Lecture 5a: Payout (Dividends)

Question 1

What is payout policy

Answer 1

Proportion of company’s net earnings should be paid to shareholders

Question 2

Typically, when are dividends paid?

Answer 2

Typically, they are paid semi-annually (interim and final)

Question 3

A company may not issue dividends unless:

Answer 3

1. ) Assets exceeds liabilities
2. ) Payment of dividend is fair and reasonable to shareholders as a whole
3. ) Payment of dividend does not materially prejudice its ability to pay its creditors

Question 4

How we calculate dividend drop-off ratio and what is the ratio usually?

Answer 4

Dividend drop off ratio = (Share price cum-dividend - Share price ex-dividend) / Dividend

Usually, it is 1

Question 5

What are the assumptions when payout policy will NOT affect shareholder wealth

Answer 5

1. ) Company has given investment plan and has determined how much of its assets will be financed by borrowing
2. ) Perfect competitive market (Not transaction cost, flotation cost, information cost, and taxes)
3. ) Investors prefer more wealth to less, and are EQUALLY satisfied with the increase either via. dividends/value of shares held

Question 6

What are the 5 factors affecting payout policy (dividends)

Answer 6

1. ) Transaction Cost
2. ) Flotation Cost
3. ) Taxes
4. ) Information effects & signalling
5. ) Agency Costs

TFTIA (The First Time I’m Anal)

Question 7

PAYOUT FACTOR 1 (dividends): Transaction Cost

What are they? And
In theory, what if there were no transaction costs?

Answer 7

Stamp duty, brokerage fees, etc…

Shareholders can develop the payout they wanted.

• Dividends > Buy shares & reinvest
• Insufficient dividends > Sell shares & receive cash

Question 8

In practice, buying/selling shares (if the company does not payout in dividends) incurs brokerage fees, what is this effect on the company?

Answer 8

Forms dividend clienteles: group of investors who invest in companies that have dividend policies meeting their requirements

Question 9

What are 2 examples of clientele groups in relation to transaction costs

Answer 9

Retirees: Prefers dividends as they prefer a regular income

Employed saving for retirement: Prefer retention for future profits (long-term returns)

Question 10

What payout policy does dividend clienteles encourage

Answer 10

Stable Dividend Policy

Question 11

What is a stable dividend policy

Answer 11

Where the company sets a long-run target dividend payout ratio - that is, a target proportion of profit to be paid out as dividends

Question 12

Under the stable dividend policy, when does dividend per share increase or decrease?

Answer 12

Dividend per share INCREASE: Expected LONG-RUN PROFIT PER SHARE INCREASE

Dividend per share DECREASE: Expected long-run profit per share DECREASE

Question 13

PAYOUT FACTOR 2 (dividends); Flotation Cost

What are flotation costs?

Answer 13

Cost incurred when raising external funds (such as underwriting fees, legal fees, advertising fees, registering fees)

Question 14

What payout policy does flotation cost encourage

Answer 14

Residual dividend policy

Question 15

What is a residual dividend policy

Answer 15

Company will only pay out when they do not require cash for profitable projects

Question 16

PAYOUT FACTOR 3 (dividends): Taxes

What returns are investors interested in

Answer 16

After all-taxes returns

Question 17

What effects do taxes on payout policy create

Answer 17

Dividend Clienteles

Question 18

What are examples of clientele groups in relation to tax system

Answer 18

1. ) Low Tax Individuals (<30%): Full payout of earnings as dividends (Access franking credits)
2. ) High Tax Individuals (>30%): May/May Not prefer payout as dividends depending on the level of tax on capital gains (Ambiguous)
3. ) Foreign Investors who cannot claim tax credits: May prefer no dividends (or unfranked dividends) because their tax on retained earnings (as capital gains)/ CAPITAL GAINS TAX LESS THAN DIVIDEND TAX «&laquo_space;Depends on their own country’s tax system. eg. classical they will face double tax

Question 19

PAYOUT FACTOR 4 (dividends) : Information Effects and Signalling

What are two outcomes that could happen on the dividend ANNOUNCEMENT date

Answer 19

1. ) Unexpected increase in dividend per share = Share price increase
   - Announce increase in dividend per share
   - Signals good news (for example, about future long-run PROFITABILITY)
   - Good news causes the share price to increase – not the increase in dividends itself
2. ) Unexpected decrease in dividend per share = Share price decrease
   - Announcement of a decrease in dividend per share
   - Signals bad news (for example, about future long-run PROFITABILITY)
   - Bad news that causes the share price to decrease – not the decrease in dividends itself

Question 20

What kind of payout policy does signalling encurage

Answer 20

Stable Dividend Policy

Question 21

Do changes in dividends per share by itself have any effects on shareholder wealth

Answer 21

No. By itself, it does not make shareholders better/worse off

Question 22

Why are managers reluctant to decrease dividends per share

Answer 22

It conveys negative signals with respect to long-run expected earnings

Question 23

When will managers increase dividends per share

Answer 23

Only when the increase is sustainable given long-run expected earnings

(If it is unsustainable and it decreases > Bad signal)

Question 24

What does the imputation tax system encourage in relation to payout ratio

Answer 24

Provide a tax-driven incentive for companies to have high dividend payout ratio (so that shareholders can access franking credits)

Question 25

What is the main problem with having a high dividend payout ratio

Answer 25

Prevents companies from adopting a stable dividend policy

Question 26

How do companies usually reap the tax benefits of dividends without sending out a bad signal

Answer 26

Special Dividends

Question 27

What are special dividends

Answer 27

Non-recurring dividends (one-off)

Question 28

PAYOUT FACTOR 4 (dividends): Agency Costs

Between which parties?

Answer 28

Companies are owned by shareholders and managed by managers.

Between shareholders and managers

Question 29

What is the argument in relation to what would reduce agency costs?

Answer 29

High dividends

Question 30

Explain why high dividends will reduce agency costs. 4 Reasons

Answer 30

1. ) Exposes company to SCRUTINY associated with raising external capital
2. ) Managers can’t invest FREE CASH FLOW with unprofitable projects «< KEY POINT
3. ) Increases MONITORING
4. ) Managers likely to act in shareholders’ BEST INTEREST

SFMB (Sofa Fan My Bed)

Question 31

Case Study: Telstra in relation to Agency Cost Dividends

Answer 31

• Company criticised for its poorly executed growth strategy
• One-page announcement (which vowed to give higher dividends and not waste money) resulted in a 4.6% jump to a nine-month high in share price

Question 32

What is the advantage of dividend reinvestment plans in relation to taxes

Answer 32

Shareholders are assumed to have dividends (even though they are reinvested) and the franking credits but company does not have to distribute cash

Question 33

What kind of taxes are dividends and off-market share buybacks based on

Answer 33

All dividends: Personal Tax involved.

Sharebuyback: Include Capital gains tax too