Dividend Policy & Firm Value

8/8/2019 Dividend Policy & Firm Value

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DIVIDEND POLICY


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DIVIDEND POLICYDIVIDEND POLICY

Investment =>Cash flowsInvestment =>Cash flows

Financing=>BorrowalFinancing=>Borrowal

Retention Rate=>Growth rateRetention Rate=>Growth rate

DividendDividend

Buy backBuy back


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SHARE BUYBACKS

Share buybacks,referred to asequityrepurchases orstockrepurchases in the

US,have becomepossiblesince 1998 inIndia.

In India,corporates generally choose theopen market purchase method. Under

this method,acompany buys sharesfrom thesecondary market overaperiodofone yearsubject to a maximum pricefixed by the board/shareholders.


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RATIONALE FOR BUYBACKS

Efficient allocation of resources (Give excess cash

back)

Rationalize capital structure. (Control)

Price stability

Tax advantage

No implied commitment


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OBJECTIONS TO BUYBACKS

Unfair advantage

Manipulation


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REGULATION OF BUYBACKS.

A company can buyback 10 percent of its shares annually with

board resolution. Beyond that a special resolution of

shareholders is required.

The post-buyback debt-equity ratio should not exceed 2:1

The buyback should not exceed 25 percent of the total paid up

capital and free reserves.

After completing a buyback programme, a company should not

make a further issue of equity securities within a period of 6

months, except in certain cases.

A buyback cannot be done through negotiated deals.

The buyback process has to be handled by a merchant bankers

duly appointed by the company.


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BuybackBuyback

E.g PAT = Rs.1 Crore EPS = Rs.10E.g PAT = Rs.1 Crore EPS = Rs.10

No: of shares(pre buy back) = 10 lakhsNo: of shares(pre buy back) = 10 lakhs

The Co. decides to repurchase 200000The Co. decides to repurchase 200000shares at Rs.180.P/E ratio stays at 20.shares at Rs.180.P/E ratio stays at 20.

New EPS = 100,00,000/8,00,000 = 12.5New EPS = 100,00,000/8,00,000 = 12.5

New Price = 12.5 * 20 = 250New Price = 12.5 * 20 = 250

Tendering does not make sense.Tendering does not make sense.


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Dividends are stickyDividends are sticky

Dividends tend to follow earningsDividends tend to follow earnings


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Pay out ratioPay out ratio

Dividend YieldDividend Yield

Rationale for payout ratio > 100% ?Rationale for payout ratio > 100% ?


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Under leveragedUnder leveraged

New DebtNew Debt

Cyclical firmsCyclical firms

Recession & BoomRecession & Boom

Firms in the declining growthFirms in the declining growth

Cash SurplusCash Surplus


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DIVIDEND POLICY : PAYOUT RATIO

The considerations relevant for determining the dividend

payout ratio are:

Funds requirement

Liquidity

Access to external sources of financing

Shareholder preferences

Difference in the cost of external equity and retainedearnings

Control

Taxes


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SCHOOLS OF THOUGHTSCHOOLS OF THOUGHT

IrrelevantIrrelevant-- Dividends does not matterDividends does not matter

Tax preferenceTax preference-- Dividends are badDividends are bad

BirdBird--inin--thethe--handhand-- Dividends are goodDividends are good


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DIVIDEND POLICIES IN PRACTICE

Generous dividend and bonus policy

More or less fixed dividend policy

Erratic dividend policy


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Electrical: Try to maintain a 10%, which isElectrical: Try to maintain a 10%, which is

required by the govt.required by the govt.

Tea: In the last 10 years, theTea: In the last 10 years, the

Parent company has not been insisting onParent company has not been insisting on

any dividend. Whatever has been paid outany dividend. Whatever has been paid out

has been accepted. Our payout has been 30has been accepted. Our payout has been 30

to 50%.to 50%.


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Chemical: Our dividend policy is to pay aChemical: Our dividend policy is to pay a

fixed rate of dividend and issue bonusfixed rate of dividend and issue bonus

shares when we are eligible. The purpose isshares when we are eligible. The purpose isto ensure that shareholders retain sharesto ensure that shareholders retain shares

to enjoy capital gains.to enjoy capital gains.


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Leasing: We would like to declare as highLeasing: We would like to declare as high

dividends as we can. If share prices rise duedividends as we can. If share prices rise due

to that we can raise relatively easily moreto that we can raise relatively easily morefunds by issuing convertible debentures.funds by issuing convertible debentures.


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Diversified: We have a very conservativeDiversified: We have a very conservative

dividend policy. Our dividend rate whichdividend policy. Our dividend rate which

used to be 10% four years ago has nowused to be 10% four years ago has nowbeen raised to 15%. We wont probablybeen raised to 15%. We wont probably

consider a change for the next few years.consider a change for the next few years.


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GUIDELINES FORDIVIDEND POLICY

Dont pay dividends at the expense of positive NPV projects.

Minimise the need to sell external equity.

Define a target dividend payout ratio along with a target

debt-equity ratio, taking into account the investment needs,

managerial preferences, capital market norms, and tax code.

Accept temporary departures from the target dividend payout

ratio and the target debt-equity ratio.

Avoid dividend cuts.

In essence, the above guidelines imply that a firm should pursue a

smoothed residual dividend policy and not a pure residual

dividend policy or a fixed dividend payout policy.


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BONUS SHARES

A bonus issue represents capitalisation of free reservesbuilt out of the genuine profits or share premium

collected in cash only

In the wake of a bonus issue:

(a) The shareholders proportional ownership remains

unchanged.

(a) The book value per share, the earnings per share,

and the market price per share decrease, but the

number of shares increases.


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Bonus IssueBonus Issue Stock Split Stock Split

The par value of the share isThe par value of the share isUnchangedUnchanged

The par value of the share isThe par value of the share isReducedReduced

A part of reserves isA part of reserves is

capitalisedcapitalised

There is no capitalisation ofThere is no capitalisation of

reservesreserves

The shareholdersThe shareholdersproportional ownershipproportional ownership

remains unchangedremains unchanged

The shareholders proportionalThe shareholders proportionalownership remains unchangedownership remains unchanged

TheThe bookbook valuevalue perper share,share, thetheearningsearnings perper share,share, andand thethe

marketmarket priceprice perper shareshare declinedecline

The book value per share, theThe book value per share, theearnings per share, and theearnings per share, and themarket price per share declinemarket price per share decline

The market price per share isThe market price per share isbrought within a popularbrought within a populartrading range.trading range.

The market price per share isThe market price per share isbrought within a more popularbrought within a more populartrading range.trading range.

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Dividend Policy & Firm Value