8) Dividends Flashcards
what impact does paying divs have on RE?
- reduces it
- firm cannot use that money to invest in profitable projects
- must issue more shares to inc RE again
what does the bird-in-hand theory state?
- dividends have a positive effect on the value
- high expected divs = high company value
what does the M&M theory about divs say?
- no impact on company value (irrelevant)
- payments actually reduce growth potential and thus future divs
how can an issue of new shares impact SH?
more dilution of control
what is the role of dividends?
- increase wealth of owners
- act as profit-creation signals
what does agency theory highlight?
the conflicts that arise when mgmt acts in their own interests rather than that of owners
what does signaling theory state?
mgmt has more info than investors, and any info they have in common will not be perceived in the same way
what is the residual approach for divs?
- suggests divs are paid from what is left over from investments and financing (pay if no inv opportunities)
- is a passive variable
what must a company identify to adopt a residual approach?
- its inv opportunities
- required rate of return
- target debt ratio
what factors impact the dividend decision?
1) info content of divs
2) nature of SH
3) tax consequences
4) legal requirements
5) contractual obligations
what signal does an increase in divs send?
that current earnings and profits are seen to be sustainable
when does a company have sustainable earnings?
both earnings and divs increase
will companies pay divs when in the growth phase?
no, they will focus on funding growth and investment
what is the clientele effect?
a change in share price due to corporate decision-making that triggers investors’ reactions
what kind of SH will prefer a low-div company?
prefer growth and capital gains, not divs
what kind of SH will prefer a high-div company?
prefer dividends and need the income
what are tax consequences of issuing a dividend?
SH will be subject to DWT and not the CGT (if the company had reinvested into itself and increased its value)
what are the legal requirements for issuing a dividend?
the Companies Act rules for when making a distribution
what are the Companies Act rules for when making a distribution?
1) authorized by BOD by way of resolution (unless they have an existing legal obl)
2) reasonably appears that company will pass S/L tests after making the distribution
3) BOD acknowledges that is has applied the test and concluded it will be satisfied
what do we test in the S/L tests?
1) A>L
2) company can pay its debts as they become due for 12 months after the distribution
what is commercial solvency?
A > L (FVs)
what is factual solvency?
company can pay its debts as they become due for 12 months after the distribution
what contractual obligations can impact the issue of dividends?
company may have entered into contracts which limit its ability to pay divs (loan covenants)
what must the div policy do?
dictate how much cash is returned to SH
