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Financial Management and Business Data Analytics · Dividend Decisions and Dividend Theories

Types of Dividend Policy: Stable, Constant Payout and Residual

Updated 10 October 2026 · Fact-checked

A dividend policy is the rule a company follows to decide how much profit to pay as dividend and how much to retain. The main types are stable, constant payout ratio, residual, regular plus extra, and no-dividend policy. To solve problems, identify the policy, then apply its rule to the profit figures given.

Understand Types of Dividend Policy

A company earns profit. It can pay part to shareholders as dividend and keep the rest as retained earnings. A dividend policy is the guideline that fixes this split. The choice matters because retained profit is a cheap internal source of finance, while dividends are what shareholders expect as a return.

In a stable dividend policy, the company pays a steady dividend per share (DPS), even when profit moves up and down. It may keep DPS fixed, raise it by a fixed amount, or raise it gradually. Investors like the certainty, and a steady DPS is read as a sign of confidence. The cost is that in a poor year the company may pay out more than it comfortably can.

In a constant payout ratio policy, the company pays a fixed percentage of each year's profit as dividend. If the payout is 40%, DPS is 40% of EPS every year. The dividend automatically moves with profit, so it is always affordable. But DPS swings from year to year, and in a loss year no dividend is paid.

In a residual dividend policy, dividend is treated as what is left after funding all acceptable investments. The company first decides its capital budget, then finances the equity part of it from profit. Only the leftover profit, if any, is paid out. This suits companies with many growth projects, but dividends become irregular.

Other policies are: regular plus extra dividend (a low steady dividend, with an extra payment in good years), no dividend policy (all profit retained, common in young growth firms), and stock dividend/bonus based policies. Compare them on three points: stability for the shareholder, affordability for the company, and effect on investment funding.

Key rules to remember

Dividend per share
DPS = Total dividend ÷ Number of equity shares
Use shares outstanding on which dividend is payable.
Constant payout ratio
Dividend = Payout ratio × Profit after tax (available to equity)
Payout ratio = DPS ÷ EPS. DPS changes whenever EPS changes.
Retention ratio
Retention ratio = 1 − Payout ratio
Equals retained earnings ÷ earnings.
Residual dividend
Dividend = Net income − (Equity share of new investment) = Net income − (Target equity % × Capital budget)
If the result is negative, dividend is nil and extra equity is needed. Assumes the company keeps its target debt-equity mix.

How to solve Types of Dividend Policy questions

Use this order for any numerical or theory question on types of dividend policy.

  1. 1Read the question and name the policy: stable, constant payout, residual, or regular plus extra.
  2. 2List the data: profit after tax, number of shares, past DPS, payout ratio, capital budget and target debt-equity mix.
  3. 3Take profit after tax and deduct preference dividend if given, to get earnings for equity shareholders.
  4. 4For constant payout: multiply earnings by the payout ratio. For stable: carry forward or raise DPS as the rule says, regardless of profit.
  5. 5For residual: find the equity part of the capital budget (target equity % × budget), subtract it from earnings, and treat the balance as dividend.
  6. 6Convert to DPS and retained earnings. Check that dividend plus retention equals earnings.
  7. 7Write a one-line comment on what the result means for shareholders and for funding.
  8. 8For theory questions, give meaning, working, merits and limitations in separate points.

Quickest way: Three-line shortcut for dividend policy sums

When to use it: Use when the question gives profit and an investment plan and asks for dividend under a stated policy.

  1. Stable: DPS stays as given or rises by the stated step. Ignore the profit swing.
  2. Constant payout: DPS = payout % × EPS. Compute EPS first.
  3. Residual: Dividend = Earnings − (Equity % × Capital budget). If negative, write nil.
  4. Finish with the check: dividend + retained earnings = earnings.

Common mistakes in Types of Dividend Policy

  • Treating stable and constant payout policies as the same thing.

    Both sound like regular dividends.

    Fix: Stable fixes the amount (DPS). Constant payout fixes the percentage of profit. Only the second makes DPS move with EPS.

  • In the residual policy, deducting the whole capital budget from earnings.

    Students forget part of the project is financed by debt.

    Fix: Deduct only the equity portion: target equity % × capital budget.

  • Showing a negative dividend when the equity need exceeds earnings.

    Mechanical subtraction without a check.

    Fix: Write dividend as nil and note that the shortfall must come from new equity.

  • Calculating constant payout dividend on profit before preference dividend.

    Skipping the earnings-for-equity step.

    Fix: Deduct preference dividend first, then apply the payout ratio and divide by equity shares.

  • Writing only merits and forgetting limitations in theory answers.

    The syllabus line stresses both, but students list only positives.

    Fix: Give at least two merits and two limitations for every policy.

Worked examples

Example 1

Arvind Textiles Ltd has 2,00,000 equity shares. Profit after tax is ₹30,00,000. It has a capital budget of ₹40,00,000 and wants to finance it 60% by equity (from retained profit) and 40% by debt. Find the dividend and DPS under a residual dividend policy.

Show the solution
  1. Equity portion of capital budget = 60% × ₹40,00,000 = ₹24,00,000.
  2. Residual earnings = ₹30,00,000 − ₹24,00,000 = ₹6,00,000.
  3. Dividend = ₹6,00,000.
  4. DPS = ₹6,00,000 ÷ 2,00,000 = ₹3.
  5. Check: dividend ₹6,00,000 + retained ₹24,00,000 = ₹30,00,000.

Answer: Dividend is ₹6,00,000, which is ₹3 per share.

Example 2

Sundaram Foods Ltd follows a constant payout ratio of 40%. It has 5,00,000 equity shares and 10% preference capital of ₹20,00,000. Profit after tax for two years is ₹16,00,000 and ₹11,00,000. Find DPS for each year and comment.

Show the solution
  1. Preference dividend = 10% × ₹20,00,000 = ₹2,00,000.
  2. Year 1 earnings for equity = ₹16,00,000 − ₹2,00,000 = ₹14,00,000. EPS = ₹14,00,000 ÷ 5,00,000 = ₹2.80.
  3. Year 1 DPS = 40% × ₹2.80 = ₹1.12.
  4. Year 2 earnings for equity = ₹11,00,000 − ₹2,00,000 = ₹9,00,000. EPS = ₹1.80.
  5. Year 2 DPS = 40% × ₹1.80 = ₹0.72.
  6. Comment: DPS fell from ₹1.12 to ₹0.72 because it follows EPS.

Answer: DPS is ₹1.12 in year 1 and ₹0.72 in year 2. The payout is always affordable, but the dividend is unstable for shareholders.

Exam tips

  • Always state the policy name in the first line of the answer; it helps the examiner award marks.
  • In theory questions, keep a two-column layout of merits and limitations for each policy.
  • For the MCQ, remember the key words: stable means fixed DPS, constant payout means fixed percentage, residual means leftover after investment.
  • In residual problems, show the equity share of the budget as a separate step, since step marks are given for it.
  • End numerical answers with a short interpretation, as ICMAI expects a comment.

Practice questions from Dividend Decisions and Dividend Theories

Types of Dividend Policy in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Types of Dividend Policy: frequently asked questions

What is the difference between stable dividend policy and constant payout ratio?

A stable policy keeps the dividend per share steady or rising slowly, whatever the profit. A constant payout policy pays a fixed percentage of profit, so DPS rises and falls with EPS.

Why is residual dividend policy called a residual policy?

Dividend is what remains of profit after funding all acceptable projects with the equity part. If nothing remains, no dividend is paid.

Which dividend policy do investors prefer?

Many investors prefer a stable policy because it gives certainty of income and signals confidence. Growth-focused investors may accept a residual policy if reinvestment earns good returns.

What is a regular plus extra dividend policy?

The company pays a modest regular dividend every year and adds an extra amount in years of high profit. It keeps stability while allowing a share in good years.