dividend decision 01

8/20/2019 Dividend Decision 01

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2/55

Dividend Payments

1) Declaration Date: the board of

directors declares the dividend,

determines the amount of the dividend,

and decides on the payment date.

Jan.4 Jan.30 Feb.1 ar. 11

Declare !"#div. $ecord %ayment

dividend date date date


3/55

Dividend Payments

&) !"#Dividend Date:





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Dividend Payments

&) !"#Dividend Date: 'o receive the

dividend, you have to buy the stoc( before

the e"#dividend date. n this date, the

stoc( be*ins tradin* +e"#dividend and

the stoc( price falls appro"imately by the

amount of the dividend.





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Dividend Payments

3) Date of $ecord:





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Dividend Payments

3) Date of $ecord: & days after the e"#dividend date, the firm receives the list ofstoc(holders eli*ible for the dividend.

• ften, a ban( trust department acts asre*istrar and maintains this list for thefirm.





7/55

Dividend Payments

4) %ayment Date: date on -hich the

firm mails the dividend chec(s to the

shareholders of record.





8/55

Stock Returns:

%1 # %o D1

%o$eturn /


9/55

%1 # %o D1

%o

%1 # %o D1

%o %o

$eturn /

/

Stock Returns:


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$eturn /

apital ain

%1 # %o D1

%o

%1 # %o D1

%o %o/

Stock Returns:


11/55

$eturn /

apital ain Dividend 2ield

/

Stock Returns:

%1 # %o D1

%o

%1 # %o D1

%o %o


12/55

Dilemma: Should the firm use

retained earnings for:

a) Financin* profitable capital

investments

b) %ayin* dividends to stoc(holders


13/55

• f -e retain earnin*s for profitable

investments,

%1 # %o D1

%o %o

$eturn /


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investments, dividend yield -ill be 5ero,

%1 # %o D1

%o %o

$eturn /


15/55


investments, dividend yield -ill be 5ero,but the stoc( price -ill increase, resultin*

in a hi*her capital *ain.

%1 # %o D1

%o %o

$eturn /


16/55

• f -e pay dividends,

%1 # %o D1

%o %o

$eturn /


17/55

• f -e pay dividends, stoc(holders receive

an immediate cash re-ard for investin*,

%1 # %o D1

%o %o

$eturn /


18/55

• f -e pay dividends, stoc(holders receive

an immediate cash re-ard for investin*,but the capital *ain -ill decrease, since

this cash is not invested in the firm.

%1 # %o D1

%o %o

$eturn /


19/55

So, dividend policy really

involves 2 decisions:• 6o- much of the firm7s earnin*s

should be distributed to

shareholders as dividends, and

• 6o- much should be retained for

capital investment


20/55

Is Dividend Policy Important?

'hree vie-points:

1) Dividends are rrelevant. f -e

assume perfect mar(ets 8no ta"es,no transaction costs, etc.) dividends

do not matter. f -e pay a

dividend, shareholders7 dividendyield rises, but capital *ains

decrease.


21/55

• 9ith perfect mar(ets, investors are

concerned only -ith total returns,and do not care -hether returns

come in the form of capital *ains or

dividend yields.

%1 # %o D1

%o %o

$eturn /


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dividend yields.

%1 # %o D1

%o %o

$eturn /


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dividend yields.• 'herefore, one dividend policy is as

*ood as another.

%1 # %o D1

%o %o

$eturn /


24/55

2) igh Dividends are !est

• ome investors may prefer a certain

dividend no- over a ris(y e"pected

capital *ain in the future.


25/55

2) igh Dividends are !est

• ome investors may prefer a certain

dividend no- over a ris(y e"pected

capital *ain in the future.

%1 # %o D1

%o %o$eturn /


26/55

") #o$ Dividends are !est

• Dividends are ta"ed immediately.

apital *ains are not ta"ed until the

stoc( is sold.

• 'herefore, ta"es on capital *ains can

be deferred indefinitely.


27/55

Do Dividends %atter?

&ther 'onsiderations:

1) $esidual Dividend 'heory:

• 'he firm pays a dividend only if it hasretained earnin*s left after financin*

all profitable investment

opportunities.• 'his -ould ma"imi5e capital *ains for

stoc(holders and minimi5e flotation

costs of issuin* ne- common stoc(.


28/55


&) lientele !ffects:

• Different investor clienteles prefer different

dividend payout levels.

• ome firms, such as utilities, pay out over;0< of their earnin*s as dividends. 'hese

attract a clientele that prefers hi*h

dividends.• ro-th#oriented firms -hich pay lo- 8or

no) dividends attract a clientele that prefers

price appreciation to dividends.


29/55


3) nformation !ffects:

• =ne"pected dividend increases

usually cause stoc( prices to rise, andune"pected dividend decreases cause

stoc( prices to fall.

• Dividend chan*es convey informationto the mar(et concernin* the firm7s

future prospects.


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4) >*ency osts:• %ayin* dividends may reduce a*ency

costs bet-een mana*ers and

shareholders.• %ayin* dividends reduces retained

earnin*s and forces the firm to raise

e"ternal e?uity financin*.

• $aisin* e"ternal e?uity sub@ects the firm

to scrutiny of re*ulators 8!) and

investors and therefore helps monitor the

performance of mana*ers.


31/55


A) !"pectations 'heory:

• nvestors form e"pectations concernin*

the amount of a firm7s upcomin*

dividend.

• !"pectations are based on past dividends,

e"pected earnin*s, investment and

financin* decisions, the economy, etc.

• 'he stoc( price -ill li(ely react if the

actual dividend is different from the

e(pected dividend .


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Dividend Policies

1) onstant Dividend %ayout $atio: ifdirectors declare a constant payout

ratio of, for e"ample, 30


33/55

Dividend Policies

&) table $upees Dividend %olicy:

the firm tries to pay a fi"ed rupee

dividend each ?uarter.• Firms and stoc(holders prefer

stable dividends. Decreasin* the

dividend sends a ne*ative si*nalB


34/55

Dividend Policies

3) mall $e*ular Dividend plus 2ear#!nd !"tras

• 'he firm pays a stable ?uarterly

dividend and includes an e"tra year#end dividend in prosperous years.

• Cy identifyin* the year#end dividend

as +e"tra, directors hope to avoidsi*nalin* that this is a permanentdividend.


35/55

inancial Signaling

• ash dividends spea( louder than -ords

• ccur if the dividend is more or less thane"pected

• %rice of the stoc( may react tounanticipated chan*es in dividends


36/55

*mpirical +esting and

Implications for Payout

• !"#dividend day tests

– Cehavior of common stoc( prices

• Dividend#yield approach – $elationship bet-een dividend yields and

stoc( returns

• Financial si*nalin* studies

– >t the time of the dividend chan*e findthat there is a si*nificant earnin*s chan*e


37/55

Implications for 'orporate Policy

• 'a" effect consistent -ith dividend

neutrality

• i*nalin* effect

– ptimal dividend policy

– a"imi5e shareholder -ealth• !"cess cash


38/55

Share Repurchase

• ncreased in importance relative todividends

• ubstitute for cash dividends• !mployee stoc( options and share

repurchase

– eans to compensate employees – !mployees -ith e"istin* stoc( options

prefer share repurchase


39/55

Method of Repurchase

• Fixed-price tender offer

– Formal offer to stockholders to purchase so

many shares at a set price

• Dutch-auction tender offer – Dominant form of tender offer

• Open-market purchase

– SEC rules• Disclose intentions


40/55

Repurchasing as Part of a

Dividend Decision• Fewer shares remaining outstanding

– ES rise

– Di!idends per share rise

– "arket price per share should rise

• E#uili$rium formula

– %here S is the num$er of shares outstanding prior to thedistri$ution& c ' is the current market price per share prior to

distri$ution& n is the num$er of shares to $e repurchased(• ersonal tax effect

• Signaling effect – Differs with the method of repurchase

nS

P X S P c

−

= )


41/55

Stock Dividends and Stock Splits

• toc( dividend: payment of additional

shares of stoc( to common stoc(holders.

• !"ample: iti5ens Can( corporation

announces a A< stoc( dividend to all

shareholders of record. For each 100

shares held, shareholders receive another

A shares.

• Does the shareholders7 -ealth increase


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• toc( plit: the firm increases the number

of shares outstandin* and reduces the

price of each share.

• !"ample: Joule, nc. announces a 3#for#&

stoc( split. For each 100 shares held,

shareholders receive another A0 shares.

• Does this increase shareholder -ealth

• >re a stoc( dividend and a stoc( split the

same


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• toc( plits and toc( Dividends are

economically the same: the number of

shares outstandin* increases and the priceof each share drops. 'he value of the firm

does not chan*e.

• !"ample: > 3#for#& stoc( split is the sameas a A0< stoc( dividend. For each 100

shares held, shareholders receive another

A0 shares.


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• !ffects on hareholder 9ealth:


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• !ffects on hareholder 9ealth: these -ill

cut the company +pie into more pieces

but -ill not create -ealth. > 100< stoc(

dividend 8or a for#1 stoc( split) *ivesshareholders & half#si5ed pieces for each

full#si5ed piece they previously o-ned.


46/55


• !ffects on hareholder 9ealth: these -ill

cut the company +pie into more pieces

but -ill not create -ealth. > 100< stoc(

dividend 8or a for#1 stoc( split) *ivesshareholders & half#si5ed pieces for each

full#si5ed piece they previously o-ned.

• For e"ample, this -ould double thenumber of shares, but -ould cause a $s.0

stoc( price to fall to $s.30.


47/55


• 9hy bother

• %roponents ar*ue that these are used to

reduce hi*h stoc( prices to a +more

popular tradin* ran*e 8*enerally $s.1A to$s.;0 per share).

• pponents ar*ue that most stoc(s are

purchased by institutional investors -hohave millions of rupees to invest and are

indifferent to price levels. %lus, stoc( splits

and stoc( dividends are e"pensiveB


48/55

Stock Dividend *(ample

• shares outstandin*: 1,000,000

• net income / $s.,000,000E

• %! / 10• &An investor has 1&0 shares. Does the

value of the investor7s shares

chan*e


49/55

Cefore the &A< stoc( dividend:

• !% / ,000,0001,000,000 / $s.• %! / % / 10, so % / $s.0 per share.

• Galue / $s.0 " 1&0 shares / $s.;,&00

>fter the &A< stoc( dividend:

• H shares / 1,000,000 " 1.&A / 1,&A0,000.

• !% / ,000,0001,&A0,000 / $s.4.I0

• %! / %4.I0 / 10, so % / $s.4I per share.

• nvestor no- has 1&0 " 1.&A / 1A0 shares.

• Galue / $s.4I " 1A0 / $s.;,&00


50/55

Stock Dividends

n#class %roblem

shares outstandin*: &A0,000

net income / $s.;A0,000E

stoc( price / $s.I4

-. stock dividend/

9hat is the ne- stoc( price


51/55

int:

stoc( price

%! / net income

H shares8 )


52/55

Cefore the A0< stoc( dividend:

• !% / ;A0,000 &A0,000 / $s.3

• %! / I4 3 / &I.

>fter the A0< stoc( dividend:

• H shares / &A0,000 " 1.A0 / 3;A,000.

• !% / ;A0,000 3;A,000 / $s.&

• %! / % & / &I, so % / $s.A per share.

8a A0< stoc( dividend is e?uivalent to a3#for#& stoc( split)


53/55

Stock Splits• *um$er of shares is increased through a

proportional reduction in the par !alue• "ay increase cash di!idends• lace the stock in a more-popular trading range• +nformational or signaling effect

– ,symmetric information• ercei!ed earnings• *ot the stock di!idend nor split itself

• e!erse stock split – educe the num$er of shares

– .sually a negati!e signal


54/55

Managerial Considerations as to

Dividend/Share-Repurchase Policy• Funds needs of the firm

• ,$ility to $orrow

• Control• *ature of stockholders

• /i#uidity

• estrictions

• Di!idend sta$ility

• 0arget-payout ratios

• ,ssessment of any

!aluation information


55/55

Some Final !servations

• Di!idend in excess of residual implies a fa!ora$le

effect on shareholder wealth

• /ack of clear empirical e!idence

• "any companies $elie!e di!idend payout affectsshare price

• epurchase of stock

– %hen si1a$le amount of excess funds exists – +ncreasingly more important

dividend decision 01

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