Stable dividend policy: meaning and reasons

Meaning. A stable dividend policy keeps the dividend regular and steady instead of letting it swing with every change in the year's earnings. A firm can keep it steady in these ways:

1. Constant dividend per share: a fixed amount every year, whatever the actual earnings, generally kept for a considerable period; a reserve such as a dividend equalisation reserve is built up in good years to pay it in poor ones.
2. Constant payout ratio: a fixed percentage of each year's net earnings is paid out. The ICAI material lists this under stable dividend policy because the ratio is held steady, though the amount of dividend then rises and falls with earnings, and in a year of loss no dividend is paid at all.
3. Dividend based on long-term earnings: the dividend is set on a long-term forecast of sustainable earnings and raised only when earnings have increased to a substantially higher level.

Why firms follow a stable dividend policy

1. Investors who depend on dividend income (individuals and institutions meeting living and operating expenses) prefer a regular dividend.
2. Higher market value of shares: many companies believe that a stable dividend policy, together with a high payout ratio, maximises the market value of their shares.
3. Better image and investor confidence: the company's standing in the market improves and investors favour such companies.
4. Easier future financing: a firm with a steady dividend record can approach the market successfully for additional funds for expansion when needed.
5. Managers' own preference: managers are more concerned with changes in the dividend than with its absolute amount, so they avoid raising a dividend that they may later have to cut.