Why Do Companies Pay Dividends on Common Stock?
For better or worse, some companies pay stock dividends. Why some choose to pay and others don't is at the discretion of the company, but implications exist for both the company and the investor.
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Dividends explained
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Companies pay dividends as a way to share their profits with shareholders. Dividends are normally paid in cash annually or quarterly and reduce the retained earnings of a company by the total amount of the dividend.
Against dividends
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Those against paying dividends say companies are better off reinvesting the dividend. The reinvestment increases the company's value and eventually the value of the underlying security.
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For dividends
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Groups in favor of dividend payments argue the payout helps investors gain a sense of security and stability about the company. Additionally, a healthy dividend is a plus for investors looking to reap a steady income from their investment without having to sell their stock.
Payment methods
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Three basic dividend payment policies exist: residual (only paid if enough money is left after all operation expenses are covered) , stability (dividends are fixed at a fraction of yearly or quarterly earnings) and hybrid (a combination of residual and stability policies).
Final thoughts
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In the March 1983 issue of the "American Economic Review", authors Martin Feldstein and Jerry Green state, "The nearly universal policy of paying substantial dividends is the primary puzzle in the economics of corporate finance."
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