Danger of Stability of Dividends

The greatest danger in adopting a stable dividend policy is that once it is established, it cannot be changed without seriously affecting investors’ attitude and the financial standing of the company. If a company, with a pattern of stable dividends, misses dividend payment in a year, this break will have an effect on investors more severe than the failure to pay dividend by a company with unstable dividend policy. The companies with stable dividend policy create a ‘clientele’, which depends on dividend income to meet their living and operating expenses. A cut in dividend is considered as a cut in ‘salary.’ Because of the serious depressing effect on investors due to a dividend cut, directors have to maintain stability of dividends during lean years even though financial prudence would indicate elimination of dividends or a cut in it. Consequently, to be on the safe side, the dividend rate should be fixed at a conservative figure so that it may be possible to maintain it even in lean periods of several years. To give the benefit of the company’s prosperity, extra or interim dividend, can be declared. When a company fails to pay extra dividend, it does not have as depressing an effect on investors as the failure to pay a regular dividend.