Dividend policy (cash, scrip, share repurchase)

F3 – Financial Strategy · CIMA (CGMA Professional Qualification) · 17 min read · Updated: 22 Oct 2026

Welcome to the World of Cash Dividends!

Hello there! Welcome to one of the most practical chapters in your F3 studies. In the previous chapters, we looked at how companies raise money (like issuing shares or taking loans). Now, we are looking at the other side of the coin: what does the company do with the profit it makes?

Should the company keep the cash to grow bigger, or should it send a "thank you" check to the shareholders? This chapter is all about Cash Dividends. Understanding this is vital because a company’s dividend policy can change its share price and how investors feel about the business. Don’t worry if this seems a bit technical at first—we’ll break it down piece by piece!

1. What are Cash Dividends?

At its simplest, a cash dividend is a distribution of a portion of a company's earnings to its shareholders, paid in cash. It is the "reward" for providing equity capital to the business.

Prerequisite Concept: Retained Earnings
Before a company pays a dividend, it must have distributable profits (accumulated realized profits minus accumulated realized losses). Any profit not paid out as a dividend is called Retained Earnings. These are kept in the business to fund future projects.

The Big Trade-Off:
Every dollar paid out as a dividend is a dollar not available for reinvestment.
- High Dividends: Happy shareholders now, but maybe slower growth later.
- Low Dividends: More money to grow the business, but shareholders have to wait for their reward.

Quick Review Box:
Dividend Yield = $ \frac{\text{Dividend per share}}{\text{Current share price}} \times 100 $
Dividend Cover = $ \frac{\text{Earnings per share}}{\text{Dividend per share}} $
(A high cover means the dividend is "safe" because the company has plenty of profit to pay it.)

2. Why do Dividends Matter? (The Theories)

Students often find the "theories" the hardest part of F3. Let’s use some simple analogies to make them stick.

A. Dividend Irrelevance (Modigliani and Miller - MM)

MM argued that in a "perfect" world, it doesn't matter if a company pays a dividend or not. They believe the value of a company is driven by its investment policy (how it makes money), not its dividend policy (how it gives money away).

Analogy: Imagine you have \$100 in a bank account. If the bank moves \$10 from your savings to your checking account, are you "richer"? No. You still have \$100. MM says dividends are just moving money from the "company's pocket" to the "shareholder's pocket."

B. "Bird-in-the-Hand" Theory

This theory suggests that investors prefer dividends now rather than the promise of capital gains (share price increases) later. Cash in your hand today is certain; a share price increase in three years is risky.

Memory Aid: "A bird in the hand is worth two in the bush." (Cash now > Possible growth later).

C. The Signaling Effect

In the real world, information isn't perfect. Investors look at dividend changes as a "signal" from the Board of Directors about the company’s future.

- Dividend Increase: "We are confident that our future profits will stay high!" (Share price usually goes up).
- Dividend Cut: "Uh oh, we are worried about cash flow." (Share price usually crashes).

D. The Clientele Effect

Different investors (clienteles) want different things.
- Retirees: Usually want steady, high cash dividends to pay for their groceries.
- Wealthy, high-tax bracket investors: Might prefer the company to keep the money and grow the share price (capital gains) because capital gains are often taxed at a lower rate than dividends.

Key Takeaway: While MM says dividends don't matter in theory, in the real world, Signaling and Clientele effects mean that managers must be very careful when changing dividend levels.

3. Types of Dividend Policies

How does a company decide how much to pay? There are three common "rules" they might follow:

1. Stable Dividend Policy:
The company tries to pay a steady, predictable dividend every year, perhaps increasing it slightly for inflation. This is great for signaling "strength" and keeping the Clientele happy.
Common Mistake: Thinking companies just pay whatever profit they made. Most large companies actually "smooth" dividends so they don't jump up and down wildly.

2. Constant Pay-out Ratio:
The company pays out a fixed percentage of profits (e.g., always 30% of earnings).
The Catch: If profits are volatile (up one year, down the next), the dividend will also be volatile. This can send "bad signals" even if the company is doing okay.

3. Residual Policy:
The company looks at all its potential projects. It funds all "Good" projects (NPV > 0) first. If there is any cash left over, that is paid as a dividend.
The Catch: This is very efficient for the company, but investors hate it because the dividend is totally unpredictable!

Did you know?
Tech companies like Google (Alphabet) or Amazon went for decades without paying a single cent in dividends! They used every penny to grow. Only recently have some "Big Tech" firms started paying dividends as they became "mature" businesses.

4. Practical Constraints on Paying Dividends

Even if a company wants to pay a dividend, sometimes they can't. Here are the "Roadblocks":

Legal Constraints: Most countries have laws saying dividends can only be paid out of accumulated realized profits. You cannot pay dividends out of "capital."

Liquidity: This is a classic exam trick! Profit is not the same as Cash. A company might have \$1 million in profit, but if all that "profit" is tied up in unsold inventory or owed by customers (receivables), they don't have the cash in the bank to pay the dividend.

Debt Covenants: If a company has a bank loan, the bank might have a rule saying "You cannot pay a dividend if your Debt-to-Equity ratio is too high." This protects the bank's interest.

Growth Opportunities: If a company has a "once in a lifetime" chance to buy a competitor, they might skip the dividend to use the cash for the acquisition.

Quick Review Box:
Before paying a dividend, ask:
1. Do we have the legal profit? (The "Law" check)
2. Do we have the physical cash? (The "Liquidity" check)
3. Are we allowed by our lenders? (The "Covenant" check)

5. The Dividend Timeline

When a dividend is paid, it follows a specific sequence. Don't worry about the exact days, just the order:

Step 1: Declaration Date
The Board of Directors announces the dividend. They now have a legal obligation to pay it.

Step 2: Ex-Dividend Date
This is the most important date for the stock market. If you buy the share on or after this date, you do not get the upcoming dividend. The share price usually drops by the amount of the dividend on this morning.

Step 3: Record Date
The company looks at its list of shareholders ("The Register"). Anyone on the list at the end of this day gets the dividend.

Step 4: Payment Date
The day the cash actually hits the shareholders' bank accounts. Success!

Summary Takeaway:
Cash dividends are a key part of Financial Strategy because they represent the balance between rewarding owners and reinvesting for the future. Managers must consider Theories (like Signaling), Policies (like Stable Payouts), and Constraints (like Liquidity) before making the final call.

You've got this! Keep practicing the dividend cover and yield formulas, and you'll be ready for any dividend question the F3 exam throws at you!

Hello! Today we are diving into a clever piece of financial strategy called Scrip Dividends. This topic sits within your F3 – Financial Strategy syllabus under Sources of Long-term Funds. Don't worry if financial jargon usually feels a bit heavy; we’re going to break this down into simple, manageable pieces.

By the end of this page, you’ll understand why a company might offer shares instead of cash, how it affects the balance sheet, and why shareholders might (or might not) be happy about it.

Think of it like this: Instead of a coffee shop giving you $ \$5 $ cash back on your loyalty card, they give you a voucher for a free bag of coffee beans. You still get value, but the shop gets to keep the $ \$5 $ in their till!

What is a Scrip Dividend?

A Scrip Dividend is a dividend payment made to shareholders in the form of additional shares rather than cash.

Usually, the company offers shareholders a choice:
1. Take the dividend in cash (the traditional way).
2. Take the dividend in the form of new shares (the "scrip" option).

Key Difference: Scrip Dividend vs. Scrip Issue

It is easy to get these confused!
- A Scrip Issue (also called a Bonus Issue) is when a company gives free shares to everyone automatically.
- A Scrip Dividend is an option given to shareholders as an alternative to a cash payment.

Quick Review:
- Scrip = Shares.
- It’s a way for the company to "pay" a dividend without any cash leaving the bank account.

Why Do Companies Offer Scrip Dividends?

You might wonder, "Why wouldn't a company just pay cash?" In F3, we focus on strategy. Here is the strategic logic behind this move:

1. Conserving Cash

This is the most common reason. If a company is growing fast or going through a tough period, it might want to keep its cash to reinvest in new projects or pay off debt. By offering shares instead of cash, the cash stays inside the business.

2. Signaling Strength

Offering a scrip dividend can signal that the company has great investment opportunities. It says, "We’d rather use this money to grow the business for you than just give it back right now."

3. Tax Benefits (for some)

Depending on the country's tax laws, receiving shares might be taxed differently than receiving cash. Some shareholders prefer this for their personal tax planning.

Did you know?
During the global financial crisis, many banks offered scrip dividends because they were required by regulators to keep as much capital (cash) as possible to remain stable!

The Advantages and Disadvantages

To master F3, you need to see both sides of the coin. Let's look at the pros and cons for the Company and the Shareholders.

For the Company

Advantages:
- Preserves Liquidity: No cash leaves the business.
- Avoids Borrowing: If the company needs money for a project, using "saved" dividend cash is cheaper than taking out a bank loan.
- Equity Base: It increases the share capital, which can make the balance sheet look "stronger."

Disadvantages:
- Future Obligations: More shares in issue means the company will have to pay more dividends in the future (because there are more "mouths to feed").
- Administration: There are legal and administrative costs to issuing new shares.

For the Shareholder

Advantages:
- Transaction Costs: Shareholders get more shares without paying broker fees or commissions.
- Flexibility: They can choose cash if they need it for bills, or shares if they want to reinvest.
- Tax Timing: In some regions, you only pay tax when you eventually sell the shares, rather than paying income tax on the cash dividend immediately.

Disadvantages:
- No Cash: If a shareholder relies on dividends for their living expenses (like a pensioner), shares don't help pay the rent!
- Dilution: If some shareholders take cash and others take shares, the cash-takers will see their percentage of ownership in the company drop slightly.

Key Takeaway: Scrip dividends are a flexibility tool. They help the company manage cash flow while keeping shareholders engaged.

How is a Scrip Dividend Calculated?

Don't let the math scare you! It’s a simple ratio. The company will announce the dividend per share and the "conversion price" for the new shares.

The Formula:

$ \text{Number of New Shares} = \frac{\text{Total Cash Dividend Owed}}{\text{Market Value of One Share}} $

Example:
Suppose you own 1,000 shares in StrategyCorp.
The company announces a dividend of 20c per share.
Instead of cash, they offer shares at a value of $ \$4.00 $ each.

Step 1: Calculate your cash value
$ 1,000 \text{ shares} \times \$0.20 = \$200 $

Step 2: Calculate your new shares
$ \$200 \div \$4.00 = 50 \text{ shares} $

So, you end up with 1,050 shares and the company keeps the $ \$200 $ cash.

Impact on Financial Statements (The Accounting Bit)

In F3, you need to know how this affects the Statement of Financial Position (Balance Sheet).

When a scrip dividend is issued:
1. Cash: Does not change (unlike a cash dividend where cash goes down).
2. Share Capital: Increases (because new shares were issued).
3. Retained Earnings: Decreases (because dividends are paid out of profits).
4. Total Equity: Remains exactly the same! You are just moving money from one "pocket" of equity (Retained Earnings) to another (Share Capital).

Memory Aid: The "Pizza Slice" Trick
Think of the company's equity as a pizza. A scrip dividend is like cutting the pizza into 12 slices instead of 8. You have more slices (shares), but the size of the whole pizza (total equity) hasn't changed at all.

Common Mistakes to Avoid

1. Confusing Scrip with Rights Issues:
In a Rights Issue, the shareholder has to pay new money to the company. In a Scrip Dividend, the shareholder gets the shares instead of cash they were already owed. No new money leaves the shareholder's pocket.

2. Thinking the Share Price Stays the Same:
When new shares are issued via a scrip dividend, the total number of shares in the market increases. Because the total value of the company hasn't changed, the share price usually drops slightly to account for the extra shares (this is called dilution).

3. Forgetting the "Choice":
Always remember that a Scrip Dividend is usually an option. If the company forces it without a cash choice, it’s effectively a Bonus Issue.

Summary Checklist

- Definition: Giving shares instead of cash as a dividend.
- Main Benefit: Cash stays in the business for reinvestment.
- Main Downside: Dilutes earnings per share (EPS) because there are more shares.
- Accounting: Dr Retained Earnings, Cr Share Capital. Total Equity stays the same.
- Strategy: Useful for companies with high growth opportunities but low cash reserves.

Keep going! You're doing great. Mastering these sources of long-term funds is a huge step toward passing your F3 exam.

Hello! In this chapter, we are exploring a very popular way for companies to manage their long-term funds. Sometimes, a company has "too much" cash and decides the best use for that money isn't to buy a new factory or launch a new product, but to buy back its own shares from the stock market. Think of it as a company "investing in itself." This topic is a favorite in the F3 exam because it links cash management, shareholder value, and financial ratios all in one go. Let’s dive in!

A share repurchase (or share buyback) is when a company uses its spare cash to buy its own shares back from the existing shareholders. Once the company buys these shares, they are either cancelled (they stop existing) or kept as treasury shares (held by the company to be sold again later).

An Everyday Analogy

Imagine you and four friends own a pizza with 10 slices (the shares). Each of you owns 2 slices. If the pizza shop "buys back" 2 slices from one friend and throws them away, there are now only 8 slices left. If the pizza stays the same size, your 2 slices now represent a bigger percentage of the total pizza than they did before. That is exactly what happens for the shareholders who stay with the company!

Quick Review: When shares are repurchased and cancelled, the total number of shares in issue goes down. This usually makes the remaining shares more valuable.

Why do Companies Repurchase Shares?

Don't worry if this seems a bit strange—why would a company want fewer owners? There are several strategic reasons why a Board of Directors would choose this path over, say, paying a dividend.

1. To Return Excess Cash

If a company has a lot of cash but no profitable projects to invest in, it should give that money back to shareholders. Repurchases are often seen as more flexible than dividends. If you start a high dividend, shareholders expect it every year. A buyback is usually a one-off event.

2. To Boost Financial Ratios (The "EPS" Trick)

This is a big one for exams! Earnings Per Share (EPS) is calculated as:

$ EPS = \frac{Total \ Earnings}{Number \ of \ Ordinary \ Shares} $

If the company reduces the Number of Ordinary Shares (the denominator) by buying them back, the EPS goes up, even if the total earnings stay exactly the same. This can make the company look more successful to investors.

3. To Change the Capital Structure

If a company wants to increase its gearing (the ratio of debt to equity), it can use debt to fund a share buyback. This replaces "expensive" equity with "cheaper" debt (because interest is tax-deductible).

4. Taxation Benefits

In many jurisdictions, receiving a dividend is taxed as income, while selling shares back to the company is taxed as a capital gain. Capital gains tax rates are often lower, making buybacks more "tax-efficient" for certain shareholders.

5. Signaling and Undervaluation

If a company’s management thinks the stock market has priced their shares too low, they might buy them back. This sends a "signal" to the market: "We think our shares are a bargain, and we are putting our money where our mouth is!"

Key Takeaway: Repurchases are a flexible tool used to return cash, improve ratios, signal confidence, or optimize the balance between debt and equity.

Methods of Repurchasing Shares

How does a company actually do this? There are three main ways:

Open Market Repurchase: The company simply buys shares on the stock exchange, just like a normal investor would. This is the most common and flexible method.
Tender Offer: The company offers to buy a specific number of shares at a fixed price (usually at a premium/higher than the current market price). Shareholders choose whether to "tender" (offer up) their shares.
Private Negotiation: The company negotiates directly with a major shareholder to buy a large block of shares.

The Impact on Financial Ratios

When you see a question about share repurchases, immediately think about how it affects the "Big Three" ratios:

1. Earnings Per Share (EPS)

As we discussed, as the number of shares falls, the EPS increases. This is usually seen as positive by the market.

2. Gearing (Leverage)

Shareholders' equity (the denominator in gearing) decreases because the company used cash (an asset) to "delete" equity. Therefore, gearing increases.
$ Gearing = \frac{Debt}{Debt + Equity} $

3. Price/Earnings (P/E) Ratio

This is tricky. If the EPS goes up and the share price stays the same, the P/E ratio goes down. However, often the share price rises because of the "buy" signal, so the P/E ratio might remain stable.

Common Mistake to Avoid: Don't forget that if the company uses cash to buy shares, it loses the interest income it would have earned on that cash. This might slightly lower the "Total Earnings" part of the EPS equation!

Treasury Shares: The "Waiting Room"

Sometimes, a company doesn't want to cancel the shares forever. They keep them in a "holding pen" called Treasury Shares.

They have no voting rights.
They receive no dividends.
The company can sell them back to the market later if they need to raise cash quickly without the paperwork of a new share issue.

Summary & Quick Review Box

Did you know? Large tech companies like Apple and Microsoft spend billions of dollars every year on share repurchases rather than just hoarding the cash!

Key Review Checklist:
- Cash Impact: Cash decreases.
- Equity Impact: Shareholders' equity decreases.
- EPS Impact: Usually increases (fewer shares).
- Gearing Impact: Increases (less equity).
- Tax: Often more efficient than dividends for shareholders.
- Flexibility: Higher than dividends (no long-term commitment).

Don't worry if the math of the ratios feels heavy. Just remember: Fewer shares = a bigger piece of the pie for everyone left behind!

Quick check

Can you answer these now?

Open each question to check the key ideas from this chapter.

What is a cash dividend?

A cash dividend is a distribution of a portion of a company's earnings to its shareholders, paid in the form of cash as a reward for providing equity capital.

What are distributable profits in the context of dividends?

Distributable profits are accumulated realized profits minus accumulated realized losses, which a company is legally required to have before it can pay a dividend.

How is Dividend Yield calculated and what does it measure?

Dividend Yield = $ \frac{\text{Dividend per share}}{\text{Current share price}} \times 100 $. It measures the cash return on a share relative to its market price.

What is Dividend Cover and why is it important?

Dividend Cover = $ \frac{\text{Earnings per share}}{\text{Dividend per share}} $. It indicates how many times over the company's profits can pay the current dividend.

What is the core argument of Modigliani and Miller's (MM) Dividend Irrelevance theory?

MM argued that in a perfect market, a company's value is determined by its investment policy (how it earns money) rather than its dividend policy (how it distributes money).

What does the "Bird-in-the-Hand" theory suggest about investor preferences?

It suggests that investors prefer certain dividends today over the uncertain prospect of higher capital gains in the future because cash now is less risky.

How does the Signaling Effect influence share prices during dividend announcements?

Dividend changes act as a signal to the market; an increase suggests management is confident in future profits, while a cut signals potential financial trouble.

What is the Clientele Effect in dividend policy?

The Clientele Effect describes how different groups of investors are attracted to companies with dividend policies that match their specific needs, such as tax status or cash flow requirements.

What characterizes a Stable Dividend Policy?

Under a stable policy, a company aims to pay a steady, predictable dividend each year, often "smoothing" payouts to avoid fluctuations regardless of short-term profit changes.

How does a Residual Dividend Policy function?

The company first uses earnings to fund all projects with a positive Net Present Value (NPV), and only pays out whatever cash remains as a dividend.

Why is liquidity a practical constraint on paying dividends?

Dividends are paid in cash, not profit; a company might be profitable on paper but lack the actual bank balance to pay shareholders if its cash is tied up in assets.

What happens on the Ex-Dividend Date?

On the ex-dividend date, the share begins trading without the right to the upcoming dividend, typically causing the share price to drop by the amount of the dividend.

What is a scrip dividend?

A scrip dividend is a dividend payment made to shareholders in the form of additional shares rather than cash, usually offered as an optional alternative.

How does a scrip dividend differ from a scrip issue (bonus issue)?

A scrip dividend is an option where shareholders choose shares over cash, whereas a scrip issue is an automatic distribution of free shares to all shareholders.

What is the primary strategic reason for a company to offer a scrip dividend?

The primary reason is to conserve cash within the business for reinvestment or debt repayment while still rewarding shareholders.

What signal does a scrip dividend send to the market?

It signals that the company has strong future investment opportunities and believes it can generate a better return by reinvesting the cash than by paying it out.

What are the main advantages of a scrip dividend for the issuing company?

It preserves liquidity, avoids the need for expensive external borrowing, and strengthens the equity base on the balance sheet.

What is a major long-term disadvantage of scrip dividends for a company?

It increases the number of shares in issue, which creates a higher future dividend obligation to maintain the same dividend per share.

How do scrip dividends benefit shareholders regarding transaction costs?

Shareholders can increase their holding in the company without paying brokerage fees, commissions, or stamp duty.

What is the risk of dilution for a shareholder in a scrip dividend scenario?

Shareholders who choose the cash option will see their percentage of ownership in the company decrease as the total number of shares increases.

What is the formula for calculating the number of new shares in a scrip dividend?

$ \text{Number of New Shares} = \frac{\text{Total Cash Dividend Owed}}{\text{Market Value of One Share}} $

What is the accounting impact of a scrip dividend on total equity?

Total equity remains unchanged; the transaction is a reclassification from Retained Earnings (debit) to Share Capital (credit).

Why does the share price usually drop slightly after a scrip dividend?

The total value of the company is spread across a larger number of shares, which causes a theoretical dilution in the value of each individual share.

What is a share repurchase (or share buyback)?

It is when a company uses its spare cash to buy back its own shares from the stock market and existing shareholders.

What is the effect of share cancellation on remaining shareholders?

Cancellation reduces the total number of shares in issue, meaning each remaining share represents a larger percentage of the company's ownership.

Why is a share repurchase considered more flexible than a dividend payment?

Dividends often create a long-term expectation of regular payments, while a repurchase is usually treated as a one-off event that does not commit the company to future payments.

How can a share repurchase be used to improve Earnings Per Share (EPS)?

By reducing the number of shares in issue, the denominator in the EPS formula decreases, which causes the EPS to rise even if total earnings remain constant.

How does a share repurchase facilitate a change in capital structure?

A company can use debt to fund a share buyback, effectively replacing expensive equity with cheaper, tax-deductible debt.

What are the potential taxation benefits of a share repurchase for shareholders?

Repurchases are often taxed as capital gains, which may have lower tax rates than the income tax applied to dividend payments.

What does a share buyback signal to the stock market?

It signals that management believes the company's shares are currently undervalued by the market.

What are the three main methods of repurchasing shares?

Open market repurchases, tender offers, and private negotiations.

Why does a share repurchase cause financial gearing to increase?

The buyback reduces the total shareholders' equity (the denominator in many gearing ratios) while cash (an asset) is depleted.

How does a share repurchase affect the Price/Earnings (P/E) ratio?

The P/E ratio may decrease if EPS rises faster than the share price, though market signaling often causes the share price to rise as well, which may stabilize the ratio.

What are the restrictions on treasury shares?

Treasury shares have no voting rights, receive no dividends, and are held by the company to be potentially resold later.

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