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8/19/2019 Session 13 14 Dividend Policy Class
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Dividend Policy
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Dividend Time Line
• Dividend declaration date
• Ex-dividend date
•
Holder-of-record date• Dividend payment date
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Types
• Cash dividends
• Stock dividends
•
Regular dividends• Liquidating dividends
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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
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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
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Dividend Irrelevance School
• Dividend policy changes does not impactvaluations
• Dividend policy is uncorrelated with totalstock returns
• Bad investments cannot create value byaltering dividend policies
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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
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“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
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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
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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
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“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
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Determinants of Dividend payouts
• Investment uncertainty (-)
• Investment alternatives (-)
•
Market cap- size (+)• Insider holdings (-)
• Financial leverage (-)
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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
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Alternatives to Cash Dividends
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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
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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
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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
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Choosing Buybacks Vs. Dividends
• Undervaluation
• Certainty about future cash flows
•
Tax preference• Uncertainty in investment needs
• Management compensation