Dividend Policy

Question 1

What are the main indicators regarding dividends and what do they mean?

Answer 1

-Dividend per share - tends to be stable, so historical values won’t be much help
-Dividend yield - part of the shareholder’s return
-Pay-out ratio - percentage of net earnings pay out to shareholders

Question 2

In what consists the stabilization policy regarding dividends?

Answer 2

stable dividends only when sustainability is granted; companies avoid changes in the amount (are sticky) do to capacity of paying high levels in the future and the market strongly reacts against dividend reductions

Question 2

What are the two presented dividend policies?

Answer 2

• Residual policy
• Stabilization policy

Question 3

In what consists the residual policy regarding dividends?

Answer 3

The company pays dividends according to a percentage of its earnings, since the company favours allocating cash-flows for investments with a positive NVP
Goes along with the pecking order theory and an objective pay-out ratio.

Question 4

Regarding share repurchases, what happens to the shares that are bought back buy the company?

Answer 4

The shares loose their rights, like voting and dividend rights, since it’s the company buying them.

Question 5

What are the same consequences for share repurchases as for dividends?

Answer 5

• Both originate a reduction of available cash-flows - reduce agency costs, equity book value and market value, and affect capital structure
• Transmit information and signalling to the market

Question 6

What are the main differences between share repurchases and cash dividends?

Answer 6

-Buybacks reduce the number of remaining shares;
-Don’t reduce share price, but don’t exactly distribute funds proportionally
-Possible different taxation regime

Question 7

What are the main reasons to favour share repurchases instead of dividends? (6)

Answer 7

• Buybacks don’t commit the company in the future like a dividend policy
• Flexibility
• Take longer - can change the decision and prolongue taxes
• Contribute to increase management power
  -Funds are paid only to shareholders needing them
• Help the incentive scheme for managers - don’t reduce their stock options which motivates them to think like shareholders, also, buybacks don’t drop the share price keeping the value of the stock options

Question 8

There are 3 different lines of thought on the effect of dividend policy. What are they?

Answer 8

-Dividend policy is irrelevant for company value
-Dividends reduce company value
-Dividends increase company value

Question 9

What are the main points regarding the line of thought that dividend policy is irrelevant?

Answer 9

For this line to be real, capital markets have to be perfect, friction less, and investors have to be rational - wealth maximizers and indifferents to dividends and capital gains

Question 10

What are the main points regarding the line of thought that dividends destroy value?

Answer 10

Dividends are commonly taxed at a higher level, but this might not affect all investors the same and change across countries. Even if the tax rate is the same, taxes can be deferred, presenting a benefit - investors prefer capital gains and share repurchases

Question 11

What are the main points regarding the line of thought that dividends create value?

Answer 11

-Clientele effect - some investors like dividends - regular payments, don’t suffer tax disadvantages
-Signalling Theory - asymetry of info: sign that announcement of dividends view as the company expects to maintain capacity to generate cash-flows
-Change the financing mix (capital structure)
-Reducing of agency costs
-Transaction costs (dividends preferable when fixed costs are high)