Why Do Corporations Pay Cash Dividends?

by Mike Parker

Investors buy stock for a number of reasons, including the potential for capital appreciation and to receive a steady stream of current income through dividend payments. While there is a significant difference of opinion among economists regarding the benefits and drawbacks of dividends, the boards of directors of a number of companies find it appropriate to pay them.

Return of Profits

Companies are in business to earn a profit, though there is no guarantee that they will do so. If a company earns a profit, its board of directors may choose to retain those earnings to fund expansion, to pay operating expenses or to promote research and development. The board may vote to pay all or a portion of the profits to the shareholders in the form of a cash dividend.

Stability of Shareholders

Some companies operate in cyclical business sectors where they experience periodic high and low earnings. The boards of directors of companies in these sectors may choose to maintain their quarterly dividend payments at a consistent level, even during times when their earnings are less than the dividend, in order to maintain investor confidence.

Stock Price Support

Companies that have a long history of paying regular quarterly dividends during both good and bad economic times are referred to as blue chip stocks. Investors have come to expect these dividends to continue as an indicator of the company's financial health. An increase in the dividend payout may result in an increase in the stock price, while a decrease or omission of a dividend payout can cause the stock's price to fall.

Attract Investors

Companies may issue different types of stock, including preferred stock, which offers a fixed dividend payment. Preferred stock is attractive to investors who want a high level of current income, and it is attractive to companies that wish to raise cash without incurring additional debt.

About the Author

Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.