Dividend Flashcards
dividend
distribution from firm to shareholders
payout policy
the way a firm chooses between alternative ways to cash out to shareholders
div policy
a subset of wider issues of financing decision making
tradeoff between paying out earnings or using them as a source of finance
there’s a strong interrelationship between
firm financing, investment and dividend decisions
dividend timeline (which comes first…)
declaration date
ex div date
record date
payable date
declaration date
firm declares and announces the next regular, irregular or special dividend (if have surplus cash)
ex div date
usually 1 biz day before record date
date by which people need to own the stock to receive divs
buyers on or after this day will not receive div
SP usually drops on
ex div date
record date
shareholders recorded by this date who will receive div
payable date
eligible shareholders will get div paid
could be months later
price behaviour of SP
theoretically if markets are efficient share price will fall by exact D amount on ex-div date
but typically fall by less than that due to taxation
is there an optimal div policy?
w and w/out PCM
in PCM div policy has no affect on shareholders wealth as investors can just recreate CFs if needed
without PCM either doesn’t matter or it does and high or low div payout is preferred
preference of high or low div payout ratio
low means firm is reinvesting lots more so could be a sign of expansion or not doing well
too high could be unsustainable and means paying out too many earnings, but could also be a good sign
3 common div policies
residual
smoothed
stable
residual div policy
leftover residuals go to payout
firm uses earnings to pay capital expenses then divs
annual divs fluctuate depending of earnings and investment needs
can be a volatile policy making divs uncertain in market
smoothed (target pay out) div policy
firms only raise divs when earnings are thought to be solid
represents the long-term average residual payout policy
constant
fluctuating div amount
aims for divs to equal long term diff between expected profits and expected investment needs
stable div policy
no matter what earnings are pay an exact C amount of D
could be increasing
increase C in response to increasing expected profits in future
what is a less formal type of stable div policy?
low, regular, div + extra policy
dividend policy and investment policy cross over and MM view
should not forgo NPV + projects in order to raise Ds
MM suggest firms investment policy is set well before and not impacted by firm changes
MM irrelevance theory
div policy has no effect on firm value
there is a tradeoff between retaining profits for investments or paying D and issues new shares to replace cash paid out as D
MM irrelevance theory states that firm value is determined by
earning power of the firms assets
does paying a D or issuing new shares change firm value or wealth of old shareholders?
no
the gain in D income is offset by
loss of capital gains
SP drops by ___ but this is offset by __
D
receiving D
repurchasing shares decreases __ but keeps __ constant
Veq and no shares issued but SP same
corporate dividend is
homemade dividend
when to sell or buy shares… (homemade)?
if D < desired, sell to gain desired cash
if D> desired, buy additional shares with excess( creation of homemade capital gain)
if participation occurs, decrease in holding value is
offset by cash received by repurchase
classical tax system
double taxation of div income @ firms and personal level
tax on cap gains < tax on div income
preference for earnings retention than div payment
Dividend imputation system
double taxation of retained earnings @ firm tax level then capital gains when shares are sold
SP for Dividend imputation system
SP decreases by > D due to value of franking credit
in Dividend imputation system firm chooses earnings distribution:
earnings retention (CG)
or
payment of franked divs (FD)
or unfranked divs (UD)
choice depends on shareholders personal tax and their status (usually franked divs is preferred)
how does the Dividend imputation system work?
firm pays tax on domestic sourced income at Tc
div paid from after tax net income to shareholders
they recieve imputation credit for the amount of corp tax paid
shareholder can deduct this amount from tax payable
firm essentially pays tax on D income on behalf of investors
with franked credits actual SP usually
less than imagined as div income you receive requires you to pay income tax on it
also not a controlled experiment
6 non-tax reasons for relevance of div policy
- info effects/ div signalling
- current income preferences
- div stability
-agency costs
-share issue costs for firm - transaction costs to investors
- div clientele
info effects and div signalling
increase in D means increase in SP
share holders think its a good sign and vice versa sends bad signs to market
current income preferences
some shareholders need stable income from shares
div stability
shareholders prefer constant stable flow and are more likely to pay a premium to reduce risk
agency costs
divs reduce FCF to wasteful managers
share issue costs for firms
firm pays div and needs to issue new shares to fund investment
transaction costs for investors
costs to buy and sell shares
low payout:
- sell shares and brokerage cost/tax
high payout:
- reinvest more shares
- brokerage cost
div clientele
different investors invest with firms that align their div likings which affects supply and demand of stocks
stock dividend
a payment to shareholders that of additional shares not cash (like DRIP)
stock div and SP
reduces SP as Veq is divided upon more shares
stock split
stock prices too high so split them so lower price and then more attractive to smaller investors
shares repurchase
firms offer to shareholders to buy back shares at a fixed price
could be financed through d or e
what does a share repurchase influence?
ownership structure, cap structure, EPS, SP(+ usually),
What do share repurchases send as market signalling?
a good sign if the company wants more shares
7 motives for shares repurchase
div substitution
shareholder preference for divs vs cap gains
increased performance
financial flexibility
FCF
Info signalling
executive compensation
div substitution
instead of paying div
shareholder preference for divs vs cap gains
if want liquidity sell shares
if want capital gains hold onto
increased performance
increases EPS, D/E ratio
less shares so increased performance
financial flexibility
divs are commitment so repurchases don’t have that commitment
FCF
using cash to buy back shares decreases FCF to wasteful managers
info signalling
good sign if a firm is repurchasing
executive compensation
avoids negative effect of divs on share and option value as when u pay divs SP decreases
in the real world what happens to SP
increases on announcement of share repurchases
