Dividend Policy

Syed Mohammed Shamsul Arifeen

Financial Theory & Practices, MBA Spring 2013, IBA, DU

Method of Dividend Payment

Declaration date Ex-dividend Record date date 2-3 weeks 2-3 days Stock has to be bought before this date for investors to receive dividends Payment date 2-3 weeks Dividend is paid to stockholders

BOD announces dividend per share

Company closes books and records owners of stock

Price Behavior around the Ex-dividend Date for a Tk 1 Cash Dividend

Ex-dividend date

Price=TkP

-t

...

-2

-1

+1 Tk 1

+2

...

Cum-dividend price

Price=Tk(P!1)

Ex-dividend price

Measures of Dividend Policy

Dividend yield = DPS/Price per share Dividend payout ratio = DPS/EPS

Empirical Evidences

Dividends tend to follow earnings Dividends follow a smoother path than earnings

Dividend and Earnings on U.S. Companies (1960-2004) Source: Damodaran

Empirical Evidences

Dividends tend to follow earnings Dividends follow a smoother path than earnings Dividends are sticky

Dividend Changes - U.S. Corporations Source: Damodaran

Empirical Evidences

Dividends tend to follow earnings Dividends follow a smoother path than earnings Dividends are sticky Dividend policy tends to follow life cycle of the rm

Dividend Yield and Payout Ratios Source: Value Line Database

Empirical Evidences

Dividends tend to follow earnings Dividends follow a smoother path than earnings Dividends are sticky Dividend policy tends to follow life cycle of the rm Dividend policy varies across countries

Stock Dividend
Distribution of more shares to the existing
shareholders

Market value falls Par value remains unchanged

Stock Dividend
Before stock dividend Paid-up capital (100,000- shares @ Tk 10 par) Share premium Retained earnings Total stockholders equity Tk 1,000,000 1,500,000 800,000 Tk 3,300,000

After 10% stock dividend (Market price Tk 30) Paid-up capital (110,00- shares @ Tk 10 par) Share premium Retained earnings Total stockholders equity Tk 1,100,000 1,700,000 500,000 Tk 3,300,000

Stock Split
Dividing the pie into smaller pieces Number of shares increases Par value falls

Stock Split
Before stock dividend Paid-up capital (100,000- shares @ Tk 10 par) Share premium Retained earnings Total stockholders equity After 2-for-1 stock split Paid-up capital (200,000- shares @ Tk 5 par) Share premium Retained earnings Total stockholders equity Tk 1,000,000 1,500,000 800,000 Tk 3,300,000 Tk 1,000,000 1,500,000 800,000 Tk 3,300,000

Stock Repurchases
Open market purchases Tender offer Targeted repurchase Dutch auction

Dividend Vs Repurchase
Firm Dividend Proposed dividend Earnings Market value after dividend Repurchase Earnings Market value after repurchase Per Share 100,000 shares Tk 300,000 Tk 3.00 450,000 4.50 2,700,000 27.00 90,000 shares Tk 5.00 30.00

Tk 450,000 2,700,000

Controversy
about dividend policy
The Dividend is Irrelevant School

The Dividend is Bad School

The Dividend is Good School

Leftists Litzenberger Ramaswamy

Middle-of-the-roaders Modigliani Miller Black Scholes

Rightists Gordon Lintner

Dividend Irrelevance
What a rm pays in dividends is irrelevant Stockholders should be indifferent about
dividend policy

Dividend Irrelevance
Assumptions

No tax advantage or disadvantage No transaction costs No oatation costs Investment decision independent of dividend decision No agency conict

Example
Operating income after taxes = Tk 100m Growth rate = 5% Cost of capital = 10% Reinvestment needs = Tk 50m Number of shares outstanding = 105m

Value to existing Dividends shareholder s Tk 0 Tk 1,100 10.00 1,090 20.00 1,080 30.00 1,070 40.00 1,060 50.00 1,050 60.00 1,040 70.00 1,030 80.00 1,020 90.00 1,010 100.00 1,000

Price per share Tk 10.48 10.38 10.29 10.19 10.10 10.00 9.90 9.81 9.71 9.62 9.52

Dividends per share Tk 0 0.10 0.19 0.29 0.38 0.48 0.57 0.67 0.76 0.86 0.95

Total value per share Tk 10.48 10.48 10.48 10.48 10.48 10.48 10.48 10.48 10.48 10.48 10.48

Homemade Dividends
Date 0
Tk 11

B A C

Tk 10

Tk 9

Tk 8.90

Tk 10.00 Tk 11.10

Date 1

Dividend Irrelevance
Does A
not mean price per share will be unaffected rm that has invested in bad projects cannot hope to increase its value to investors by offering them higher dividends

Dividends Are Good

The Rightists

The bird-in-the-hand fallacy Preference for dividends

Price Differential on Citizens Utility Stock Source: Long (1978)

Company Consolidated Bathurst Donfasco Some Petroleum Imperial Oil Newfoundland Light & Power Royal Trustco Stelco TransAlta Average

Premium on Cash Dividend Shares over Stock Dividend Shares (%) 19.30 13.30 0.30 12.10 1.80 17.30 2.70 1.10 7.54

Price Differential between Cash and Stock Dividend Shares Source: Bailey (1988)

Dividends Are Good

The Rightists

The bird-in-the-hand fallacy Preference for dividends Information content

Excess Returns around Announcements of Dividend Changes Source: Aharony and Swary (1981)

Dividends Are Bad

The Leftists

Taxing ordinary income and capital gains Timing of tax payments

Clientele Effect

Clustering of stockholders in companies with dividend policies that match their preferences

Clientele Effect
Dividend yieldt = a + b !t + c Aget + d Incomet + e Differential Tax Ratet + "t

Clientele Effect
Variable Constant Beta coefcient Age/100 Income/1000 Differential tax rate Coefcient 4.22% -2.145 3.131 -3.726 -2.849 Higher beta stocks pay lower dividends Firms with older investors pay higher dividends Firms with wealthier investors pay lower dividends If ordinary income is taxed at a higher rate that capital gains, the rm pays less dividends Implies

Source: Petit (1977)

Clientele Effect
Firms get the investors they deserve Firms will have a difcult time changing an
established dividend policy