Dividend and Payout Policy

Question 1

What are the steps to the payout decision?

Answer 1

Cashflows from operations
Cashflows from operations to equity investors after debt paid.
Cash available to return to stockholders after the firm chooses how much to reinvest.
Cash paid out to either buyback stocks or given as dividends.

Question 2

What do managers not increases dividends till?

Answer 2

Managers do not increase dividends unless they are confident that dividend can be maintained

Question 3

What are the advantages of stock repurchases instead of increasing dividends?

Answer 3

More flexible
Tax advantage

Question 4

What are the three types of dividends?

Answer 4

Cash dividend
Stock dividend
Stock splits

Question 5

What is a cash dividend?

What are the two types?

Answer 5

Payment of cash by the firm to its shareholders.

Regular dividend- A dividend that is expected to be paid consistently into the future

Special dividend- – A dividend that is not likely to be repeated

Question 6

What is a stock dividend?

Answer 6

Distributions of additional shares to a firm’s stockholders

Question 7

What are stock splits?

Answer 7

Issue of additional shares to firm’s stockholders

Question 8

What is a dividend reinvestment plan (DRIP)?

Answer 8

A plan offered by a corporation that allows investors to reinvest their cash dividends by purchasing additional shares or fractional shares on the dividend payment date.

Question 9

Imagine a company currently has 10 million shares outstanding selling at $60 per share and declares a three-for-two stock split. After the split, how many shares will be outstanding?
What stays the same?

Answer 9

10 mil × (3/2) = 15 mil shares outstanding

Market cap

Question 10

What are the key dates of dividend policy?

Answer 10

Declaration Date – The date on which the corporation announces a dividend payment.

Ex-dividend Date – Without dividend. Buyer of a stock after the ex-dividend date does not receive the most recently declared dividend.

Record Date – Shareholders registered on this date will be the ones to receive the most recently declared dividend.

Payment Date – The date the dividend payment is actually sent to shareholders.

Question 11

What would you expect to happen to the price of a share of stock on the day it goes ex-dividend?

Answer 11

The price should decrease by the amount of the dividend

Question 12

What is meant by ex-dividend?

Answer 12

Describes a stock that is trading without the value of the next dividend payment.

Question 13

Look at slide on stock price reaction to dividends

Question 14

What happens to a company’s market cap after dividends are paid out?

Answer 14

The market cap falls

Question 15

What is the argument for dividends over capital gains? (Idea that when you receive dividends, capital gains decreases as price of stock drops)

Answer 15

Dividends now are more certain than capital gains later. Hence dividends are more valuable than capital gains. Stocks that pay dividends will therefore be more highly valued than stocks that do not

Question 16

What is a counterargument for dividends over capital gains?

Answer 16

The appropriate comparison should be between dividends today and price appreciation today (compare apple to apples). The stock price drops on the ex-dividend day

Question 17

A firm buys back stock from its shareholders, what are the four ways to implement?

Answer 17

Open-market repurchase
Tender Offer
Dutch Auction
Private Negotiation (greenmail)

Question 18

Imagine a firm has 100,000 shares outstanding, worth $1 million in total. If the firm buys back 10,000 shares at $10 each, how is shareholder wealth affected?

Answer 18

Share number decreases

Value of firms decreases

Price per share remains the same

Question 19

What are the differences between stock repurchase and dividends in terms of the shareholders?

Answer 19

Stock repurchase has no capital loss, and the price of shares stay the same.
However, the value of your shares decreases as you have less of them

Question 20

What is an open market repurchase?

Answer 20

firm purchases stock in the secondary market

Question 21

What is a tender offer?

Answer 21

firm offers to buy back a stated number of shares on pre-specified terms (amount, price and time)

Question 22

What is a dutch auction?

Answer 22

A share repurchase method in which the firm lists different prices at which it is prepared to buy shares, and shareholders in turn indicate how many shares they are willing to sell at each price

Question 23

What is a private negotiation?

Answer 23

When a firm avoids a threat of takeover and removal of its management by a major shareholder by buying out the shareholder, often at a large premium over the current market price

Question 24

What do managers try to avoid doing in terms of dividends?

Answer 24

Avoid reducing the dividend and maintain a smooth dividend stream

Question 25

If the dividend is below or above the target, what do firms do?

Answer 25

Less than target: the dividend is increased gradually toward the target.

Above the target: the dividend usually is not cut immediately; it is often left alone

Question 26

What is meant by sticky dividends?

Answer 26

Dividends don’t change too much

Question 27

What is the MM dividend irrelevance proposition?

Answer 27

In a perfect capital market and ignore personal taxes, holding fixed the investment policy of a firm, the firm’s choice of dividend policy is irrelevant

Question 28

What are the 3 implications of the MM dividend irrelevance proposition?

Answer 28

(a) There are no tax differences to investors between dividends and capital gains.
(b) If companies pay too much in cash, they can issue new stock, with no flotation costs or signaling consequences, to replace this cash.
(c) If companies pay too little in dividends, they do not use the excess cash for bad projects or acquisitions.

Question 29

Look at slides on alternative payout policy

Question 30

What are the three alternative dividends theories?

Answer 30

Dividends do not affect value

Dividends increase value
- Clientele effect
- Behavioural psychology
- Management incentive

Dividends reduce value
- Income vs. capital gain tax

Question 31

What are the two factors driving dividend policy?

Answer 31

Inertia

Mee-too-ism

Question 32

What is inertia?

Answer 32

Companies seem to hate to let of their past, when it comes to dividend policy

Question 33

What is met-too-ism?

Answer 33

Companies want to behave like their peer group