The final method is that of a hybrid method. Dividends are paid on a stable basis. But over the long-term, the debt-to-equity ratio is reviewed, and if the firm is regularly coming short on paying its debts and other expenses, payments to shareholders may be curtailed (How and why do companies pay dividends, 2010, Investopedia). This is the preferred method, given the added flexibility it offers the firm. Hybrid methods have the ability to ensure the firm's long-term financial health, as payments can be curtailed in times of sustained economic hardship -- but hybrid payments still offer stable returns for investors, in most instances.
How much cash should a firm hold?
On one hand, it might seem from an investor's point-of-view that it is always 'good' to receive more money in the form of larger dividend payments -- either 'special' dividends, regular payments, or in the form of stock repurchases. However, a long-term investor wants to see the firm's value grow, and paying too large a dividend can mean the firm has less money to reinvest in new projects and add to its long-term value (Tajirian 2010).
From the firm's perspective, it might seem as if paying investors less and investing more in its future, paying off debt, and paying operating costs is in its best financial interest. But it needs to attract investors to survive, and if it does not pay its shareholders a fair dividend, its stock price and ability to raise capital by selling shares will decrease.
The amount of cash a firm should have on hand will...
At present, given the uncertainty of the current economic environment, U.S. companies are stocking upon their cash reserves and are being conservative about paying dividends and investing in new projects: nonfinancial U.S. companies now hold $1.84 trillion in cash and liquid assets. This marks an increase of 26% over 2009 figures, the greatest upswing in this total since records were kept, beginning in the year 1952 (Lahart 2010).
References
Baker, Kent H., Tarun K. Mukherjeel, Gary E. Powell (2005, Summer). Distributing excess cash:
the role of specially designated dividends. Financial Services Review.
Retrieved October 11, 2010 at http://findarticles.com/p/articles/mi_qa3743/is_200507/ai_n14685355/?tag=content;col1
How and why do companies pay dividends? (2010). Investopedia. Retrieved October 11, 2010 at http://www.investopedia.com/articles/03/011703.asp
Lahart, Justin. (2010, June 10).U.S. firms build up record cash piles. The Wall Street Journal.
Retrieved October 11, 2010 at http://online.wsj.com/article/SB10001424052748704312104575298652567988246.html
Residual divided policy. (2010). Finance maps of the world. Retrieved October 11, 2010 at http://finance.mapsofworld.com/dividend/stock/residual-policy.html
Tajirian, Alex. (2010). Dividend: Cash vs. stock repurchase. More Value.com. Retrieved October
11, 2010 at http://www.morevalue.com/glossary/restrict/Dividend-PGE.html
