4. Dividends And Dividend Policies Flashcards
What are dividends?
It is a distribution of a company’s earnings to its shareholders.
This process is decided by the board of directors.
How are dividends quoted?
- Either in terms of lei/euro/dollar each share receives (dividend per share)
- Either as a percent of the current market price (Dividend yield)
What is a dividend policy?
It is a document by which companies decide how much of the earnings to keep and how much to give to shareholders in dividends.
What are the types of dividends?
- Cash dividends
- Stock dividends
- Stock split
- Share repurchase
What is a stock dividend payment?
It is a payment in the form of additional shares.
Eg: shareholder receives 1 share for every 50 shares they own
What is share repurchase?
It is a practice by which a company buys back its share from the market.
Which are the dividend theories?
- The middle-of-the-road party
- The rightists
- The leftists
What does the middle-of-the-road dividend theory say?
Increasing or decreasing the dividend has no effect on stock price
(Dividend irrelevance theory)
What doe the rightist dividend theory say?
It claims that if the firm increases the dividends, the stock price will increase too
This means that investors value dividends more than capital gains
What does the leftist dividend theory say?
It says that if the firm increases the dividends, the stock price will decrease.
It tells that dividends are taxed in the current period, while the tax on capital gain is deferred to the future.
Therefore investors prefer capital gains to dividends.
How do dividend policies work in practice?
Investors prefer to reinvest earnings if they can get a higher risk adjusted return.
What does the residual dividend policy say?
It says that dividends are part of earnings, which cannot be invested at a rate lower or equal to WACC (weighted average cost of capital)
What are the steps of a residual dividend policy?
- Determine the optimal capital budget
- Determine the retained earnings that can be used to finance the capital budget
- Use retain earning to supply as much of the equity investment in the capital budget as necessary
- Pay dividends only if there are left-over earnings
What are the steps for a stable (predictable) dividend policy?
It maintains a constant dividend.
- Pay a predictable dividend each year
- Base optimal capital budget on residual retained earnings
What is a drawback of the stable (predictable) dividend policy?
Once it has been established it cannot be changed without seriously affecting the investor’s attitude and the financial standing of the company
