Dividend Decisions

Session No. 2

Dividend Policy and Firm value

1 Manish Parmar

Key Concepts and Skills

2

Understand dividend types and how they

are paid

Understand the issues surrounding

dividend policy decisions

Understand why share repurchases are an

alternative to dividends

Understand the difference between cash

and stock dividends

Chapter Outline: Ross 18.1 Different Types of Dividends

18.2 Standard Method of Cash Dividend Payment

18.3 The Benchmark Case: An Illustration of the Irrelevance of Dividend Policy

18.4 Repurchase of Stock

18.5 Personal Taxes and Dividends

18.6 Real-World Factors Favoring a High Dividend Policy

18.7 The Clientele Effect: A Resolution of Real-World Factors?

18.8 What We Know and Do Not Know about Dividend Policy

18.9 Stock Dividends and Stock Splits

3

Dividend payments can be made in

either of the following ways:- (18.1)

4

Cash Dividend - Payment of cash by the firm to its

shareholders. (Normally companies pay regular

dividends and sometimes it pays special dividend)

Public companies often pay quarterly.

Sometimes firms will pay an extra cash dividend,

i.e. Special Dividend.

The extreme case would be a liquidating

dividend.

Dividend payments can be made

in either of the following ways:-

5

Stock Dividend - Distribution of additional shares to

a firm’s Shareholders. (Bonus shares)

Stock Splits – The par value per share is reduced

and the number of shares is increased

proportionately. In both the above cases:-

No cash leaves the firm

The firm increases the number of shares

outstanding

6

TABLE 1 Effect of Bonus Shares and Share Splits

(I) Equity portion before the bonus issue:

Equity share capital (30,000 share of Rs 100 each) Rs 30,00,000

Share premium (@ Rs 25 per share) 7,50,000

Retained earnings 62,50,000

Total equity 1,00,00,000

(II) Equity portion after the bonus issue (1 : 2 ratio):

Equity share capital (45,000 shares of Rs 100 each) 45,00,000

Share premium (45,000 shares × Rs 25) 11,25,000

Retained earnings (Rs 62,50,000 – 15,000 shares × Rs 125) 43,75,000

Total equity 1,00,00,000

(III) Equity portion after the share splits (10 : 1 ratio):

Equity share capital (3,00,000 shares of Rs 10 each) 30,00,000

Share premium 7,50,000

Retained earnings 62,50,000

Total equity 1,00,00,000

18.2 Standard Method of Cash

Dividend

7

Record Date – Date on which company

determines existing shareholders.

Ex-Dividend Date - Date that determines

whether a stockholder is entitled to a dividend

payment; anyone holding stock immediately

before this date is entitled to a dividend.

Cash Dividend - Payment of cash by the firm

to its shareholders.

Procedure for Cash Dividend

8

25 Oct. 1 Nov. 2 Nov. 4 Nov. 7 Dec.

Declaration

Date

Cum-

dividend

Date

Ex-

dividend

Date

Record

Date

Payment

Date

…

Declaration Date: The Board of Directors declares a payment

of dividends.

Cum-Dividend Date: Buyer of stock still receives the dividend.

Ex-Dividend Date: Seller of the stock retains the dividend.

Record Date: The corporation prepares a list of all individuals

believed to be stockholders as of 4 November.

9

Price Behavior

In a perfect world, the stock price will fall by the amount of the dividend on the ex-dividend date.

$P

$P - div

Ex-

dividend

Date

The price drops

by the amount of

the cash

dividend.

-t … -2 -1 0 +1 +2 …

Taxes complicate things a bit. Empirically, the

price drop is less than the dividend and occurs

on of the ex- dividend date.