Certified Financial Management Specialist Practice Exam

Which of the following best describes a constant dividend policy?

1. Dividends are fixed regardless of earnings

2. A percentage of earnings is paid as dividends every year

3. Dividends fluctuate based on quarterly performance

4. Companies pay only when there is an increase in profits

The correct answer is: A percentage of earnings is paid as dividends every year

A constant dividend policy is best described by the practice of paying out a percentage of earnings as dividends every year. This means that as a company's earnings change, the dividend paid to shareholders is directly tied to those earnings figures. By using a fixed percentage approach, the company ensures that dividends reflect its performance, leading to a more stable and predictable income stream for shareholders. In contrast, a fixed dividend regardless of earnings does not take into account the company's financial health, which could potentially jeopardize its sustainability. Fluctuating dividends based on quarterly performance can lead to uncertainty for shareholders, as reliance on short-term performance might result in inconsistent payments. Lastly, limiting dividend payments only when there is an increase in profits does not establish a consistent policy, as it only rewards increases rather than providing a predictable structure for payouts based on all earnings. This highlights the distinctiveness of a constant dividend policy as it promotes consistency and a clear relationship to company performance.