Question

Your goal here is to explain how dividends work. Answer the following in the space provided.

1. In your own words, what is a dividend?
2. Within a corporation, who decides whether to pay dividend?
3. Google pays no dividend while Con Edison pays a large dividend. What would influence a company to pay or not to pay a dividend? Why?
4. Why might a rational investor invest in the stock of a company that pays no dividend?

Answer 1

A dividend is a specific amount paid by a company to its shareholders, out of its profits.

In a corporation, the board of directors decide whether to pay dividends or not.

If a company has extra cash on its balance sheet but does not yet have use for that cash, it can distribute some of it to its shareholders. This action can have a positive impact as shareholders usually like receiving dividends.

An investor might want his/her company to reinvest its profits back into the company so that it grows bigger. If a company distributes dividends, it is left with less amount of money to reinvest back into its operations. This is why a rational investor might invest in a stock that pays no dividend in the hopes that the company will grow bigger, faster.