Chapter 8 Strategic Question

Instead of paying out a fixed dividend amount every quarter, as 95 percent of companies do that pay dividends, a few companies, such as Progressive Corporation (stock symbol = PGR), pay dividends based on the firm’s operating profits. Progressive pays a once-a-year variable dividend based on the same formula that it uses to determine employee bonuses.
A variable dividend payout policy may be more effective than a fixed payout policy, for several reasons that include:

1. A variable payout rewards excellent performance, whereas a fixed payout may reward mediocre or even poor performance.

2. In good years management and owners receive a lot of money. In bad years they receive no dividend income.

3. Employee bonuses and owner dividends may be determined based on a common criteria (profitability), promoting a fair/ethical business culture.

4. With a variable payout policy, a company can avoid committing to paying dividends that it cannot afford. No shareholder wants to receive capital if the firm will have to replace that capital by diluting their ownership, ie selling stock.

5. A variable dividend payout policy is less predictable but more sustainable than a fixed policy.

However, there are reasons why the vast majority of firms that pay dividends have a fixed, quarterly, predictable amount, include the following:

1. A fixed dividend payout policy can enhance a company’s stock price better than a variable payout policy.

2. Individuals/firms that purchase stocks for dividend income are uncertain whether they will receive anything from a firm that has a variable payout policy.

3. A fixed dividend payout policy results in executives managing for long-term shareholders’ equity, rather than trying to maximize short-term profitability all the time.

Another firm, Cal-Maine Foods (stock price = CALM), has a variable dividend payout policy, paying one-third of its net income in dividends to shareholders. Most recently in 2015, CALM shareholders are eligible for a $47.7 million dividend, based on earnings of $143 million the company.
The bottom line is that dividend policy is a strategic issue and a relevant strategic question relates to the policy. Specifically, would a variable dividend payout policy be better than a fixed policy? Managers in a given firm must decide the answer to this strategic question. However, the textbook authors (David & David) believe that a variable dividend payout policy should be much more commonly used – for the reasons listed above.

Source: Based on https://guybetterbid.wordpress.com/2011/04/26/the-rational-dividend-a-variable-dividend/