Part of the company’s net profit may be distributed to shareholders as dividends or retained by the company as retained earnings. The dividend payment procedure is determined by the Board of Directors and must be approved by the shareholders. These payments can be issued in cash or in shares.
Dividend cut occurs when a dividend of the company either completely stops paying out dividends (a worst case) or reduces the amount of the payment. This often will lead to a sharp decline in stock prices of the company because this is usually a sign of a weakening of the financial position of the company, which generally makes the company less attractive to investors.
Why Dividends Can Be Drastically Reduced
Dividends are usually cut due to factors such as a weakening profit or a limited amount of funds available to meet payment of dividends. As a rule, dividends are paid from profits of the Company, and if earnings decline over time, companies will either need to increase payments or access to capital from other places, such as short-term investments or debt to meet the latest dividend levels.
If a company uses the money from the room, sources of income or too much income, it can put yourself in an awkward financial position. For example, if she has no money to pay off his debt because he’s paying too many dividends the company may declare a default on its debt. But, as a rule, he doesn’t come to that, because dividends are usually at the top of the list of things to cut when a company faces financial problems.
Therefore, the reduction of the dividends are treated as negative. The cut is a sign that the company is no longer able to pay the same amount of dividends as before without creating further financial difficulties.
(For more insight, read why it’s important dividends and dividend payout: can You count on it?)