How much of the profits earned by a company will be distributed as profit and how much will be retained in the business is affected by many factors. Identify which of the factors listed below is incorrect:
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Large and reputed companies generally have easy access to the Securities and Exchange Board of India.
The dividend decision fixes how much of the profit is paid to shareholders as dividend and how much is kept in the business as retained earnings. Several factors affect this decision.
Option (1) Large and reputed companies generally have easy access to the Securities and Exchange Board of India. — An incorrect statement of the factor (Correct). The real factor is access to the capital market. A large, well-known company can easily raise money by issuing shares or debentures in the capital market. It therefore depends less on retained earnings and can pay a higher dividend. SEBI is the regulator of the securities market. It does not lend money to a company or raise money for it, so “access to SEBI” has nothing to do with dividends.
Option (2) There is impact of the dividend policy on the equity share prices. — A factor, correctly stated (Incorrect). A higher dividend usually raises the market price of the share, and a cut in dividend can lower it. Management keeps this effect in mind.
Option (3) Certain provisions of the Companies Act place restrictions on payouts as dividend. — A factor, correctly stated (Incorrect). These are legal constraints. The Act lays down conditions on how much may be paid as dividend and from which profits.
Option (4) The companies are required to ensure that the dividend does not violate the terms of the loan agreement. — A factor, correctly stated (Incorrect). These are contractual constraints. A lender may limit the dividend a company can pay while the loan is outstanding.
Note: The opening sentence of the question comes straight from the NCERT book, which prints “how much of the profits earned by a company will be distributed as profit”. This is a mistake in NCERT. The part of the profit that is paid out to shareholders is the dividend, so the sentence should read “distributed as dividend”. NTA copied the NCERT line so faithfully that the mistake came along too. Read it as “distributed as dividend”. If the word “profit” made you stop and think, the book is to blame, not you.
NCERT (2026-27 Edition): “Factors Affecting Dividend Decision How much of the profits earned by a company will be distributed as profit and how much will be retained in the business is affected by many factors. Some of the important factors are discussed as follows:” “Stock Market Reaction: Investors, in general, view an increase in dividend as a good news and stock prices react positively to it. Similarly, a decrease in dividend may have a negative impact on the share prices in the stock market. Thus, the possible impact of dividend policy on the equity share price is one of the important factors considered by the management while taking a decision about it.” “Access to Capital Market: Large and reputed companies generally have easy access to the capital market and, therefore, may depend less on retained earning to finance their growth. These companies tend to pay higher dividends than the smaller companies which have relatively low access to the market.” “Legal Constraints: Certain provisions of the Companies Act place restrictions on payouts as dividend. Such provisions must be adhered to while declaring the dividend.” “Contractual Constraints: While granting loans to a company, sometimes the lender may impose certain restrictions on the payment of dividends in future. The companies are required to ensure that the dividend does not violate the terms of the loan agreement in this regard.” |