Dividend Policies and Decisions

8/15/2019 Dividend Policies and Decisions

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Dividend Policy


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Recall: Stock Returns

P1 - Po + D1

PoReturn =


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P1 - Po + D1

Po

P1 - Po D1

Po Po+

Return =

=


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Return =

Capital Gain


P1 - Po + D1

Po

P1 - Po D1

Po Po+=


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Return =

Capital Gain Dividend Yield


P1 - Po + D1

Po

P1 - Po D1

Po Po+=


7/55

Dilemma: Should the firm use

retained earnins for:

a! "inancin profita#le capital

investments$

#! Pa%in dividends to stockholders$


8/55

&f 'e retain earnins for profita#le

investments(

P1 - Po D1

Po Po

+Return =


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investments( dividend %ield 'ill #e )ero(

P1 - Po D1

Po Po

+Return =


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investments( dividend %ield 'ill #e )ero(#ut the stock price 'ill increase( resultin

in a hiher capital ain*

P1 - Po D1

Po Po

+Return =


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&f 'e pa% dividends(

P1 - Po D1

Po Po

+Return =


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&f 'e pa% dividends( stockholders receive

an immediate cash re'ard for investin(

P1 - Po D1

Po Po

+Return =


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&f 'e pa% dividends( stockholders receive

an immediate cash re'ard for investin(#ut the capital ain 'ill decrease( since

this cash is not invested in the firm*

P1 - Po D1

Po Po

+Return =


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So( dividend polic% reall%

involves decisions:

,o' much of the firms earnins

should #e distri#uted to

shareholders as dividends( and,o' much should #e retained for

capital investment*


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&s Dividend Polic% &mportant$

.hree vie'points:

1! Dividends are &rrelevant* &f 'e assume

perfect markets /no ta0es( notransactions costs( etc*! dividends do not

matter* &f 'e pa% a dividend(

shareholders dividend %ield rises( #utcapital ains decrease*


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Dividend irrelevance: &n perfect markets(

an increase in dividends

Po =D1

kc -


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an increase in dividends

Po =D1

kc -


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an increase in dividends means lessmone% 'ill #e invested( so the ro'th rate

declines*

Po =D1

kc -


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declines*

Po =D1

kc -


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declines*

.he increase in D1 is offset #% thedecrease in *

Po =D1

kc -


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declines*

.he increase in D1 is offset #% thedecrease in *

Conseuentl%( dividend polic% does not

affect stock price*

Po =D1

kc -


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Dividend irrelevance: &n perfect

markets( investors do not care if

returns come in the form of dividend%ields or capital ains*

P1 - Po D1 Po Po

+Return =


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P1 - Po D1 Po Po

+Return =


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P1 - Po D1 Po Po

+Return =


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! ,ih Dividends are 2est

Some investors ma% prefer a certain

dividend no' over a risk% e0pected

capital ain in the future*


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! ,ih Dividends are 2est

Some investors ma% prefer a certain

dividend no' over a risk% e0pected

capital ain in the future*

P1 - Po D1

Po Po+Return =


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3! 4o' Dividends are 2est

Dividends are ta0ed immediatel%*

Capital ains are not ta0ed until the

stock is sold*.herefore( ta0es on capital ains can

#e deferred indefinitel%*


28/55

Do Dividends 5atter$

Other Considerations:

1! Residual Dividend .heor%:

.he firm pa%s a dividend onl% if it hasretained earnins left after financin all

profita#le investment opportunities*

.his 'ould ma0imi)e capital ains forstockholders and minimi)e flotation

costs of issuin ne' common stock*


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! Clientele 6ffects: Different investor clienteles prefer

different dividend pa%out levels*

Some firms( such as utilities( pa% outover 789 of their earnins as dividends*

.hese attract a clientele that prefers hih

dividends*Gro'th-oriented firms 'hich pa% lo' /or

no! dividends attract a clientele that

prefers price appreciation to dividends*


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3! &nformation 6ffects:

Raisin a firms dividend usuall% causes

the stock price to rise and decreasin the

dividend causes the stock price to fall*

Dividend chanes conve% information to

the market concernin the firms futureprospects*


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! ;enc% Costs: Pa%in dividends ma% reduce aenc% costs

#et'een manaers and shareholders*

Pa%in dividends reduces retained earninsand forces the firm to raise e0ternal euit%

financin*

Raisin e0ternal euit% su#


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! 60pectations .heor%: &nvestors form e0pectations concernin

the amount of a firms upcomin dividend*

60pectations are #ased on past dividends(e0pected earnins( investment and

financin decisions( the econom%( etc*

.he stock price 'ill likel% react if theactual dividend is different from the

e0pected dividend*


33/55

Dividend Policies

1! Constant Pa%out Ratio Polic%: ifdirectors declare a constant pa%out ratio

of( for e0ample( 389( then for ever%

dollar of earnins availa#le tostockholders( 38 cents 'ould #e paid out

as dividends*

the ratio remains constant over time( #utthe dollar value of dividends chanes as

earnins chane*


34/55

Dividend Policies

! Sta#le Dollar Dividend Polic%: the firmtries to pa% a fi0ed dollar dividend each

uarter*

firms and stockholders prefer sta#ledividends* Decreasin the dividend sends

a neative sinal>


35/55

Dividend Policies

3! Small Reular Dividend plus Year-6nd60tras

the firm pa%s a sta#le uarterl% dividend

and includes an e0tra %ear-end dividendin prosperous %ears*

2% identif%in the %ear-end dividend as

?e0tra(@ directors hope to avoid sinalinthat this is a permanent dividend*


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Dividend Pa%ments

1! Declaration Date: the #oard ofdirectors declares the dividend(

determines the amount of the dividend(

and decides on the pa%ment date*

Aan* Aan*B "e#*1 5ar* 11

Declare 60-div* Record Pa%ment

dividend date date date

A A B " # 1 5 11


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Dividend Pa%ments

! 60-Dividend Date:




A A B " # 1 5 11


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Dividend Pa%ments

! 60-Dividend Date: .o receive thedividend( %ou have to #u% the stock

#efore the e0-dividend date* n this

date( the stock #eins tradin ?e0-

dividend@ and the stock price falls

appro0imatel% #% the amount of the

dividend*





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A A B " # 1 5 11


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Dividend Pa%ments

3! Date of Record: da%s after the e0-dividend date( the firm receives the list of

stockholders elii#le for the dividend*

often( a #ank trust department acts as

reistrar and maintains this list for the

firm*




A A B " # 1 5 11


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Dividend Pa%ments

! Pa%ment Date: date on 'hich thefirm mails the dividend checks to the

shareholders of record*




Stock Dividends and Stock


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Splits

Stock dividend: pa%ment of additionalshares of stock to common stockholders*

60ample: Citi)ens 2ancorporation of

5ar%land announced a 9 stock

dividend to all shareholders of record on

5arch 7( 1B7* "or each 188 shares

held( shareholders received another

shares*

Did the shareholders 'ealth increase$



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Splits

Stock Split: the firm increases the num#erof shares outstandin and reduces the price

of each share*

60ample: Aoule( &nc* announced a 3-for-

stock split* "or each 188 shares held(

shareholders received another 8 shares*

Does this increase shareholder 'ealth$

;re a stock dividend and a stock split the

same$



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Splits

Stock Splits and Stock Dividends areeconomicall% the same: the num#er of

shares outstandin increases and the

price of each share drops* .he value ofthe firm does not chane*

60ample: ; 3-for- stock split is the

same as a 89 stock dividend* "or each

188 shares held( shareholders receive

another 8 shares*



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Splits

6ffects on Shareholder Eealth:



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Splits

6ffects on Shareholder Eealth: these 'illcut the compan% ?pie@ into more pieces

#ut 'ill not create 'ealth* ; 1889 stock

dividend /or a -for-1 stock split! ivesshareholders half-si)ed pieces for each

full-si)ed piece the% previousl% o'ned*



47/55


Splits

6ffects on Shareholder Eealth: these 'illcut the compan% ?pie@ into more pieces

#ut 'ill not create 'ealth* ; 1889 stock

dividend /or a -for-1 stock split! ivesshareholders half-si)ed pieces for each

full-si)ed piece the% previousl% o'ned*

"or e0ample( this 'ould dou#le the

num#er of shares( #ut 'ould cause a F8

stock price to fall to F38*



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Splits

Eh% #other$Proponents arue that these are used to

reduce hih stock prices to a ?more

popular@ tradin rane /enerall% F1 toF78 per share!*

pponents arue that most stocks are

purchased #% institutional investors 'hohave Fmillions to invest and are

indifferent to price levels* Plus( stock

splits and stock dividends are e0pensive>


49/55

Stock Dividend 60ample

shares outstandin: 1(888(888 net income = F(888(888H PI6 = 18

9 stock dividend*

;n investor has 18 shares* Does the

value of the investors shares

chane$

2efore the 9 stock dividend:


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2efore the 9 stock dividend:

6PS = (888(888I1(888(888 = F

PI6 = PI = 18( so P = F8 per share*Jalue = F8 0 18 shares = F7(88

;fter the 9 stock dividend:

K shares = 1(888(888 0 1* = 1(8(888*

6PS = (888(888I1(8(888 = F*B8

PI6 = PI*B8 = 18( so P = FB per share* &nvestor no' has 18 0 1* = 18 shares*

Jalue = FB 0 18 = F7(88


51/55

Stock Repurchases

Stock Repurchases ma% #e a oodsu#stitute for cash dividends*

&f the firm has e0cess cash( 'h% not #u%

#ack common stock$


52/55

Stock Repurchases

Stock Repurchases ma% #e a oodsu#stitute for cash dividends*

&f the firm has e0cess cash( 'h% not #u%

#ack common stock$


53/55

Stock Repurchases

Repurchases drive up the stock price(producin capital ains for

shareholders*

Repurchases increase leverae( and can#e used to move to'ard the optimal

capital structure*

Repurchases sinal positiveinformation to the market - 'hich

increases stock price*

S


54/55

Stock Repurchases

Repurchases ma% #e used to avoid ahostile takeover*

60ample: .* 2oone Pickens attempted

raids on Phillips Petroleum and Lnocalin 1B* 2oth 'ere unsuccessful

#ecause the taret firms undertook

stock repurchases*

S k R h


55/55

Stock Repurchases

Methods:

2u% shares in the open market throuh

a #roker*

2u% a lare #lock #% neotiatin thepurchase 'ith a lare #lock holder(

usuall% an institution* /tareted stock

repurchase!.ender offer: offer to pa% a specific

price to all current stockholders*

Documents

Dividend Policies and Decisions