Topics Covered
The Choice of Payout Policy Types of Dividends How Firms Pay Dividends and Repurchase Stock The Dividend Decision Dividend Policy Irrelevancy of Dividends The Clientele Effect The Si nalin Effect Ta!es and Dividend Policy Dividends and " ent#Principle conflicts Information Content of Dividends $arious Hypotheses of Dividend Policy Share Repurchases
Types of Dividends
Cash Div Re ular Cash Div Special Cash Div Stock Div Stock Repurchase %& methods'
() *uy shares on the market +) Tender ,ffer to Shareholders -) Dutch "uction &) Private .e otiation %/reen 0ail'
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Dividend Payments
Cash Dividend # Payment of cash 2y the firm to its shareholders) Ex-Dividend Date # Date that determines whether a stockholder is entitled to a dividend payment1 anyone holdin stock 2efore this date is entitled to a dividend) Record Date # Person who owns stock on this date received the dividend)
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Dividend Payments
Stock Dividend # Distri2ution of additional shares to a firm3s stockholders) Stock Splits # Issue of additional shares to firm3s stockholders) Stock Repurchase # Firm 2uys 2ack stock from its shareholders)
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Dividend Decisions
Dividend Decision Survey (2004)
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Dividend Chan e
DI$ DI$ DI$ = tar tar et etchan chan e e ((##DI$ 77 = = = tar tar et etratio ratio EPS EPS DI$ (( ##DI$ 77
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DI$ DI$ DI$ =ad8ustment ad8ustmentrate rate tar tar et etchan chan ee ((##DI$ 77 = = =ad8ustment ad8ustmentrate rate ( (tar tar et etratio ratio EPS EPS DI$ ((##DI$ 77) )
Dividend Policy
Impact of Dividend Changes on EPS
Change EPS/Price at t = 0 as %
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Dividend Policy
*efore Dividend "fter Dividend .ew stockholders Total value of firm
Each share worth this 2efore 9 9 and worth this after
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,ld stockholders
$%am le o& !'(rd o& wort) aid as dividend and raisin* money via new s)ares
Dividend Policy
Dividend financed 2y stock issue .o dividend4 no stock issue
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#e$ stockholders
Shares Cash
#e$ stockholders
ir!
Cash
Cash
Shares
"ld stockholders
"ld stockholders
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Record Date Cash %&000 "sset $alue '&000 Total $alue %0&000 ( .ew Pro8 .P$ )&000 = of Shares %&000 price>share *%)
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Record Date Cash (4777 "sset $alue ?4777 Total $alue (74777 @ .ew Pro8 .P$ +4777 = of Shares (4777 price>share :(+
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Record Date Cash (4777 "sset $alue ?4777 Total $alue (74777 @ .ew Pro8 .P$ +4777 = of Shares (4777 price>share :(+
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Stock = %&0'%sh , *%%3 = %)&000 "ssume stockholders purchase the new issue with the cash dividend proceeds)
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.e!t yearL s price Dividend Total preta! payoff TodayL s stock price Capital ain Preta! rate of return %I' Ta! on div B 57I Ta! on Cap /ain B +7I Total "fter Ta! income %div + cap ain # ta!es' "fter ta! rate of return %I'
(77 = (+)5
(77 = (5)75
)&7 (7 = &)77 )+7 &)J+ = 7)?& %(7 &)J+' %& + 7)?&' = ?)JK
?)JK ?J)JK
(77 = (7)7
(77 = (7)7
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Two ma8or principal#a ent pro2lems attend to the dividend policyE # Free cash flow pro2lem
F 0ana ement incentive to increase siMe of the firm and earn hi her perks and salaries %therefore reduce dividends' F "lso makes the firm comple! and therefore difficult to fire current mana ement%entrenchment incentive' F *ut for firms with no Nfree cash flows3 %2ecause profita2le opportunities4 or the e!penditures e!ceed availa2le cash' pay less or no dividends
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Information content of dividend chan es ,n avera e4 market reacts positively to dividend increase announcements and ne atively to dividends cut9whyD This is perceived as the mana ement3s assessment of the lon #term earnin s prospects of the firm 0ana ement are conservative4 increase dividends only when they can maintain it) Ohen can dividend increase is 2ad news and dividend decrease is ood newsD
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Hypotheses
Cash flow si nalin hypothesis# posits positive relationship 2etween dividend chan es and capital e!penditure chan es) Free Cash Flow Hypothesis F posits that dividends increase is ood news 2ecause the firm3s mana ement is 2ein disciplined to pay hi her dividends and reduce wasteful capital e!penditures4 whereas a dividend decrease is 2ad news as mana ement has more free cash flows to waste on unprofita2le investments) Therefore there is ne ative relationship 2etween dividend chan es and capital e!penditures) Information Content Hypothesis F posits that the announcement conveys info a2out the value of the firm# hi her than market e!pected in case of dividend increase and lower than market e!pected in case of dividend decrease) Oealth Redistri2ution Hypothesis F posits that a dividend increase is an e!propriation of wealth from creditors to shareholders and dividend decrease is e!propriation of wealth from shareholders to creditors)
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