Dividend policy refers to the financial policies of a company regarding paying cash dividends in the present or paying an increased dividend at a later stage. It outlines how a company will distribute its dividends to its shareholders. The policy is important for dividend-paying companies as it provides a structure that highlights several key points, including whether to issue dividends, what amount, and when, how much, and how often money will be paid.

There are different types of dividend policies, including stable, constant, residual, and hybrid. The stable dividend policy is the most commonly used, and its goal is to provide shareholders with a steady and predictable dividend payout each year, which is what most investors seek. The constant dividend policy aims to maintain a constant dividend payout even if the results in a particular period are not up to the mark. The residual dividend policy pays dividends from the residual earnings after all the necessary investments have been made. The hybrid dividend policy combines two or more of the other dividend policies.

The dividend policy should be set based upon the type of company and what management determines is the best use of those dividend resources for the firm to its shareholders. Financial theory suggests that shareholders of growth companies would prefer managers to have a share buyback program, whereas shareholders of value or secondary stocks would prefer the management of these companies to payout surplus earnings in the form of cash dividends.

A dividend policy sets a level of discipline that a company must follow with the use of cash flow, and it communicates the companys financial strength and value, creates goodwill among shareholders, and drives demand for stocks. While it doesnt necessarily affect share price, which is more tied to valuation and market fluctuations, a dividend policy is an important factor that investors consider when deciding what stocks to invest in.