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Dividend Policy
By :
Kharul Azhar Bin Ramli
Stock Returns:
P1 - Po +
Return =
D1
Po
=
P1 - +
Po
Po
Capital Gain
D1
Po
Dividend Yield
a) Financing profitable
capital
investments?
b) Paying dividends to
stockholders?
Financing Profitable
Capital Investments:
If we retain earnings for profitable
investments, dividend yield will be
zero, but the stock price will increase,
resulting in a higher capital gain.
Return =
P1 - Po
Po
D1
Po
Paying Dividends:
If we pay dividends, stockholders
receive an immediate cash reward for
investing, but the capital gain will
decrease, since this cash is not
invested in the firm.
Return =
P1 - Po
Po
D1
Po
Is Dividend Policy
Important?
Three viewpoints:
1) Dividends are Irrelevant
2) High Dividends are Best
3) Low Dividends are Best
Three viewpoints:
1) Dividends are Irrelevant.
If we assume perfect
markets (no taxes, no
transaction costs, etc.)
dividends do not matter. If
we pay a dividend,
shareholders dividend yield
rises, but capital gains
decrease.
Return =
P1 - Po
Po
D1
Po
Return =
P1 - Po
Po
D1
Po
Return =
P1 - Po
Po
D1
Po
are taxed
immediately. Capital gains are
not taxed until the stock is sold.
Therefore, taxes on capital gains
can be deferred indefinitely.
Do Dividends
Matter?
Other Considerations:
1) Residual Dividend
Theory
2) Clientele Effects
3) Information Effects
4) Agency Costs
5) Expectations Theory
Other Considerations
1) Residual Dividend Theory:
The firm pays a dividend only if
it has retained earnings left
after financing all profitable
investment opportunities.
This would maximize capital
gains for stockholders and
minimize flotation costs of
issuing new common stock.
Other Considerations
2) Clientele Effects:
Different investor clienteles prefer
different dividend payout levels.
Some firms, such as utilities, pay
out over 70% of their earnings as
dividends. These attract a
clientele that prefers high
dividends.
Growth-oriented firms which pay
low (or no) dividends attract a
clientele that prefers price
appreciation to dividends.
Other Considerations
3) Information Effects:
Unexpected dividend increases
usually cause stock prices to rise,
and unexpected dividend decreases
cause stock prices to fall.
Dividend changes convey
information to the market
concerning the firms future
prospects.
Other Considerations
4) Agency Costs:
Paying dividends may reduce
agency costs between managers
and shareholders.
Paying dividends reduces retained
earnings and forces the firm to
raise external equity financing.
Raising external equity subjects
the firm to scrutiny of regulators
(SEC) and investors and therefore
helps monitor the performance of
managers.
Other Considerations
5) Expectations Theory:
Investors form expectations
concerning the amount of a firms
upcoming dividend.
Expectations are based on past
dividends, expected earnings,
investment and financing decisions,
the economy, etc.
The stock price will likely react if
the actual dividend is different from
the expected dividend.
1)
Dividend
Policies
Dividend
Policies
Stable Dollar Dividend
Policy:
The firm tries to pay a fixed
dollar dividend each quarter.
Firms and stockholders
prefer stable dividends.
Decreasing the dividend
sends a negative signal!
2)
Dividend
Policies
3)
Dividend
Payments
Declaration
Date: The board of
1)
directors declares the dividend,
determines the amount of the
dividend, and decides on the payment
date.
Jan.4
Jan.30
Declare
dividend
Ex-div.
date
Feb.1
Record
date
Mar. 11
Payment
date
Dividend
Payments
Ex-Dividend
Date: To receive the
2)
dividend, you have to buy the stock
before the ex-dividend date. On this
date, the stock begins trading exdividend and the stock price falls
approximately by the amount of the
Jan.4
Jan.30
Feb.1
Mar. 11
dividend.
Declare
dividend
Ex-div.
date
Record
date
Payment
date
Dividend
3) DatePayments
of Record: Two days after the
Ex-div.
date
Record
date
Payment
date
Dividend
Payments
4) Payment
Date: Date on which the
Jan.4
Jan.30
Declare
dividend
Ex-div.
date
Feb.1
Record
date
Mar. 11
Payment
date
Why bother?
Proponents argue that these are
used to reduce high stock prices to a
more popular trading range
(generally $15 to $70 per share).
Opponents argue that most stocks
are purchased by institutional
investors who have millions of dollars
to invest and are indifferent to price
levels. Plus, stock splits and stock
dividends are expensive!
Stock Dividends
In-class Problem
What is the new stock price?
Shares outstanding:
250,000.
Net income = $750,000.
Stock price = $84.
50% stock dividend.
Hint:
P/E =
stock price
net income
# shares
Stock Dividend
Common stock
Par value
$2,300,000
(a)
(1,150,000 shares outstanding;$2 par value)
Paid in Capital
$9,800,000
(b)
Retained earnings
$12,900,000
Total Equity $25,000,000
a)
b)
c)
(c)
Stock Split
Common stock
Par value
$2,000,000 (a)
(2,000,000 shares outstanding;$1 par value)
Paid in capital
$8,000,000
Retained earnings
$15,000,000
Total Equity
$25,000,000
Stock split 2:1
Par price after split :
Par price before split x 1 = $2 x 1 = $1
2
2
No.of shares after split :
No of shares before split x 2 = 1,000,000 x 2 =
2,000,000
1
1
a)
Stock Repurchases
Stock
Repurchases may be
a good substitute for cash
dividends.
If the firm has excess
cash, why not buy back
common stock?
Stock Repurchases
Stock
Repurchases may be
a good substitute for cash
dividends.
If the firm has excess
cash, why not buy back
common stock?
Stock Repurchases
Repurchases
Stock Repurchases
Repurchases
may be used to
avoid a hostile takeover.
Example:
T. Boone Pickens attempted
raids on Phillips Petroleum and
Unocal in 1985. Both were
unsuccessful because the target
firms undertook stock
repurchases.
Stock Repurchases
Methods:
Buy shares in the open market
through a broker.
Buy a large block by negotiating
the purchase with a large block
holder, usually an institution
(targeted stock repurchase).
Tender offer: offer to pay a specific
price to all current stockholders.
Exercise 2 :
The Manville corporations capital structure is as follows:
Common stock($4 par;5,000,000 shares)
Paid in capital
1,000,000
Retained earnings
9,000,000
Total net worth
$30,000,000
$20,000,000
Exercise 3 :
Describes
policy.
Explain the concept of residual dividend theory.
What are the motivates corporations to pay stock
dividends and split their common stock?
Differentiate between constants dividends payout
ratio & stable dollar dividend policy.
What are the advantages firms repurchase its own
shares?
Define the following:
Declaration date
Record date
Payment date
Ex-dividend date