- AS, A-Level
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Last updated 14 Apr 2017
The owners of an incorporated business (shareholders) may wish to extract some of the profits (returns) earned by the firm. This is done through the use of dividends.
A dividend is a payment from the accumulated profits earned by a company to shareholders who qualify for such a payment.
A dividend can only be paid if the company has sufficient reserves of profit. A dividend cannot be paid if a company has accumulated losses.
The payment of a dividend per share is authorised by the shareholders.
Dividends and Market Capitalisation
For public companies whose shares are listed on public stock markets, it is sometimes the case that the share price is linked to the value of dividends paid out by the company.
Each year, the shareholders of a company (or the Board who make the recommendation on behalf of shareholders) need to decide whether to:
(1) Keep profits earned in the company (so-called "retained profits), or
(2) Pay some or all of those profits out to shareholders via dividends
This decision is known as the dividend policy.
For some investors, an expectation that a reasonably high level of dividends will be paid out to shareholders each year may be a reason to invest.
For other businesses, a policy of reinvesting profits back into the business rather than paying them out as dividends may be seen as a positive reason for shareholders to invest.