Dividends and payout policy

Question 1

What is the definition of a dividend?

Answer 1

A payment made out of a firm’s earnings to it’s owners, in the form of either cash or stock

Question 2

What are the 4 different types of dividend in this course?

Answer 2

• Regular cash dividends
• Extra dividends
• Special dividends
• Liquidating dividends

Question 3

What are regular cash dividends?

Answer 3

A cash payment made by a firm to its owners in the normal course of business

Question 4

What are extra dividends?

Answer 4

Paid on top of normal dividend, may or may not be paid in the future, typically if a firm is performing particularly well

Question 5

What are special dividends?

Answer 5

Similar to extra dividend other than being truly ONE-OFF for high-performance.

Question 6

What are liquidating dividends?

Answer 6

All of the business are sold off, e.g. in the case of bankruptcy

Question 7

what is the standard method of cash dividend payment?

Answer 7

• Declaration date (the date on which a resolution is passed by the board to pay a dividend)
• Ex-dividend date
• Date of record
• Date of payment

Question 8

What is the ex-dividend date?

Answer 8

The date two business days before the date of record, establishing those individuals entitled to dividend

Question 9

what is the date of record?

Answer 9

The date by which a holder must be on record to be designated to receive a dividend

Question 10

How do we expect the share price to react when the equity goes ex-dividend?

Answer 10

We would expect the share price to go down by about the dividend amount when the equity goes ex-dividend

Question 11

Why is determining the value of the actual share-price change difficult?

Answer 11

Because of the different tax rates and rules that apply for different buyers and different cash flows for different buyers

Question 12

How is the share-price effected if the dividend per share at a given date is raised while the dividend per share at every other date is held constant?

Answer 12

The share price will rise

Question 13

Why may dividend policy be irrelevant?

Answer 13

Any increase in dividend at some point in time is exactly offset by a decrease somewhere else, so the net effect once we account for time value is 0

Question 14

What is homemade dividend policy?

Answer 14

The tailored dividend policy created by the individual investors who undo corporate dividend policy by reinvesting dividends or selling shares of equity

Question 15

What real world factors favour low dividend policy?

Answer 15

• Taxes
• Flotation costs (e.g. transaction)
• Dividend restrictions

Question 16

What real world factors favour high dividend policy?

Answer 16

• Desire for current income
• Information content of dividends and dividend signalling
• Agency costs
  Behavioural finance

Question 17

How do dividend preferences vary between different investors?

Answer 17

• Tax free or low paying investors prefer high dividends
• High tax paying investors prefer low dividends or no dividends

Question 18

How is dividend policy structured?

Answer 18

It is optimised for the tax preference of it’s investor clientele

Question 19

What is the dynamic clientele effect?

Answer 19

Ignoring transaction costs, investors can trade shares at the time of the dividend, so that non-tax investors receive the dividend that is non-tax investors need NOT hold the high dividend, paying stocks all the time it is necessary only that they hold them when the dividend is actually paid

Question 20

Why do companies even pay dividends>

Answer 20

The decisions to pay dividends is driven by prevailing investor demand for dividend payers managers, cater to invest us by paying dividends when investors put a stock price or premium on payers, and by not paying when investors prefer nonpayers

Question 21

What are share repurchases?

Answer 21

The purchase by corporation of its own shares of equity

Question 22

How do share buybacks effect investor perception?

Answer 22

Positively, a share buyback improves EPS giving investors the perception of an improvement in EPS after the share buyback

Question 23

Why do executives prefer share buybacks to dividend payments?

Answer 23

Because they boost the share price more typically

Question 24

Why do investors like dividends from a long-term perspective?

Answer 24

A dividend is typically seen as a commitment to the shareholders as managers are typically quite hesitant to reduce the existing dividend

Question 25

What do firms consider when deciding between a dividend payment and a share repurchase?

Answer 25

• Flexibility
• Executive comp
• Undervaluation
• Taxes (repurchases have a tax advantage)

Question 26

What are the pros of paying dividends?

Answer 26

Dividends may attract institutional investors
- Share price usually increases with the announcement of a new or increased dividend
- Dividend absorb excess cash flow and may reduce the agency costs that arise from conflicts between management and shareholders

Question 27

What are the cons of paying dividends?

Answer 27

Dividends are taxed
Dividends can reduce internal sources of financing
Dividend cuts are hard to make without adversely affecting the firm’s share price

Question 28

What is dividend smoothing?

Answer 28

Dividend growth lags earnings growth as firms don’t increase or cut dividends in response to temporary earnings fluctuations

Question 29

What is a stock dividend?

Answer 29

A payment made by a firm to its shareholders in the form of equity diluting the value of each share outstanding

Question 30

What is a stock split?

Answer 30

An increase in a firm’s shares outstanding without any change in owners equity

Question 31

What is a reverse split?

Answer 31

A stock split in which a firm’s number of shares outstanding is reduced