What is a Dividend?

A dividend is a payment to shareholders of a portion of a corporation's earnings. The amount to be paid is decided by the organization's board of directors. The payment is usually in cash, but can also take the form of property or additional shares of stock.

Dividends are typically paid on a recurring quarterly or annual basis, though the board may occasionally vote to issue a one-time dividend, usually as a distribution of a large amount of cash received by the business, and for which there is no internal need. On an ongoing basis, dividends are usually set at a consistent and predictable level, so that investors will be more willing to hold the stock as a reliable form of income. They typically use the dividend yield measure to calculate the return they are receiving on their investment.

Newer and rapidly-growing companies rarely issue dividends, since they need the cash to fund their growth. Instead, larger firms with steady market shares and less internal need for cash are more likely to issue dividends.

Disadvantages of Dividends

While some types of investors appreciate the steady income from dividends, there are several concerns with issuing dividends. These issues are as follows:

Adverse shareholder taxation. Another problem with dividends is that shareholders are taxed on the amount received; this constitutes double taxation, since the issuing entity also paid taxes on its earnings. This might deter certain investors who prefer capital gains over dividend income.
Limits cash reserves. If the company faces financial difficulties or needs cash during economic downturns, issuing dividends can strain liquidity, leaving the business less flexible to handle challenges.
Limits investor types. Companies that issue dividends may become less attractive to growth-oriented investors who prefer companies that reinvest earnings to fuel rapid expansion. This can limit the stock’s appeal to certain investor segments.
Limits reinvestment opportunities. Paying dividends reduces the amount of cash a company has on hand. This cash could otherwise be used for reinvestment into the business, such as funding research and development, expanding operations, acquiring other businesses, or improving infrastructure.
Possible negative signaling. A problem with using a consistent payment strategy for dividends is that a decline in the announced amount of the dividend to be paid is a clear signal that the firm is having cash flow difficulties, which can trigger a significant sell-off of shares, dropping the market price of the stock.
Short-term focus. Dividends can encourage short-term shareholder satisfaction, potentially leading management to prioritize dividend payouts over long-term value creation or strategic initiatives.