Lecture 5a: Payout (Dividends) Flashcards

1.) Payout declaration procedures 2.) Impact of - Transaction Cost - Flotation Cost - Taxes - Information Effects/ Signalling - Agency cost & corporate governance 3.) Special Dividends Characteristics 4.) Dividend Reinvestment Plans

1
Q

What is payout policy

A

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

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2
Q

Typically, when are dividends paid?

A

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

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3
Q

A company may not issue dividends unless:

A
  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
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4
Q

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

A

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

Usually, it is 1

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5
Q

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

A
  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
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6
Q

What are the 5 factors affecting payout policy (dividends)

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

TFTIA (The First Time I’m Anal)

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7
Q

PAYOUT FACTOR 1 (dividends): Transaction Cost

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

A

Stamp duty, brokerage fees, etc…

Shareholders can develop the payout they wanted.

  • Dividends > Buy shares & reinvest
  • Insufficient dividends > Sell shares & receive cash
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8
Q

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

A

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

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9
Q

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

A

Retirees: Prefers dividends as they prefer a regular income

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

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10
Q

What payout policy does dividend clienteles encourage

A

Stable Dividend Policy

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11
Q

What is a stable dividend policy

A

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

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12
Q

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

A

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

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

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13
Q

PAYOUT FACTOR 2 (dividends); Flotation Cost

What are flotation costs?

A

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

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14
Q

What payout policy does flotation cost encourage

A

Residual dividend policy

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15
Q

What is a residual dividend policy

A

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

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16
Q

PAYOUT FACTOR 3 (dividends): Taxes

What returns are investors interested in

A

After all-taxes returns

17
Q

What effects do taxes on payout policy create

A

Dividend Clienteles

18
Q

What are examples of clientele groups in relation to tax system

A
  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
19
Q

PAYOUT FACTOR 4 (dividends) : Information Effects and Signalling

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

A
  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
20
Q

What kind of payout policy does signalling encurage

A

Stable Dividend Policy

21
Q

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

A

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

22
Q

Why are managers reluctant to decrease dividends per share

A

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

23
Q

When will managers increase dividends per share

A

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

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

24
Q

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

A

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

25
What is the main problem with having a high dividend payout ratio
Prevents companies from adopting a stable dividend policy
26
How do companies usually reap the tax benefits of dividends without sending out a bad signal
Special Dividends
27
What are special dividends
Non-recurring dividends (one-off)
28
PAYOUT FACTOR 4 (dividends): Agency Costs Between which parties?
Companies are owned by shareholders and managed by managers. Between shareholders and managers
29
What is the argument in relation to what would reduce agency costs?
High dividends
30
Explain why high dividends will reduce agency costs. 4 Reasons
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)
31
Case Study: Telstra in relation to Agency Cost Dividends
- 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
32
What is the advantage of dividend reinvestment plans in relation to taxes
Shareholders are assumed to have dividends (even though they are reinvested) and the franking credits but company does not have to distribute cash
33
What kind of taxes are dividends and off-market share buybacks based on
All dividends: Personal Tax involved. Sharebuyback: Include Capital gains tax too