Dividend policy, in financial management and corporate finance, is concerned with the policies regarding dividends; more specifically paying a cash dividend in the present, as opposed to, presumably, paying an increased dividend at a later stage. Practical and theoretical considerations will inform this thinking.

In setting dividend policy, management must pay regard to various practical considerations, often independent of the theory, outlined below. In general, whether to issue dividends, and what amount, is determined mainly on the basis of the company's unappropriated profit (excess cash) and influenced by the company's long-term earning power: when cash surplus exists and is not needed by the firm, then management is expected to pay out some or all of those surplus earnings in the form of cash dividends or to repurchase the company's stock through a share buyback program. At the same time, although the decisioning must weigh the best use of those resources for the firm - i.e. investment needs and future prospects - it must also take into account shareholders' preferences, and the relationship with capital markets more broadly.

As regards the firm: If there are no NPV positive opportunities, i.e. projects where returns exceed the hurdle rate, and excess cash surplus is not needed, then management should return some or all of the excess cash to shareholders as dividends. However, potentially limiting any distribution, the firm's overall finances, liquidity, and legal / debt covenants in place will also be of relevance. Management may also wish to avoid "unsettling" the capital markets by changing policy abruptly; see below re signaling.

As regards shareholders: As a general rule, shareholders of "growth companies" would prefer managers to retain earnings so as to fund future growth internally (or have a share buyback program) whereas shareholders of value or secondary stocks would prefer the management to distribute surplus earnings in the form of cash dividends. Re the former, for example, the thinking is dividend payments, and share price, will be higher in the future, (more than) offsetting the retainment of current earnings. See Clientele effect.

Regarding both: Management must choose the form of the dividend distribution, generally as cash dividends or via a share buyback. Various factors may be taken into consideration: where shareholders must pay tax on dividends, firms may elect to retain earnings or to perform a stock buyback, in both cases increasing the value of shares outstanding. Alternatively, some companies will pay "dividends" from stock rather than in cash; see Corporate action.

There are several schools of thought on dividends, in particular re their impact on firm value. A key consideration will be whether there are any tax disadvantages associated with dividends: i.e. dividends attract a higher tax rate as compared, e.g., to capital gains; see dividend tax and Retained earnings § Tax implications. Here, per the Modigliani–Miller theorem, as below: if there are no such disadvantages - and companies can raise equity finance cheaply, i.e. can issue stock at low cost - then dividend policy is value neutral; if dividends suffer a tax disadvantage, then increasing dividends should reduce firm value. Regardless, but particularly in the second (more realistic) case, other considerations apply; see Corporate finance § Dividend theory.

The Modigliani–Miller theorem states that dividend policy does not influence the value of the firm. The theory, more generally, is framed in the context of capital structure, and states that — in the absence of taxes, bankruptcy costs, agency costs, and asymmetric information, and in an efficient market — the enterprise value of a firm is unaffected by how that firm is financed: i.e. its value is unaffected by whether the firm is funded by retained earnings, or whether it raises capital by issuing shares or by selling debt.

The dividend decision, relating to both equity financing and retained earnings, is, in turn, value neutral. Here, shareholders are indifferent as to how the firm divides its profits between new investments and dividends. The logic, essentially, is that capital used in paying out dividends will be replaced by new capital raised through issuing shares. The latter will increase the number of shares, diluting earnings, and hence lead to a decline in share price. Thus any increase in firm value because of the dividend payment (e.g. per the Gordon model, as below, where value is a function of dividend) will be offset by the decrease in value due to raising new capital.