Payout Policy

Question 1

What two ways can companies pay cash to their shareholders?

Answer 1

Paying a dividend

Buying back some of the company’s stock (repurchase)

Question 2

How do firms pay dividends?

Answer 2

• Board of directors sets dividend
• They make an announcement that a payment will be made to all stockholders at a particular recored date
• On day before record date, stocks trade ex-dividend, I.e., price falls by amount of dividend
• Dividend cheques are mailed to registered shareholders

Question 3

Regular Cash Dividend

Answer 3

The dividend paid to each shareholder every quarter

Question 4

Special Cash Dividend

Answer 4

A one-off supplement to the regular dividend

Question 5

Automatic Dividend Reinvestment Plans (DRIPs)

Answer 5

Sometimes offered to stockholders

New shares issued at discount from market price

Question 6

Stock Dividends

Answer 6

Issue of additional shares to stockholders

Question 7

How do firms repurchase stocks?

Answer 7

• Buying shares on the market
• ‘Tender’ offer to shareholders
• ‘Dutch’ action
• Private negotiation

Question 8

Why is the announcement of a dividend increase good news for investors?

Answer 8

• Signals managers’ confidence in future profits

- Predicts safer earnings

Question 9

What do repurchases signal about managers?

Answer 9

It signals that managers are:

• Not wasting resources on perks, empire building
• Confident about the firm’s future prospects and that the company’s stock is currently undervalued

Question 10

Payout Policy Irrelevance

Answer 10

If markets are efficient, firm’s payout policy leaves the total value of the firm unaffected. The wealth of shareholders unaffected

Shareholders should be indifferent to payout policy

Question 11

Does it matter to old shareholders that they receive an extra dividend and an offsetting capital loss?

Answer 11

As long as capital markets are efficient:

• old stockholders/investors do not need dividends to convert shares into cash;
• they can raise the cash by selling their own shares.

Therefore, old shareholders can cash in either:

• by persuading the management to pay higher dividend;
• or by selling some of their shares.

→ In either case, there will be a transfer of value from old to new shareholders

Question 12

When does the Miller-Modigliani proposition break? Rightist

Answer 12

• Inefficient market
• Transaction costs
• ‘Free’ cash flow

Question 13

When does the Miller-Modigliani proposition break? Leftist

Answer 13

Taxation

• normally dividends are taxed more heavily than capital gains
  
  • Pay lowest cash dividend they can get away with
  • Shareholders should prefer stock repurchasing
  • Lower taxes should be welcomed by any tax-paying investor