financial newspapers announcing the declaration of a dividend. A typical dividend announcement includes the payment date and the record date. All shareholders recorded as of this record date are entitled to the declared dividend.

Date Traded Date Settled Ex-dividend or Cum Dividend
Monday, June 9 Wednesday, June 11 Cum Dividend
Tuesday, June 10 Thursday, June 12 Cum Dividend
Wednesday, June 11 Friday, June 13 Cum Dividend
Thursday, June 12 Monday, June 16 Ex-dividend
Friday, June 13 Tuesday, June 17 Ex-dividend
Monday, June 16 Wednesday, June 18 Ex-dividend

When a stock is actively traded, the record of shareholders is continually changing. For convenience, the issuing company names a


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## Who primarily determines a company's dividend policy? - [ ] Shareholders - [ ] CEO - [x] Board of directors - [ ] Government regulators > **Explanation:** The board of directors is responsible for determining the company's dividend policy, taking into account the company's size, financial position, goals, and the industry context. ## Why might a growing tech company retain a higher proportion of earnings? - [ ] To pay large bonuses to employees - [x] To fund research and development - [ ] To pay off debt - [ ] To buy competitors > **Explanation:** A growing tech company might retain more earnings to invest in research and development, key to its growth strategy. ## Which of the following is a risk of common share investment? - [ ] Guaranteed dividends - [ ] Price stability - [ ] Fixed income - [x] Dividends may be reduced or halted > **Explanation:** Dividends on common shares can be reduced or halted, particularly during economic downturns, making it a risk of common share investment. ## What does a "regular" dividend indicate? - [ ] One-time special payment - [x] Expected to be paid barring a major collapse in earnings - [ ] A rare bonus given to shareholders - [ ] It will vary significantly each year > **Explanation:** The term "regular" dividend indicates that the company aims to maintain these payments annually, except in case of significant earnings collapse. ## If a company decides to pay shareholders an additional amount at the end of the fiscal year, it is called: - [ ] A regular dividend - [ ] A stock dividend - [x] An extra dividend - [ ] A reinvestment plan > **Explanation:** An extra dividend is a bonus payment over and above the regular dividend, usually given at the end of the fiscal year. ## On what basis are dividends on common shares paid? - [ ] Contractual obligation - [ ] Fixed schedule determined by the law - [ ] Per employee recommendation - [x] Board of directors' decision > **Explanation:** Unlike debt interest payments, dividends on common shares are decided by the company’s board of directors and are not a contractual obligation. ## What does "ex-dividend" mean? - [ ] With dividend - [x] Without dividend - [ ] Extra dividend - [ ] Dividend reinvestment > **Explanation:** "Ex-dividend" refers to shares purchased without the entitlement to the declared dividend that will be paid to the previous share owner. ## What is the sequence that determines the entitlement to a dividend? - [ ] Record date → Payment date → Announcement date - [x] Announcement date → Record date → Ex-dividend date → Payment date - [ ] Ex-dividend date → Record date → Payment date - [ ] Payment date → Record date → Ex-dividend date → Announcement date > **Explanation:** The correct sequence is 1) Announcement date, 2) Record date, 3) Ex-dividend date, and 4) Payment date, ensuring the dividend is properly distributed. ## How often may companies pay dividends? - [ ] Every month - [ ] Only once a year - [ ] Every day - [x] Once, twice, or four times a year > **Explanation:** Companies typically pay dividends once, twice, or four times a year, as decided by the board of directors. ## What is dollar cost averaging in the context of dividend reinvestment plans? - [ ] Buying a large number of shares at once - [ ] Receiving dividends in the form of cash - [x] Gradually increasing share position at a reduced average cost per unit - [ ] Selling all stock dividends for cash > **Explanation:** Dollar cost averaging involves regularly investing dividends to buy additional shares, thus reducing the average cost per share over time.

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Tuesday, July 23, 2024