1

Dividend Policy

11/19/07

2

Learning Objectives

Factors that influence dividend policy Factors that influence dividend policy How dividends are paidHow dividends are paid Major dividend theoriesMajor dividend theories Alternatives to cash dividendsAlternatives to cash dividends Stock DividendsStock Dividends Stock SplitsStock Splits Stock RepurchasesStock Repurchases

3

Factors that affect Dividend Policy

Company projects low growth, has excess funds, Company projects low growth, has excess funds, may = large dividends (PG & E)may = large dividends (PG & E)

Management expects high growth, high need for Management expects high growth, high need for cash; may = high retained earnings and low or no cash; may = high retained earnings and low or no dividends (high tech firms)dividends (high tech firms)

Stockholders’ preferencesStockholders’ preferences

Capital gains vs ordinary incomeCapital gains vs ordinary income

4

Factors that affect dividend policy

Restrictions on dividend paymentsRestrictions on dividend payments

Bond indenture agreementsBond indenture agreements

Lack of retained earningsLack of retained earnings Availability of cashAvailability of cash

5

Dividend Payment Procedures

On August 25, 2002 Southside Bankshares On August 25, 2002 Southside Bankshares announced a quarterly dividend of $1 per share announced a quarterly dividend of $1 per share to be paid to shareholders of record September 9, to be paid to shareholders of record September 9, 2002. Dividend will be paid on Sept. 15, 20022002. Dividend will be paid on Sept. 15, 2002

Each dividend must be declared (approved) by the Board of Directors.This is usually done at the quarterly Board meetings.

6

Date that dividend is announced by Date that dividend is announced by the Board of Directors. A dividend the Board of Directors. A dividend payable is recorded on the books.payable is recorded on the books.

Debit retained earningsDebit retained earnings

Date that dividend is announced by Date that dividend is announced by the Board of Directors. A dividend the Board of Directors. A dividend payable is recorded on the books.payable is recorded on the books.

Debit retained earningsDebit retained earnings

On August 25, 2002 Southside Bankshares On August 25, 2002 Southside Bankshares announcedannounced a quarterly dividend of $1 per share a quarterly dividend of $1 per share for shareholders of record as of Sept. 9, 2002, and for shareholders of record as of Sept. 9, 2002, and payable to shareholders on Sept. 15, 2002payable to shareholders on Sept. 15, 2002

25 31 1 5 915

AugustAugustAugustAugust SeptemberSeptemberSeptemberSeptember

Declaration DateDeclaration Date

Dividend Payment Procedures

7

All owners of record will All owners of record will receive the dividend.receive the dividend.

All owners of record will All owners of record will receive the dividend.receive the dividend.

On August 25, 2002 Southside Bankshares On August 25, 2002 Southside Bankshares announced a quarterly dividend of $1 per share announced a quarterly dividend of $1 per share for share holders of for share holders of recordrecord as of September 9, 2002, as of September 9, 2002, and to be paid on September 15, 2002and to be paid on September 15, 2002

25 31 1 5 915

AugustAugustAugustAugust SeptemberSeptemberSeptemberSeptember

Declaration DateDeclaration DateDate of RecordDate of Record

Dividend Payment Procedures

8

To allow time for the official list of stockholders to be updated, stockholders must buy stock before the ex-dividend date which is 2 business days prior to date of record.

To allow time for the official list of stockholders to be updated, stockholders must buy stock before the ex-dividend date which is 2 business days prior to date of record.

On August 25, 2002 Southside Bankshares On August 25, 2002 Southside Bankshares announced a quarterly dividend of $1 per share announced a quarterly dividend of $1 per share for for shareholders of recordshareholders of record September 9, 2002, and September 9, 2002, and to be paid on September 15, 2002to be paid on September 15, 2002

25 31 1 7 915

AugustAugustAugustAugust SeptemberSeptemberSeptemberSeptember

Declaration DateDeclaration DateDate of RecordDate of Record

Ex-Dividend DateEx-Dividend Date

Dividend Payment Procedures

9

On August 25, 2002 Southside Bankshares On August 25, 2002 Southside Bankshares announced a quarterly dividend of $1 per share announced a quarterly dividend of $1 per share for shareholders of record September 9, 2002, and to for shareholders of record September 9, 2002, and to be be paid onpaid on September 15, 2002 September 15, 2002

25 31 1 7 915

AugustAugustAugustAugust SeptemberSeptemberSeptemberSeptember

Declaration DateDeclaration DateEx-Dividend DateEx-Dividend Date

Date of RecordDate of Record

Date that the dividend is paid out in cash to the stockholders.

Date that the dividend is paid out in cash to the stockholders.

Payment Date

Payment Date

Dividend Payment Procedures

10

Dividend determination methods

Dividend Rate. Most companies use a fixed Dividend Rate. Most companies use a fixed dollar amount per share. This amount is dollar amount per share. This amount is determined by the Board of Directorsdetermined by the Board of Directors

Dividends tend to stay the same or increase Dividends tend to stay the same or increase slightly each year; shows stability, positive slightly each year; shows stability, positive futurefuture

Decreases in dividends can severely impact Decreases in dividends can severely impact the stock pricethe stock price

11

Leading Dividend Theories

Clientele Dividend TheoryClientele Dividend Theory Some investors, such as elderly people on Some investors, such as elderly people on

fixed incomes, tend to prefer to receive fixed incomes, tend to prefer to receive dividend income. dividend income.

Others, such as young investors often Others, such as young investors often prefer growth, and tend to like their prefer growth, and tend to like their income in the form of capital gains rather income in the form of capital gains rather than as dividend income.than as dividend income.

12

Alternatives to Cash Dividends Stock Dividends Stock Dividends

Existing shareholders receive additional shares Existing shareholders receive additional shares of stock instead of cash dividendsof stock instead of cash dividends

Stock dividends represent a distribution of stock Stock dividends represent a distribution of stock of less than 25% of total shares outstandingof less than 25% of total shares outstanding

Done usually if the firm wants to conserve cashDone usually if the firm wants to conserve cash The number of shares is expressed as a The number of shares is expressed as a

percentage of current stock holdings.percentage of current stock holdings.

e.g. if there is a 10% stock dividend, you e.g. if there is a 10% stock dividend, you would receive one additional share for would receive one additional share for every 10 that you currently own.every 10 that you currently own.

13

Stock Dividend A stock dividend is recorded at the current market A stock dividend is recorded at the current market

price of the stockprice of the stock For example, if the market price of the stock is $21, For example, if the market price of the stock is $21,

and the par value of the stock is $1, then stock and the par value of the stock is $1, then stock dividend of 20,000 shares would be recorded as:dividend of 20,000 shares would be recorded as:

Retained EarningsRetained Earnings 420,000 420,000

Common Stock (at $1 par)Common Stock (at $1 par) 20,000 20,000

Capital in excess of parCapital in excess of par 400,000400,000

14

Stock Dividends Impact on Balance Sheet (Market price $21 per share)

BEFORE 10% Stock DIVIDENDBEFORE 10% Stock DIVIDEND

Common Stock (200,000 shares, $1 par) $200,000 Capital in Excess of Par $1,800,000 Retained Earnings $10,000,000 TOTAL COMMON STOCK EQUITY $12,000,000

AFTER 10% STOCK DIVIDEND (Stock price = $21)AFTER 10% STOCK DIVIDEND (Stock price = $21)

Common Stock (220,000 shares, $1 par) $220,000 Capital in Excess of Par $2,200,000 Retained Earnings $9,580,000 TOTAL COMMON STOCK EQUITY $12,000,000

15

Alternatives to Cash Dividends

Stock SplitsStock Splits If total shares will increase by more than If total shares will increase by more than

25%, the company will usually declare a 25%, the company will usually declare a stock split.stock split.

Expressed as a ratio to original shares.Expressed as a ratio to original shares.

Link to Reuters

e.g. a 2-1 split means that each investor e.g. a 2-1 split means that each investor will end up with twice as many shares as will end up with twice as many shares as they had prior to the split.they had prior to the split.

16

Stock split

Typically signals good news, in that the Typically signals good news, in that the company expects to grow and increase stock company expects to grow and increase stock priceprice

Keeps stock price affordable for the greatest Keeps stock price affordable for the greatest number of potential investorsnumber of potential investors

Gives something of value to the shareholder Gives something of value to the shareholder without using up cashwithout using up cash

Has no impact on the capital structure of the Has no impact on the capital structure of the companycompany

17

BEFORE SPLITBEFORE SPLIT

Common Stock (200,000 shares, $1 par) $200,000 Capital in Excess of Par $1,800,000 Retained Earnings $10,000,000 TOTAL COMMON STOCK EQUITY $12,000,000

AFTER THE 2 to 1 STOCK SPLITAFTER THE 2 to 1 STOCK SPLIT

Common Stock (400,000 shares, $.50 par) $200,000 Capital in Excess of Par $1,800,000 Retained Earnings $10,000,000 TOTAL COMMON STOCK EQUITY $12,000,000

Stock Splits Impact on Balance Sheet

18

Impact of Stock Splits and Dividends on Stock Price The book argues that no significant economic The book argues that no significant economic

event has taken place and that the price of event has taken place and that the price of the stock will drop in proportion to the size of the stock will drop in proportion to the size of the increase in sharesthe increase in shares

I disagree. Stock splits especially are an I disagree. Stock splits especially are an indication that the company believes the indication that the company believes the stock price will continue to grow.stock price will continue to grow.

As a result, shareholder wealth typically As a result, shareholder wealth typically increases as the result of a splitincreases as the result of a split

19

Impact of Stock Split on Shareholder

Before SplitBefore Split

100 shares x $10 = $1,000 value100 shares x $10 = $1,000 value After 2 for 1 SplitAfter 2 for 1 Split

Per book argument (no increase in value)Per book argument (no increase in value) 200 shares x $5 = $1,000 value200 shares x $5 = $1,000 value Investor positive reaction (value increases Investor positive reaction (value increases

to $11.00 per share prior to split)to $11.00 per share prior to split) 200 shares x $5.50 = $1,100 value200 shares x $5.50 = $1,100 value

20

Stock Repurchases

A firm buys back its own stock on the open marketA firm buys back its own stock on the open market A very common occurrence recentlyA very common occurrence recently By reducing the number of shares outstanding, By reducing the number of shares outstanding,

earnings per share are increasedearnings per share are increased Rather than payout a dividend, which would have Rather than payout a dividend, which would have

immediate tax consequences for the investor, a immediate tax consequences for the investor, a stock repurchase increases the share pricestock repurchase increases the share price

Stock repurchase reverses the impact of dilutionStock repurchase reverses the impact of dilution

21

Stock Repurchase Effect

Serves as a perfect replacement for a Serves as a perfect replacement for a dividend payment to shareholdersdividend payment to shareholders

Example: stock worth $60 per share pays $4 Example: stock worth $60 per share pays $4 dividend. Shareholder has a Stock worth $60 dividend. Shareholder has a Stock worth $60 and must pay tax on the $4 dividendand must pay tax on the $4 dividend

If dividend money used to repurchase stock If dividend money used to repurchase stock instead, shareholder ends up with stock worth instead, shareholder ends up with stock worth $64 with no immediate recognition of income$64 with no immediate recognition of income