There may be three types of dividend policy:
(1)Strict or Conservative dividend Policy which envisages the retention of profits on the cost of dividend pay-out. It helps in strengthening the financial position of the company
(2) Lenient Dividend Policy which views the payment of dividend at the maximum rate possible taking in view the current earning of the company. Under such policy company retains the minimum possible earnings
(3) Stable Dividend Policy suggests a mid-way of the above two views. Under this policy, stable or almost stable rate of dividend is maintained. Company maintains reserves in the years of prosperity and uses them in paying dividend in lean year. If company follows stable dividend policy, the market price of its shares shall be higher.
There are reasons why investors prefer stable dividend policy. Main reasons are:-
1. Confidence Among Shareholders. A regular and stable dividend payment may serve to resolve uncertainty in the minds of shareholders. The company resorts not to cut the dividend rate even if its profits are lower. It maintains the rate of dividends by appropriating the funds from its reserves. Stable dividend presents a bright future of the company and thus gains the confidence of the shareholders an the goodwill of the company increases in the eyes of the general investors.
2. Income Conscious Investors. The second factor favoring stable dividend policy is that some investors are income conscious and favor a stable rate of dividend. They too, never favor an unstable rte of dividend. A Stable dividend policy may also satisfy such investors.
3. Stability in Market Price of Shares. Other things beings equal, the market price very with the rate of dividend the company declares on its equity shares. The value of shares of a company having a stable dividend policy fluctuates not widely even if the earnings of the company turn down. Thus, this policy buffer the market price of the stock.
4. Encouragement to Institutional Investors. A stable dividend policy attracts investments from institutional investors such institutional investors generally prepare a list of securities, mainly incorporating the securities of the companies having stable dividend policy in which they invest their surpluses or their long term funds such as pensions or provident funds etc.
In this way, stability and regularity of dividends not only affects the market price of shares but also increases the general credit of the company that pays the company in the long run.