A cash distribution of net income after taxes by a company to its shareholders is a cash dividend. It is commonly expressed as a certain amount of money per share for common stock and as a percentage of par value for preferred stock. The dividend payout ratio shows the amount of cash dividends paid to shareholders relative to a company’s total net income:
Dividend Payout Ratio = Cash Dividends/Net Income
Four dates are significant in distributing cash dividends:
- Declaration date – The date when a company declares a cash dividend, which creates a liability for the dividend (dividends payable);
- Ex-dividend date – For publicly traded shares, the date specified by the market where traded as of when a stock trades without the new buyer receiving the declared dividend;
- Record date – The date the shareholders of record on that date in the stockholders’ ledger will receive the declared dividend; and
- Payment date –The date when the dividend is actually paid out to the shareholders, as of when the liability for the dividends is eliminated (the period between record date and payment date will be as long as is necessary to deal with the administration, which may last from a few days up to several weeks).
For transactions close to the record date, there is often uncertainty as to whether the transfer will be recorded on the share register in time for record date. To eliminate such uncertainty, stock exchanges specify an ex-dividend date. The shares that trade from the ex-date until the date of payment are said to trade ex-dividend. Prior to the ex-date, the shares trade cum-dividend, which is from the declaration date to the date prior to the ex-date. Investors purchasing shares trading ex-dividend (i.e., from ex-dividend date to payment date) do not receive the current dividend payment, instead the dividend goes to the seller. If all other things remain the same, on the ex-date the share price should fall by the amount of the dividend.
The declaration of dividends (type, amount and date) is the responsibility of the board of directors in the Anglo-American corporate governance system. Dividends are proposed by the management board for approval at the annual shareholders’ meeting in the two-tier structure as in Continental Europe.
In the United States, cash dividends are usually paid and distributed quarterly by mail in the form of checks. In most other countries, cash dividends are distributed annually by bank transfer.
Cash dividends are generally paid out of retained earnings and, as with all dividends, paid only on outstanding shares. When a cash dividend is declared, a current liability (i.e., dividends payable) is created and retained earnings are reduced by the amount of the dividend. When the dividend is paid out, the liability is eliminated and cash is reduced accordingly.