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Question 15.18: How does dividend policy affect the need for capital?

How does dividend policy affect the need for capital?

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The retention ratio is of great importance to management. A retention ratio set too low results in slower growth of internal capital, which may increase the failure risk and retard the expansion of earning assets. A retention ratio set too high can result in a cut in stockholders’ dividend income. Other factors held constant, such a cut would reduce the market value of stock issued by a financial institution. The optimal dividend policy is one that maximizes the value of the stockholders’ investment.

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