session 13 14 dividend policy class

8/19/2019 Session 13 14 Dividend Policy Class

1/22

Dividend Policy


2/22


3/22

Dividend Time Line

• Dividend declaration date

• Ex-dividend date

•

Holder-of-record date• Dividend payment date


4/22

Types

• Cash dividends

• Stock dividends

•

Regular dividends• Liquidating dividends


5/22

Measures

share per ice

share per Dividends Annual Yield Dividend

Pr

on AppreciatiiceYield Dividend Stock onturn Expected Pr Re

Earnings

Dividends Ratio Payout Dividend

Ratio Payout Dividend Ratiotention 1Re


6/22


7/22


8/22


9/22

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


10/22

Dividend Irrelevance School

• Dividend policy changes does not impactvaluations

• Dividend policy is uncorrelated with totalstock returns

• Bad investments cannot create value byaltering dividend policies


11/22

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


12/22

“Dividends are Bad” School

• Dividends are taxed heavier than capital gains – creates disadvantage

• Reduce returns for an investor after personaltaxes

• Timing of dividend tax payments compared tocapital gain taxes- disadvantage


13/22

Measuring the Disadvantage

•Price drop is less than dividends empirically – Arbitrage for other investor –

ividend capture

CG B B B T P P P CF ).(

)1.().( DCG A A A

T DT P P P CF

)1(

)1(

CG

D A B

T

T

D

P P


14/22

Implications of Tax Disadvantage

• Firms with individuals as marginal investorsas compared to tax-exempt institutions willhave lower dividend payouts

• Higher the income level of marginal investors,lower the dividend payout


15/22

“Dividends are Good” School

• Tenable arguments

– Some investors like regular cash flows or do notpay 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


16/22

Determinants of Dividend payouts

• Investment uncertainty (-)

• Investment alternatives (-)

•

Market cap- size (+)• Insider holdings (-)

• Financial leverage (-)


17/22

Market reactions to Dividend policychanges

• 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 betteropportunities ahead or earnings increase


18/22

Alternatives to Cash Dividends


19/22

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


20/22

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 publicdisclosure of intent; can spread over longer period

– Private negotiation• Motivated by altering control


21/22

Why Repurchase?

• One time commitment (as in specialdividends) – good for uncertain future

• Flexibility to reverse and spread out to longerperiods than special dividends

• Increase insider control

• Support for declining share prices

• Tax advantage

• Selective for investors


22/22

Choosing Buybacks Vs. Dividends

• Undervaluation

• Certainty about future cash flows

•

Tax preference• Uncertainty in investment needs

• Management compensation

session 13 14 dividend policy class

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