Payout policy at Linear Technology

Outline
Analysis of the general background
Ability to return cash: funding requirement analysis
Return cash or retain cash: Cost of retaining cash
How to distribute

General background
Basic description: Exhibit 1
1986: first IPO
1992 starting paying dividends: increasing the div by
about 0.01$ per share each year
2002: significant drop in sales: -47% in sales, - 54% in
profit
2003: an other increase in dividend to 33.1% of payout
ratio.

Historical payout policy

Describe Linears approach to dividends and repurchases in
the past. Exhibit 3
Calculate the dividend yield and Dividends per share. How does
dividend change?

How does repurchase change?

Calculate the payout ratio. Has the firm a long-run target
payout ratio? (analyzing exhibit 2)
How do you interpret the variation of the payout ratio? (Ex.
TN-1
Lintner (1956): firms have a LR target payout ratio, but follow
a conservative process to raise dividends at an adjustment rate.

Ability to return cash: Funding

requirement
Do you think whether a payout ratio of 33.1% presents
any problems for Linear?
Analyzing Exhibit 2, what is the trend of change of net
income, operating cash flow, relative to sales?
How about the pre-capital expenditure cash flow as
compared to the capital expenditure?
Look at the cash balance in 2003, what do you think
the cash position of Linear?

Funding requirements
Exhibit TN-1:
Both Net income in % sales and cash flow in % of sales
remains stable, even if the sales dropped by 47% in 2002
The pre-capital expenditure cash flow ranged from 4-19
times capital expenditures.
Large cash balance in 2003: 1.57billion or 16.2% of its
market value.
=> Linear is able to pay a dividend of 33% pre-investment
cash flow while still meeting its investment needs.

Return cash or retain cash?

Cost of excess cash
Taxes:
td :Distribution tax for dividends or capital gains
tp :personal tax
tc : Corporate tax
Option 1: hold an extra dollar of Treasury bonds (get r) and
distribute it with interest later.
Option 2: distribute an extra dollar right away.

look at Exhibit 7, what do you infer about the dividend

return and capital gain in the presence of corporate and
personal taxes?

Return cash or retain cash?

Agency: investment opportunity of Linear
Read the 4th paragraph in page 3. What do you infer in
respect to the business plan of Linear?
Has the manager incentive to work for the maximum
value of the firm? (compensation plan for the CEO, ref
ex.6)
What do you infer the cost of carrying cash inside the
company?

How to distribute cash to

shareholders?
Consider the various theories that make the dividend
policy relevant. What do you think the pricing
behavior for a $ 1 dividend?
On the announcement day
On the ex-div day?
Table

How should Linear return cash to

its shareholders?
EPS effects:
Back to the MM world, what are the different effects on
stock price and the EPS under the following payout
policy? (data from Ex-2 in 2002)
Retain all cash
Repurchase stock
Pay dividend

Table

How should Linear return cash to

its shareholders?
Taxes:
What is the price behavior on the announcement day
and the ex-dividend day?

If dividends result in higher taxes,

why do firms pay dividends?
Signaling:
Analyze Ex-3, what is the market price responds to the
dividend increase?
Asquith and Mullins (JoB) find that the reaction of stock
price is about 5%.
Table

If dividends result in higher taxes,

why do firms pay dividends?
Agency:
What is the signal conveyed about the agency relation
inside the company?
With the executive stock options, what do you think the
managers incentive in paying dividend?
Compute the loss of the CEO if it exercise its stock
option after ex-div date (Ex-6)

If dividends result in higher taxes,

why do firms pay dividends?
Clientele effect:
From a tax rate clientele, who prefers the dividends to
capital gain?
From a transaction cost clientele, small investors prefer
what kind of payout policy?
Read the 2nd paragraph in p. 3, which kind of clienteles
does Linear try to attract?
Read the description of Janus Capital (5-6 paragraph). How
does this owner like Linears dividend policy?
(Table)

Other determinants?market
conditions
Dividend policy changes
Early 1960s, most listed firms paid a div
1999, fewer than 2% firms initiate a div.
2002-03, div initiates again and increased slightly. (ex-9b)

What account for the change over time?

Change in taxes? Ex-7
Changes in the investment opportunity? Ex 9
Changes in the distribution of firms? In response to the
scandals at Enron, Worldcom, etc?

What should Paul Coghlan

recommend to the board?
A better way? Div/ stock repurchase
Ability to return cash?
Advantage/disadvantage of paying div?
What happened?
In the end, Linear increased it dividend by $0.01 per
share.
The stock price rose by 8.7% on a day.