There are various legal restrictions, which limit the amount of dividends paid by a firm, such as statutory restrictions that prevent firms from paying dividends. There are some unique situations in which restrictions are applicable on firms in terms of debt and stock contracts. In such cases, as a measure of reducing the risks, investors restrict the companies while paying dividends. Some of the common legal restrictions are liquidity constraints, predictability of earnings, and maintaining a control of the ownership . In the case of liquidity constraints, the liquidity position of the firm decides the firm’s ability to pay the dividends. In situations where the liquid assets of a firm are independent of the retained earnings, such as cash, firms gain extreme profits, while being poor in terms of cash. The major reason is the requirement of cash to pay the dividends rather than retained earnings.
The second legal constraint is the predictability of earnings, which determines the profits gained by a firm over time. In a situation that involves fluctuation of earnings, firms retain larger funds once they realize profits in order to meet the future demand of the firm. However, in the case of stable earnings, firms pay out larger earnings in the form of dividends as they do not have any concern about the profits and future requirements of capital . The third legal constraint, namely maintaining a control of the ownership is of a higher priority for small and medium-sized companies. In order to yield new stocks, possessing a control over the current stockholders is essential. Furthermore, in several cases, owners prefer the managers to finance new investments through the use of debt rather than issuing new stock. In such scenarios, the growth of a firm depends on the available debt capital and the capability of the firm to generate future profits.
Work Cited
Keown, A. J., Martin, J. D., Petty, J. W., & Jr., D. F. (2003). Foundations of Finance: The Logic and Practice of Financial Management, 6th Edition. San Francisco; CA: Prentice Hall.
