Lecture 10 - Payout Policy Flashcards
What are the two ways firms can pay out cash to shareholders?
- Cash dividends.
- Stock repurchases.
What are dividends?
Usually refers to a cash distribution of earnings. They are a regular payment of cash by the firm to its shareholders.
The policy is set by a firm’s…
Board of directors.
When a dividend has been declared, it becomes a…
A liability of the firm and cannot be easily cancelled by the firm.
Measures of dividends are…
- Dividend per share.
- Dividend yield (% of price).
- Dividend payout (% if earnings).
What is the dividend payment process?
- Declaration date is the date the dividend is formally announced and begins the dividend process for that specific dividend.
- Ex dividend date is the first day on which the stock trades without the right to receive the announced dividend.
- Record date is the date on which the list of shareholders eligible to receive the dividend is made.
- Payment date is the date on which dividend checks are sent to the shareholders on record.
Shares trade constantly, and the firm’s records of who owns its shares are never fully up to date.
Investors who buy shares on or after ex dividend date do not have their purchases registered by the record date and are not entitled to the dividend.
Shares usually fall on the ex dividend date.
In a perfect world, the stock price will fall by…
The amount of the dividend on the ex dividend date.
Taxes complicate things. Empirically, the price drop is less than the…
Dividend and occurs within the first few minutes of the ex dividend date.
What is stock dividend?
Distribution of additional shares to a firm’s stockholders. For example, 5% stock dividend means shareholders get 5 new shares for every 100 shares owned.
Do stock dividends have any impact on cash?
No. No cash leaves the firm. Market value of equity will stay the same, the number of shares in the market will increase and the price will decrease.
Why may stock dividends occur?
Firms want to give shareholders some benefits but there is no sufficient cash, so they pay stock dividends. No cash leaves the firm, there is only an increase in the number of shares.
What are stock splits?
Issues of additional shares to firm’s stockholders. The impact of stock splits are bigger than the impact of stock dividends. A stock split resembles a stock dividend except that it is usually much larger. The value of equity is constant, number of shares increases and price per share will decline. Usually expressed as a ratio. For example, 3:1 means shareholders have 3 shares for every share held earlier.
Why are stock splits preferred over stock dividend?
To make stocks more accessible to investors. Reduces share price.
What are share repurchases?
Instead of paying dividends, firms may use cash to buy shares of their own stock. Reduces the number of shares outstanding. The reacquired shares are kept in the company’s treasury. it can be resold if the company needs money.
What are the four ways to implement a stock repurchase?
Open market repurchase - buy stock in the secondary market. This is the most common method. The firm announces its plans to buy back shares in the secondary market. In practice, there are regulations limiting how many of its own shares a firm can repurchase. Repurchases are spread out over months or years at a time.
Tender offer - offers to buy a stated number of shares at a fixed price. Usually at a premium.
Auction - here the firm states a range of prices from which they are willing to purchase.
Direct negotiation - negotiate purchase from a major shareholder. Usually private and not related to public shareholders in the market.
What is information content?
A change in payout provides information about managers’ confidence in the firm and so may affect stock price. It can give a signal. Managers are reluctant to make dividend changes that may be reversed. Shareholders will increase dividends only if they can maintain that higher level in the future. Managers try to smooth the dividend stream and hate to cut them back. They try to avoid reducing the dividend. Managers focus more on dividend changes rather than the absolute levels. Dividends changes are more important than levels of dividends. Changes in dividends can have signals.
Information content in dividends.
- Dividend increases convey managers’ confidence about future cash flow and earnings. Managers are reluctant to increase dividends unless they are confident they will maintain that payment later. Hence, a rise in share price is a positive signal.
- Dividend cuts convey managers’ lack of confidence and therefore are bad news. There will be a fall in share price.
Information content in stock repurchases.
- Signals managers’ optimism. If managers are confident, they will repurchase shares from the market.
- Indicate that shares are underpriced.
What does the payout controversy question?
Can payout policy change the underlying value of the firm’s common stock, or is it just a signal about the value?
What is the effect of a change in payout given the firm’s investment and financing decisions? It holds and assumes investment and financing decisions are constant, isolating the effect of payout policy on firm value.
What are the three opposing ideas about payout controversy?
Middle - payout policy is irrelevant.
Right - high dividends increase value.
Left - high dividends reduce firm value.
What does the MM (1961) irrelevance theorem for dividends assume?
- A perfect and efficient capital market.
