The board of directors determines whether or not dividends will be declared for the current financial period. Such decisions are made during semi-annual or quarterly meetings of the board of directors.

If a decision to distribute dividends is made, it will be paid to all shareholders whose names are listed as shareholders on the record date.

Due to time that it takes for new shareholders to be listed, dividends are only paid out to those shareholders who acquired shares of the firm earlier than two business days before the record date.

Two business days prior to record date, along with usual fluctuations of the market, the stock price starts selling as ex dividend and drops by an amount close to the declared dividend. The payment date of the dividend usually occurs few weeks after the record date.

Test yourself:

ABC Company declared a quarterly dividend of $0.5 per share on 15^th of November. You purchased 800 shares of ABC on 1^st of November and 15% tax is applicable to any dividends received. Determine whether you are eligible to receive dividends and, if so, how much will you receive after tax is taken into account.

Solution:

The dividends were declared on 15^th of November. Since you purchased stock on 1^st of November, you are eligible to receive the dividends. Your before tax dividends amount to $400 (=800*$0.5). Your after-tax dividends amount to $340 (=$400*(1-.15)).

Dividend reinvestment plans (DRIPs) – many firms offer dividend reinvestment plans which allow current stockholders to use dividends to acquire more shares at about five percent below the market price of the firm’s shares.

This allows company to avoid under pricing and flotation costs involved in issuing new shares and shareholders also benefit due to lower prices per share. This arrangement makes obtainment of additional shares more attractive for current stockholders.

Dividend relevance and irrelevance

Whether dividend policy affects the share price and, therefore, a value of the firm is still an unresolved issue. Residual theory of dividends, the dividend irrelevance theory proposed by Merton H. Miller and Franco Modigliani, and dividend relevance theory proposed by Myron J. Gordon and John Lintner, provide different viewpoints on the issue and are briefly discussed in the next set of articles.