lecture chapter 17 (1)

Question 1

Choice of payout options

Answer 1

Repurchase shares
Pay dividends

Question 2

Payout policy

Answer 2

The way a firm chooses between the alternative ways to distribute free cash flow to equity holders

Question 3

Declaration date

Answer 3

The date the board declares a special dividend

Question 4

Ex-dividend date

Answer 4

Buyers of stock on or after this date do not receive dividend

Question 5

Record date

Answer 5

shareholders recorded by this date receive dividend

Question 6

payout date

Answer 6

Eligible shareholders receive payments of x/share

Question 7

special dividend

Answer 7

A one time dividend payment a firm makes, which is usually much larger than a regular dividend

Question 8

Stock dividend

Answer 8

Instead of cash, shareholders get more shares

Question 9

share repurchase

Answer 9

An alternative way to pay cash to investors is through a share repurchase or buyback

The firm uses cash to buy back shares of its own outstanding stock

Question 10

Open market repurchase

Answer 10

When a firm repurchases shares by buying shares in the open market

Open market share repurchases represent about 95% of all repurchase transactions

Question 11

Greenmail

Answer 11

When a firm avoids a threat of takeover and removal of its management by a major shareholder by buying out the shareholder, often at a large premmium over the current market price

Question 12

comparison of dividend and share repurchases: the usual approach to seek an answer

Answer 12

A simple example:
Keep investment constant
Only focus on the policy choice (dividend or repurchase)
Compare the value of investors holdings before and after dividends/repurchase

To make things a little simpler, we are going to consider an all-equity case (i.e. an unlevered firm)

Question 13

Cum-dividend

Answer 13

A moment prior to the ex dividend date, the price is called Cum-dividend

Question 14

Effective dividend tax rate formula

Answer 14

T*d =(Td - Tg/1-Tg)

when the two rates are the same, dividends do not have a tax disadvantage

Question 15

Taxes and cash retention

Answer 15

in the presence of taxes, cash retention and firm-level investment creates corporate taxable income

If the investment was done at the individual level, there would only be personal taxes (no corporate taxation)

So, in the presence of taxes, cash retention is not a good idea for the firm

Question 16

Agency costs of retaining cash

Answer 16

When firms have excessive cash, managers may use the funds inefficiently by paying excessive executive perks, over-paying for acquisitions, etc.

Paying out excess cash through dividends or share repurchases, rather than retaining cash, can boost the stock price by reducing managers ability and temptation to waste resources

Question 17

Issuances and distress costs (retaining cash)

Answer 17

Generally, firms retain cash balances to cover potential future cash shortfalls, despite the tax disadvantage to retaining cash

A firm might accumulate a large cash balance if there is a reasonable chance that future earnings will be insufficient to fund future positive-NPV investment opportunities

Question 18

dividend smoothing

Answer 18

The practice of maintaining relatively constant dividends

Firm changes dividends infrequently, annd dividends are much less volatile than earnings

Question 19

Signaling with payout policy (research has found that)

Answer 19

Management believes that investors prefer stable dividends with sustained growth

Mangement desires to maintain a long-term target level of dividends as a fraction of earnings

Thus, firms raise their dividends only when they perceive a long term sustainable increase in the expected level of future earnings and cut them only as last resort

Question 20

Dividend signaling hypothesis

Answer 20

The idea that dividend changes relfect managers views about a firms future earnings prospects

If forms smooth dividends, the firms dividend choice will contain information regarding managements expectations of future earnings

Question 21

dividend signaling (cont’d)

Answer 21

when a firm increases its dividend, it sends a positive signal to inveestors that management expects to be able to afford the higher dividend for the foreseable future

When a firm decreases its dividend, it may signal that management has given up hope that earnings will rebound in the near term and so need to reduce the dividend to save cash