While taking a loan from a financial institution, ABC Enterprises signed an agreement that it shall not pay a dividend of more than 10% to its shareholders until the loan is repaid. Identify the factor of dividend decision described in this case.
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Contractual Constraints
Given:
Lender: a financial institution
Term of the loan agreement: dividend of not more than 10% until the loan is repaid
Option (1) Contractual Constraints — Correct. While granting a loan, a lender may put limits on future dividends. ABC Enterprises agreed with the financial institution not to pay more than 10% until the loan is repaid. Its dividend is bound by the loan agreement.
Option (2) Legal Constraints — Incorrect. Legal constraints are limits set by provisions of the Companies Act. Here the 10% limit comes from a loan agreement.
Option (3) Shareholders' Preference — Incorrect. This factor is about what shareholders want, such as a certain minimum dividend each year. The limit here is set by the lender.
Option (4) Access to Capital Market — Incorrect. Large firms with easy access to the capital market depend less on retained earnings, so they can pay higher dividends. The case says nothing about the firm's access to the market.
NCERT (2026-27 Edition): “Factors Affecting Dividend Decision … (j) Legal Constraints: Certain provisions of the Companies Act place restrictions on payouts as dividend. Such provisions must be adhered to while declaring the dividend. |