CHANGING PERSPECTIVES ON

DISTRIBUTION POLICY
.
The evolution from dividends to share
repurchase
Presenter:
Sadia Khaliq (19426)
Zareen Fatima (18231)

Robert A Weigand
H. Kent Baker
Introduction: Perspectives
Goal of Financial Management To create Value for Stock
holder Role of Firms Distribution Policy

Williams
(1938),
Gordon
(1959),
Lintner (1956)
One
Perspective
Dividends
important
determinant
of firms
value
Miller &
Modigliani
(1961),
Black (1976)
Second
Perspective
Dividends
irrelevant
for firms
value &
Value
Destroyer
Introduction: Approaches
First
approach
Secondary
Data
Capital market
& accounting
statements
Second
approach
Primary
Data
Survey from
Financial Managers
* Second approach is more direct way of gaining
information that how companies operate in relation to their
distribution policy.
Dividends Past & Present & Idea Of
Intrinsic Value (US Stocks)
Years Dividend yield (%) Capital Gains (%) Total Returns
(%)
1802-1870 6.4 0.7 7.1
1871-1925 5.2 2.2 7.4
1926-2001 4.1 6.2 10.3
1982-2001 2.9 11.6 14.5
Years Dividend yield (%) Capital Gains (%) Total Returns
(%)
1802-1870 6.4 (90% ) 0.7(10%) 7.1
1871-1925 5.2 (70%) 2.2 (30%) 7.4
1926-2001 4.1 (40%) 6.2 (60%) 10.3
1982-2001 2.9 (20%) 11.6 (80%) 14.5
June-2000 1.2 (lowest) - -
Oct-2007 1.8 - -
Dividend payouts in the 19
th
century & early 20
th

comprised much higher percentage of investors income
than those offered by corporations today.
Dividends Past & Present & Idea of Intrinsic
Value (US Stocks)
Dividend Cash Flow Model-Williams (1938)
Depicts the intrinsic value of a firms stock as the present
value of growing stream of dividends.
Dividend Discount Model-Gordon (1959)
Price of any security is equals to sum of present values of
all its future cash flows.
The research on these views show that market is in the
favor of liberal dividends as compare to niggardly
dividends.


Dividends Past & Present & Idea of Intrinsic
Value (US Stocks)

Partial Adjustment Model-Lintner (1956)
Dividend should relate to permanent increase in profit
rather temporary
Fundamental relation exists between dividends and firm
value
Dividends should be uninterrupted
Provide signal to market
Fama and Babaik (1968) supported Lintners model
Surveys about managerial attitudes over decades &
across different countries presented similar results as that
of Lintner

Dividends Past & Present & Idea of Intrinsic
Value (US Stocks)
Factors influencing dividend policy are (Baker et al. (1985):
*(almost similar factors in 2001 survey)
Anticipated level of future earnings
Pattern of past dividends
Availability of cash
Desire to maintain or increase the stock price
*Stability of earnings

Firms should avoid changing dividend rates-soon be
reversed
Dividends provide signaling mechanism-helps in stock
valuing
Pruitt and Gitman (1991)-Profits & prior years dividends
exert a major influence on current dividends (consistent
with Lintner model)
Dividends Past & Present & Idea of Intrinsic
Value (US Stocks)


Brav et al. (2005)
Perceived stability of future earnings still affects dividend policy but relation
between dividends & earnings weakened over time because of share
repurchase concept.
Share repurchase-Company buybacks its own stocks from the
market
Now a days, share repurchase are more important form of
payouts
Survey evidence leads to certain generalizations

Key factors influencing distribution policy are stable over time
(Lintner)

Managers belief that dividend policy affects stock value (support
dividend relevance hypothesis)

Another view: Dividends are irrelevant to
firms Value

Modigliani & Miller (1961)
Disagree that dividends directly affect firm value
Value of company-determined by its assets and cash flows
generated by those assets not the way cash flows are
distributed to shareholders
Dividend policy irrelevant to share value in perfect & efficient
capital markets
Rational investors-indifferent between dividends & capital
gains



Another view: Dividends are irrelevant to
firms Value

Black (1976)
Dividends actually value destroyer (Tax disadvantage)
Regarded dividends as Puzzle

DeAngelo & DeAngelo (2006)
They criticized the M & M and Blacks analysis of irrelevance theorem.
M & M framework mandates 100% payout but did not check the impact of
niggardly payouts
Their assumptions were unrealistic







Explanations for paying dividends
DeAngelo & DeAngelo (2006)
Dividends & Signaling
By Ackerloff (1970) & Spence (1973)
Firms pay dividends because they reflect the managers expectation of future
earnings
Recent studies show that dividends communicate information related to current
earnings rather than future earnings.
Dividends & Agency cost
Dividends provide investors with a way to monitor managers behavior
(Easterbrook, 984).
It increases firms value by limiting managers tendency to waste money (Jensen,
1986).
Limited accounting frauds (Siegel, 2002)
Dividends result in ownership clientele effects when institutional investors are
taxed at lower rates than individuals (Allen et al., 2000)
Dividends & Risk
Dividend payment reduce stock return volatility (Venkatesh, 1989)




Recent development in payout
Dividend yield reduced (1984-1999)
Dividend paying companies-reduced
US industrial firms- dividend fell from 32% to 16%
Dividend disappeared for Canada, UK, Germany,
France, Japan
Dividend payers reduced to 15% in 2001 then began to
rise
2004, 20% of US Industrials paying dividends
Mature companies having larger capitalization now
usually pay dividends



Explanations for share repurchases
Three most common explanations are:
1. Repurchase and taxes(Now dividend & capital gains
taxed at 15% in US)
2. Repurchase and signaling
3. Repurchase and agency costs
4. other explanation for repurchase
Adjust level of shares
Manages can change their firms capital structure
To fund stock options plans
To defend against takeover attempts




Explanations for share repurchases
Repurchase and taxes:
Managers use share repurchase as an alternative of cash
dividends to minimize taxes for stockholders.
But afterwards the growth tax relief reconciliation act of(2003)
would motivate companies to pay more dividends.

Repurchase and signaling:
By repurchasing shares of the firms management signals that
the current stock price is less than the stock intrinsic value.
Ikenberry (1995) firms are undervalued at the time they
announce a repurchase.




Explanations for share repurchases
Repurchase and agency cost
Share repurchase provide the means of dealing with free
cash flow of agency problems.
Managers overinvesting
Investing in nonproductive activities



Specially designated dividends
Generally declared after exceptionally strong companies
earnings.
Share repurchase have not replaced SDDs
SDDs fell into disfavor because managers mostly use
regular dividends to convey information to market
Managers would prefer repurchase to an SDDs when
firms stock was undervalued 92 %.
Indication of survey that SDDs communicate positive
information about short term earnings.


Conclusion
Dividends Prominent part of Investors Total Return
Role declined with time

Share repurchases Important part of Firms Payout
Policies

US Co. distributed more cash to shareholder using
Repurchases rather cash dividends up till 1998

Survey little supports for payout policies to agency,
signaling, & clientele explanations of payout policy

Taxes Not a dominant factor affecting payout choices.

Not able to found all the answers about Why managers
choose one method of cash disbursement over the
other