Legally directors have considerable liberty to use their discretion’ to dispose of the earnings of the company. But shareholders are the legal owners of the company, and directors, appointed by them, are their representatives. Therefore, directors should give due importance to the expectations of shareholders in the matter of dividend decision. Shareholders’ preference for dividends or capital gains depends on their economic status and the effect of tax differential on dividends and capital gains. A wealthy shareholder in a high income-tax bracket may be interested in capital gains as against current dividends. On the other hand, a retired person with small means, whose main source of income is dividend, would like to get regular dividend and may not be interested in capital gains.
Closely Held Company
In case of a closely held company, management usually knows the expectations of share-holders. Therefore, they can easily adopt a dividend policy, which satisfies all shareholders. The body of the shareholders is a small, homoge-neous group in a closely-held company. If most of the shareholders are in high tax brackets and have a preference for capital gains to current dividend incomes, the company can establish a dividend policy of paying less or no dividends and retaining the earnings within the company.
Widely Held Company
It is a formidable task to ascertain the preferences of shareholders in a wide-held company. The number of shareholders is very large and they may have diverse desire regarding dividends and capital gains. As a result, it is not possible in case of widely held company to follow a dividend policy, which equally satisfies all sharehold-ers. The firm can follow a dividend policy, which serves the purpose of the dominating group, but does not completely neglect the desires of others. Shareholders of a widely held company may be divided, for example, into four groups: small, retired, wealthy and institutional shareholders?
Small shareholders are not the frequent purchasers of the shares. They hold a small number of shares in a few companies. They generally purchase or sell shares on the advice of stockbrokers or friends. Their purpose sometimes is to receive dividend income, and sometimes, if possible, they may like to make capital gains. Thus, the small shareholders do not have a definite investment policy. They purchase shares only when their savings permit. This group rarely proves to be dominating in the body of shareholders in a company and it is not much
concerned with the dividend policy of the company.