Chapter 7 - Dividend policy Flashcards
What does M & M’s dividend irrelevancy theory suggest?
Entities should focus on investment policy rather than dividend policy, and that if investors required income, they could sell shares to ‘manufacture’ dividends
What are M & M’s assumptions?
There exists a perfect capital market
There are no transaction costs
There are no taxes, or dividends and capital gains are taxed in the same way
The entity’s operating cash flows are the same no matter which dividend policy is adopted
What are two important considerations in the interests of shareholders?
Clintele effect: Companies should follow a consistent dividend policy so as to ensure thst they gather to them a clientele of shareholders whole like that particular policy
The bird-in-the-hand-argument: A dividend is certain and some investors prefer a certain dividend now, to the promise of uncertain future dividends
What are the practical dividend policy considerations?
The interests of shareholders
Dividend signalling
The cash needs of the entity
What are the key considerations of the dividend policy in the real world?
The clientele effect
The cash needs of the company
Signalling
Legal factors
Debt covenants
Tax implications
Link to investment and financing
Inflation
What is scrip dividends?
Shareholders are offered bonus shares free of charge as an alternative to a cash dividend
What are the reasons for scrip dividend?
If the company wishes to retain cash in the business
If shareholders wish to reinvest dividends in the company but avoid brokerage costs of buying shares
If there are tax advantages of receiving shares rather than cash
What are the impacts of scrip dividend?
If all shareholders opt for bonus shares, the scrip issue has the effect of capitalising reserves. Reserves reduce and share capital increases.
Both share price and earnings per share will fall due to the greater number of shares in issue
What is share repurchase?
Alternative to paying a dividend is to buy back shares. Used when the company has no positive NPV projects to invest in, so it returns the cash to shareholders.
What are the advantages of share repurchase?
Choice for investors
Lower future total dividends
Can change control
No change in the share price
Removes the dividend policy precedent
What are the disadvantages of share repurchase?
Approval needed in general meeting
Difficult to set a fair prce for the repurchase
What is the impact of scrip dividends on financial ratios?
No overall impact on shareholder wealth
More shares in issue - EPS falls
Share price falls
What is the impact of share repurchase on financial ratios?
Same impact on shareholder wealth as a cash dividend
Fewer shares in issue - EPS rises
Share price stays constant
