The Definition Of A DividendThe definition of a dividend as it relates to finance is: a. a pro-rata share in an amount to be distributed b. a sum of money paid to shareholders of a corporation out of earnings These seem reasonably straightforward, but as with anything in life, there is much that lurks beow the surface... An investor holding common stock / ordinary shares in a company will receive a return in one of two ways, either through capital gains (or losses) which come from price changes and dividends. There are practical limitations to a company paying out a dividend. Firstly, the payment must be legal. Company law will lay down the rules and guidelines. A firm must have distributable reserves on the balance sheet to be able to pay a dividend. A company may therefore dip into the undistributed profits of previous years. Many firms will want to do this to ensure a dividend payment is made every year and maintained at a certain level. Failure to do this can send out a negative signal about the firm. No CEO wants to do this! A firm also must have the cash availaible to pay out. Any experienced investor will know that profits do not necessarily mean cash!
Again, this would be done to maintain the standing of the company and it's management in the short-term. Once a dividend is being paid, managements are loathe to miss making payments. Since some collective funds select their investments partly based on dividend policy and history, missing one or more payments can lead to funds selling their holdings. These sales can lead to an imbalance in the supply and demand of stock available in the market leading to a fall in the price in the market. If one fund were to sell a large holding, this may be problematic, but since many funds use exactly the same criteria for selecting and holding an investment, a cut in size or the failure to pay a dividend can cause a number of fund managers to sell at the same time.
More details about the workings and definition of a dividend can be found on thense pages:
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