Dividend Policy

Dividend Time Line

Dividend declaration date

Ex-dividend date
Holder-of-record date
Dividend payment date

Types

Cash dividends
Stock dividends
Regular dividends
Liquidating dividends

Measures
Dividend Yield

Annual Dividends per share

Pr ice per share

Expected Re turn on Stock Dividend Yield Pr ice Appreciation

Dividend Payout Ratio

Dividends
Earnings

Re tention Ratio 1 Dividend Payout Ratio

Empirical Evidences
Dividends tend to follow earnings
Set as percentage of earnings
Match long term shift in earnings

Dividends are Sticky

Maintenance of dividends in future

Negative signal for dividends cut

Dividends follow a smoother trail than earnings

Changes are less volatile than earnings
Management concerned for changes rather than
levels

Dividend policy tend to follow product life cycle

Dividend Irrelevance School

Dividend policy changes does not impact
valuations
Dividend policy is uncorrelated with total
stock returns
Bad investments cannot create value by
altering dividend policies

Dividend Irrelevance
ABC Corp. with after tax EBIT of 100mn,
reinvestment need of 50mn, growing at 5%,
WACC is 10% and number of shares are
105mn
Current total value per share
Total value if doubles dividend
Total value if stops dividend

Dividends are Bad School

Dividends are taxed heavier than capital gains
creates disadvantage
Reduce returns for an investor after personal
taxes
Timing of dividend tax payments compared to
capital gain taxes- disadvantage

Measuring the Disadvantage

CFB PB ( PB P).TCG
CFA PA ( PA P).TCG D.(1 TD )
PB PA
(1 TD )

D
(1 TCG )

Price drop is less than dividends empirically

Arbitrage for other investor Dividend capture

Implications of Tax Disadvantage

Firms with individuals as marginal investors
as compared to tax-exempt institutions will
have lower dividend payouts
Higher the income level of marginal investors,
lower the dividend payout

Dividends are Good School

Tenable arguments

Some investors like regular cash flows or do not

pay taxes equivalent to marginal investors
Accumulation of desired investor base for firms
clientele effect

Market signals through dividends

Dividends as tool to alter financing mix
Disciplining managers

Determinants of Dividend payouts

Investment uncertainty (-)

Investment alternatives (-)
Market cap- size (+)
Insider holdings (-)
Financial leverage (-)

Market reactions to Dividend policy

changes
Empirical evidences on cutting dividends

Market reacts negatively to announcements

Reaction persists for firms announcing earning
declines at the announcements
Reaction reverses for firms announcing better
opportunities ahead or earnings increase

Alternatives to Cash Dividends

Buyback Vs. Dividends

Similarity:

Cash balance is reduced

Book value of equity is reduced
Market value of equity is changed but differently

Dissimilarity:

Selective stockholder Vs. all stockholders

Tax burden
Buying back own stock is sometimes prohibited
Strength of corporate governance

Alternatives to Returning Cash

Equity repurchase (stock buy back)
Tender offer

Large repurchase over short time period;

predetermined prices; premium over market price

Open market

Small repurchase; prevailing market prices; no public

disclosure of intent; can spread over longer period

Private negotiation

Motivated by altering control

Why Repurchase?
One time commitment (as in special
dividends) good for uncertain future
Flexibility to reverse and spread out to longer
periods than special dividends
Increase insider control
Support for declining share prices
Tax advantage
Selective for investors

Choosing Buybacks Vs. Dividends

Undervaluation
Certainty about future cash flows
Tax preference
Uncertainty in investment needs
Management compensation