Dividend Policy - unideb.huoktato.econ.unideb.hu/domician/Downloads/ppt/C16a_new.pdf · Slide Contents •Learning ... •This chapter provides answers to three questions ... about

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

Dividend Policy

Chapter 16

Copyright © 2011 Pearson Prentice Hall. All rights reserved.16-2

Slide Contents

• Learning Objectives

• Principles Used in This Chapter

1. How Do Firms Distribute Cash to their Shareholders?

2. Does Dividend Policy Matter?

3. Cash Distribution Policies in Practice

• Key Terms


Learning Objectives

1. Distinguish between the use of cashdividends and share repurchases.

2. Understand the tax treatments of dividends and capital gains, and stock dividends and stock splits.

3. Discuss the conditions under which dividend policy is an important determinant of stock price.

4. Describe corporate dividend policies that are commonly used in practice.


Principles Used in This Chapter

• Principle 1: Money Has a Time Value.

• Principle 3: Cash Flows Are the Source of Value.

• Principle 4: Market Prices Reflect Information.


Introduction

• When a firm generates cash from operations, what can the firm do with the cash?

1. Use the cash to fund new investments,

2. Use the cash to pay off some of its debt, and/or

3. Distribute the cash back to the firm’s shareholders either as a cash dividend or as stock repurchases.


Introduction (cont.)

• This chapter provides answers to three questions regarding a firm’s dividend policy:

1. What are the pros and cons of the methods the firm can use to distribute cash?

2. Why should the firm’s shareholders care about the firm’s dividend policy given that they can generate cash when they need it by selling some of their shares?

3. What cash distribution policies do most firms use in practice?


How Do Firms Distribute Cash to their Shareholders?

Cash distributions can take two basic forms:

• With cash dividend, cash is paid directly to the shareholders.

• With a share repurchase, a company uses cash to buy back its own shares from the market place, thereby reducing the number of outstanding shares.


Remember: The Balane Sheet

Current AssetsCashAccounts ReceivableInventoriesOther current assetsTotal current assets

Current LiabilitiesAccounts payableShort-term debtOther current liabilities

Total current liabilities

Long-term LiabilitiesLong-term debt

Long-term (fixed) assetsGross PPELess: Accumulated depreciationNet property, plant and equip.

Other long-term assets

Total long-term assets

Owner’s EquityPar value of common stockPaid-in-capitalRetained earningsTotal equity

Total Assets Total Liabilities and Owners’ equity


How Do Firms Distribute Cash to their Shareholders? (cont.)

• The impact on the balance sheet will be as follows:

– On the Assets side, cash will be reduced due to cash dividend or share repurchase.

– On the Equity side, there will be a corresponding decrease.


Cash Dividends

• A firm’s dividend policy determines how much cash it will distribute to its shareholders and when these distributions will be made.

• Dividends are generally described in terms of dividend payout ratio, which indicates the amount of dividends paid relative to the company’s earnings.


Dividend Payment Procedures

• Generally, companies pay dividends on a quarterly basis. There are several dates that are important with regard to dividend payment:

• (a) Announcement date: It is the date on which dividend is formally declared by the board of directors.


Dividend Payment Procedures (cont.)

• (b) Ex-dividend date: This is two days before the date of record and any investor who buys shares after the ex-dividend date is not entitled to dividend.

• (c) Date of record: Investors who own stock on this date receive the dividend. However, this date was pushed forward two days to ex-dividend date.

• (d) Payment date: This is the date on which dividend checks are mailed to the investors.


Dividend Payment Procedures (cont.)

Date Explanation Calendar Date

Announcement Date Dividend is declared. March 15

Ex-Dividend Date Shares begin trading ex-dividend.

May 17

Record Date Dividend will be paid to shareholders who own the stock on this date.

May 19

Payment Date Dividends are distributed to the shareholders of record on the record date.

May 27


Stock Repurchases (Stock Buyback)

• Stock repurchase is when a firm uses its cash to repurchase some of its own stock.

• This results in a reduction in the firm’s cash balance as well as the number of shares of stock outstanding.

• Firms use one of three methods to purchase the shares: (1)Open market repurchase, (2) tender offer, and (3) direct purchase.


How do Firms Repurchase Their Shares?

• Open Market Repurchase

– Here the firm acquires the stock on the market, often buying a relatively small number of shares everyday.

– This will put upward pressure on share prices.

– This is the most widely used method for stock repurchase.


How do Firms Repurchase Their Shares? (cont.)

• Tender Offer

– A company uses this method when it wants to buy a relatively large number of shares very quickly.

– The company makes a formal offer to buy a specified number of shares at a stated price.

– The price is set above the market price to attract sellers.


How do Firms Repurchase Their Shares? (cont.)

• Direct Purchase from a large investor

– Here the firm purchases the stock from one or more major stockholders on a negotiated basis. This method is not used frequently.


Non-Cash Distributions: Stock Dividends and Stock Splits

• A stock dividend is a pro-rata distribution of additional shares of stock to the firm’s current stockholders.

• These distributions are generally defined in terms of a fraction paid per share.

– For example, a firm might pay a stock dividend of .20 shares of stock per share or 2 shares for every 10 held.


Non-Cash Distributions: Stock Dividends and Stock Splits (cont.)

• Stock split is essentially a very large stock dividend. For example, a 2-for-1 split would entail receiving two new shares for every old share currently held.

• With a 2-for-1 split, the number of shares will double and the share price will drop in half.

Copyright © 2011 Pearson Prentice Hall. All rights reserved.

16.2 Does Dividend Policy Matter?


Does Dividend Policy Matter?

• Modigiliani and Miller suggest that without taxes and transaction costs, cash dividends and share repurchases are equivalent and the timing of the distribution is unimportant.

• This is known as the Modigiliani and Miller dividend irrelevancy proposition.


The Irrelevance of the Distribution Choice

• The distribution choice is irrelevant under the following assumptions:

1. There are no taxes.

2. No transaction costs are incurred in either buying or selling shares of stock.

3. The firm’s operating and investment policies are fixed.


The Irrelevance of the Distribution Choice (cont.)

• The dividend irrelevancy proposition can be illustrated in two ways:

1.Timing of dividend distributions does not affect firm value.

2.In the absence of taxes and transaction costs, a cash dividend is equivalent to a share repurchase.


Individual Investor Wealth Effects –Personal Taxes

• What are the tax rules with regard to dividends and share repurchases?

1.100% of cash dividends are taxable in the year in which they are received.

2.When individuals sell shares, tax is assessed only on the capital gain (i.e. price appreciation of stock).

3. If an individual decides not to sell his or her share back to the company making the stock repurchase, they will not incur any taxes.


Why Dividend Policy is Important?

• Transactions are costly

–Since taxes are incurred when dividends are received and transactions costs are incurred when buying and selling shares, investors will prefer to select companies whose dividend policy match up with their own preferences.

Because firms with different dividends attract different dividend clienteles(clients), it is important that dividend policy remain somewhat stable.


Why Dividend Policy is Important? (cont.)

• A second possibility is that stock splits and stock dividends tend to attract attention. Naturally, firm would like to attract attention only when the prospects are favorable.

• Thus even though there is no direct effect on cash flows, the market reacts favorably.


Key Terms

• Date of record

• Declaration date

• Ex-dividend date

• Payment date

• Dividend payout ratio

• Dividend policy


Key Terms (cont.)

• Cash dividend

• Stock repurchase

• Open Market repurchase

• Tender offer

• Stock dividend

• Stock split

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Dividend Policy - unideb.huoktato.econ.unideb.hu/domician/Downloads/ppt/C16a_new.pdf · Slide Contents •Learning ... •This chapter provides answers to three questions ... about