A company pays out dividends as a way of rewarding its current shareholders and convincing new investors to purchase its stock. Dividends are optional for most companies. The company can also delay paying a regular dividend if it has a bad year, but its preferred shareholders get the right to receive new dividend payments in future years before common shareholders get dividends.
Paying out a dividend affects the company's stock price. When investors expect to receive a dividend, they add this dividend to the amount they believe a share of stock is worth. After the date of record for a dividend, when the company records the stockholders who will receive the dividend, a new shareholder will have to wait to receive the next dividend, so the price of the stock drops by the value of the dividend payment. If a company announces a future dividend, the price of the stock rises, and if the company announces it will not pay a dividend this year, the stock price drops.
Some companies have to pay out dividends. A real estate investment trust must distribute 95 percent of its taxable earnings to shareholders to keep its tax advantages, according to the Journal of Real Estate Portfolio Management. This restriction makes it difficult for a real estate investment trust to use its own equity to buy property, although the dividend payout requirement also helps the trust find investors.
Rate of Return
A dividend policy can keep the company from making bad investment decisions. A company determines the rate of return on each project and uses this rate to select the most profitable project. If the company can't find any projects that provide the minimum acceptable rate of return, it can give its excess cash back to investors as a dividend. The investors can invest in other companies, and then buy back more of the company's stock to give it cash when it finds a more profitable project.
Dividends show the health of a company. If a company can pay a dividend, it has enough money to pay for inventory, utilities, wages, and the rest of its bills. The dividend also shows that the company can borrow money at low rates, because most companies have some debt so they can deduct the interest payments. The dividend suggests that the company is established, instead of a rapidly growing company, because a rapidly growing company needs to use money to expand, according to Ohio State University.