Wednesday, September 23, 2015

"Sustainable Dividend" theory

Companies which are conservative in declaration of dividends justify their tightfistedness towards shareholders on the ground that they aim at sustainability of dividend rate over the long run.

In the AGM held on 23rd of September, Chairman of Manali Petrochemicals asserted that the Board recommends only 10% as rate of dividend to ensure sustainability in the long term. Stinginess of dividend became an issue especially in view of remuneration to Managing Director alone being more than 12% of total quantum of dividends (Rs.110 lakh vs Rs.860 lakh).

Sustainability argument ought to apply to MD's remuneration also. Chairman, A.C.Muthiah also claimed that enhanced salary levels are required to get the services of effective managers. Thus the argument is that the shareholders are captive whereas management has overriding bargaining power.

Sustainability argument for dividends is specious in the light of provisions contained in Companies (Declaration and Payment of Dividend) Rules, 2014 which are restrictive. A company can declare dividends out of profits earned in earlier years only if following conditions are satisfied: (These become relevant when the company incurs loss during any year. Losses are not totally avoidable to any company and more so to the company under reference.)

"(1) The rate of dividend declared shall not exceed the average of the rates at which
dividend was declared by it in the three years immediately preceding that year:
 Provided that this sub-rule shall not apply to a company, which has not declared
any dividend in each of the three preceding financial year.

(2) The total amount to be drawn from such accumulated profits shall not exceed
one-tenth of the sum of its paid-up share capital and free reserves as appearing in
the latest audited financial statement.

(3) The amount so drawn shall first be utilised to set off the losses incurred in
the financial year in which dividend is declared before any dividend in respect of
equity shares is declared.

(4) The balance of reserves after such withdrawal shall not fall below fifteen per
cent of its paid up share capital as appearing in the latest audited financial

(5) No company shall declare dividend unless carried over previous losses and
depreciation not provided in previous year are set off against profit of the company
of the current year the loss or depreciation, whichever is less, in previous years is
set off against the profit of the company for the year for which dividend is declared
or paid. "

Because of these stringent provisions, if and when the company incurs loss despite the acumen of MD and others, shareholders are sure to be denied any dividend. Therefore, really sustainable dividend percentage is only 0% Hence, companies should look for some pretext other than sustainability to justify conservative dividend policy.

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