[7] Payout Flashcards
Two alternative ways through which companies pay cash to their shareholders:
Which do companies prefer to do?
paying a Dividends
Buying back some of the company’s stock
Prefer to buy back stock = regain ownership
Explain each of the 4 types of dividend payments:
Regular cash dividend: the dividend paid to each stockholder every quarter (regular payment).
Special cash dividend: a one-off supplement to the regular dividend (irregular payment).
Automatic Dividend Reinvestment Plans (DRIPs): sometimes offered to stockholders. New shares issued at discount from market price.
Stock dividends (instead of cash): issue of additional shares to stockholders. If a stock dividend of 5% is paid, the company distributes 5 extra shares for every 100 shares currently owned.
How do firms pay dividends:
The board of ___sets the dividend, e.g. $0.28 per share per quarter
They make an announcement that a ___will be made to all ___registered at a particular record ___.
On day before record date, stocks trade _-___, i.e. __ falls by amount of __.
Dividend cheques are mailed to registered ___.
directors payment shareholders date ex-dividend price dividend shareholders
4 ways firms repurchase stocks?
Whats the difference?
Buying shares on the market: the firm announces that it plans to repurchase part of its stock in the open market.
‘Tender’ offer to shareholders: the firm offers to buy back part of the stock at a fixed price:
usually with a mark-up over the current market price; shareholders may accept or decline the offer
‘Dutch’ auction:
the firm states a series of prices at which it is prepared to repurchase stock
shareholders submit offers declaring how many shares they wish to sell at each price;
the firm calculates the lowest price at which it can repurchase the desired number of shares.
Private negotiation: direct negotiation with a major shareholder.
The announcement of a dividend increase is good news for investors: x2
→ signals managers’ confidence in future profits. If managers thought increase in earnings were temporary, they would be cautious about committing to cash payouts.
→ predicts safer earnings. Managers are less likely to increase dividends when cash flows are uncertain and volatile.
It is not the ___ ___ but the ___ in the dividend that gives investors a signal on the sustainability of a company’s earnings:
→dividend increase: prompts share price increase
absolute value
change
Give an example of when dividend cuts aren’t bad?
What did investors interpret the dividend cut as?
On 23rd February 2009, J.P. Morgan cut its quarterly dividend from 38 cents to 5 cents per share. The cut was a surprise to investors, BUT the bank’s share price increased by about 5%.
J.P. Morgan acted from a position of relative strength. It remained profitable when other large U.S. banks were announcing horrific losses as consequence of the Financial crisis.
The J.P. Morgan dividend cut would save $5 billion a year and prepare it for a worst-case recession.
It would also put the bank in a position to pay back more quickly the $25 billion that it took from the government relief programme.
Thus investors interpreted the dividend cut as a signal of confidence, not of distress.
Repurchases signal that managers are: x3
- Not wasting resources on perks, empire building etc.
- Confident about the firm’s future prospects
and that the company is currently undervalued. - Therefore stock repurchasing announcements correlated with a subsequent rise in the share price.
Argument for dividend payouts:
Argument for Repurchase of stock:
Middle of the Road argument is?
investors prefer higher dividend payouts, so they pay more for firms with generous and stable dividends.
repurchases are better; higher dividends decrease value, because dividends are taxed more heavily than capital gains.
And in the center, there is a ”middle-of-the-road” that claims that the payout policy makes no difference!
Who founded the middle of the road policy argument and what does it imply?
What does it assume ?
The middle-of-the-road party was “founded” in 1961 by
Miller and Modigliani (MM).
They published a proof that dividend policy value is irrelevant in a world without taxes, transaction costs, or other market imperfections (assuming that capital markets are efficient).
Must consider dividend policy after holding fixed the company’s __, ___ and __ ___.
Now suppose that the firm wants to provide a higher dividend to existing ___.
The only way to raise the extra cash is via the issue of __ ___.
Potential investors will buy the new stock if it is fairly ___, i.e., reflecting the__ __ of the firm).
However, as the asset, earnings and investment decisions are unchanged…
The total (__) __ of the firm does not change.
How can firm sell more shares?
→
→
There has to be a transfer of value from __ to __ shareholders.
assets,
investment
borrowing policies
shareholders
new equity
valued, true valuation
real, value
Higher number of shares & unchanged total value
value per share must be lower!
old, new
Transfer of value from old to new shareholders
↓
___ shareholders’ __ __ __ falls (if the new equity is to be sold).
New shareholders get the __ shares, but each will be __ __ than before the extra dividend was announced.
Old shareholders suffer __ __ on their __.
↓
As capital loss borne by shareholders just offset extra dividend receive → _____ of shareholders to higher dividends!
old shareholders’ __ loss offset by __
Existing, value per share
new, worth less
capital loss, shares
indifference
capital, dividend
Does it matter to shareholders that they receive extra dividend and capital loss?
As long as capital markets are effi cient:
old stockholders/investors do not need dividends to convert shares into cash;
they can raise the cash by selling their own shares
As investors do not need ___ to get their hands on __,
They will not pay higher ___ for the shares of firms with ___ ___ payouts.
Hence, firms should not to worry about dividend policy!
They can let dividends __ as a by-product of their investment and financing decisions.
The dividend policy will have no impact on the value of the firm.
dividends cash Prices higher dividend fluctuate
If markets are efficient, stock repurchasing leaves
the total value of the firm ___.
the wealth of shareholders __.
→shareholders should be ____ to payout policy!
unaffected
unaffected
indifferent
Consider a firm with 1,000 shares outstanding, no debt (for simplicity), real assets worth £10,000, a cash surplus of £1,000 that can be paid out as dividends.
So the actual market capitalization is? .
So, each of its shares is worth ?
£11,000
£11
Suppose it pays out the surplus cash; the market capitalization falls to £10,000.
But does the price per share depend on whether the surplus cash is paid out as a dividend or by repurchases?
If a dividend of £1 per share is paid, 1,000 shares are still outstanding, and stock price is £10 (10,000/10).
Shareholders’ wealth, including the cash dividends, is £10 + 1 = £11 per share.
If repurchase shares instead, spends £1,000 surplus cash to repurchase 91 shares at £11 each, leaving 909 (1000-91) shares outstanding.
Stock price remains at £11 (£10,000 /909 shares). Shareholders’ wealth is £ 11 per share.
It doesn’t matter whether a particular shareholder decides to sell shares back to the firm.
If he sells, he gets £11 per share in cash.
If he doesn’t want to sell, he retains shares worth £11 each.
A repurchase does not __- the stock price,
but it avoids the __ in stock price that would occur on the __-___ date if the amount spent on repurchases were instead paid out as ____.
Repurchases also reduce the ___ of shares outstanding, so ___ earnings per share are ___ than if the same amount were paid out as dividends.
increase
fall
ex-dividend
cash dividends
number
future
higher
Consider again a firm with 1,000 shares outstanding, no debt, real assets worth £10,000, a cash surplus of £1,000 that can be paid out as dividends. So the actual market capitalization is £11,000. So, each of its shares is worth £11.
Suppose it decides to pay a dividend of £2 per share (instead of £1).What will ti do to raise extra £1000?
What will the ex-dividend stock price be?
How many shares will it have to issue?
What will the market capitalization now be?
How is value transferred?
To do so it will have to issue new shares to replace the extra £1,000 paid as dividends.
The ex-dividend stock price is £9 (11-2), so it will have to issue 111 shares at £9 each, to raise £1,000.
Market capitalization is brought back to 1,111 * £9 = £10,000.
Thus, shareholders receive a dividend of £2 versus £1 per share, but the extra money they receive is offset by a lower stock price.
They own a smaller fraction of the firm, because the firm had to finance the extra dividend by issuing 111 new shares.
When does the Miller-Modigliani proposition break? x2
Inefficient market: including information asymmetry
Transactions costs (trading in stock exchange is relatively costly)
→dividend payouts are preferable.
How can ‘free’ cash-flows cause conflicts of interest between shareholders and managers?
managers may have the incentive to put the money back into building a larger empire rather than a more profitable one,
while shareholders would prefer a more careful,
value-oriented investment policy
→ any form of payout of this ‘free’ cash-flow may be preferable for shareholders.
(‘free’ cash-flows = cash flow in excess of what is required to fund all projects that have positive net present values.)
What is taxed more heavily dividends or capital gains?
normally, dividends are taxed more heavily than capital gains
Why do firms prefer stock repurchasing?
Shareholders should prefer stock repurchasing.
Pay lowest cash dividend they can get away with
Lower taxes should be welcomed by any tax-paying investor.
SUMMARY:
A corporation has to decide how much cash to pay out to ___.
They have to decide whether to pay out cash via ___ or __.
A company’s payout policy can be a source of ___ for ___.
There are three opposing views on the effect of payout policy on shareholder value:
Rightist:
Leftist:
M&M:
shareholders dividends repurchases information investors
Dividends are preferred
Repurchases are better
Payout policy is irrelevant
What did the BoE announce following the Coronavirus?
What is this expected to be equivalent to ?
BoE not paying dividends in Covid-19 pandemic period, which is expected to be worth £9billion pounds.
Still yet to see if this will improve their situation in the longer term
