Payout Policy

Question 1

What is the process for paying dividends?

Answer 1

Declaration date - date on which the board of directors announces the dividend, including the amount per share, the record date, and the payment date.

Ex-Dividend date - cutoff date. To receive the dividend, shareholders must own the stock before this date.

Record Date - The date on which the company reviews its shareholder records to determine who is eligible to receive the dividend.

Payment date - The date on which the dividend is actually paid to the shareholders, either by electronic transfer or mailed checks.

Question 2

What types of dividends can firms pay?

Answer 2

Cash Dividends: Payments made in cash to shareholders.

Stock Dividends: Additional shares of the company given to shareholders instead of cash.

Special Dividends: One-time payments often made in exceptional circumstances.

Preferred Dividends: Fixed dividends paid to preferred shareholders before any dividends are paid to common shareholders.

Dividend Reinvestment Plans (DRIPs): sometimes new shares issued at discount from market price offered to stockholders.

Question 3

What ways do firms repurchase stock?

Answer 3

Instead of paying dividend firm can repurchase stock instead. This can be done by:

1) Open Market Repurchase
2) Tender Offer
3) Direct Negotiation
4) Dutch Auction

Question 4

What is a Dutch auction?

Answer 4

Shareholders submit bids indicating the number of shares they want to sell and the price they are willing to accept. The company then buys back shares at the lowest price within the range that allows it to purchase the desired number of shares.

This method allows the company to potentially buy back shares at a lower average price.

Question 5

What is a tender offer?

Answer 5

The company makes a public offer to shareholders to sell their shares at a specified price, usually higher than the market price. (premium)

The offer is open for a fixed period, and shareholders can decide whether to sell their shares back to the company.

Question 6

What is an open market repurchase?

Answer 6

The firm sets up a repurchase program and buys shares over time at the market price.

Companies must follow rules set by regulators, such as the SEC in the U.S.

Question 7

What does news of increase in dividends mean for investors?

Answer 7

Signals managers confidence in future profits. If they thought temporary they would be cautious to commit to increasing payout.

Predicts safer earnings, managers are less likely to increase payout when cash flows are uncertain and volatile.

Dividend increase causes share price increase, vice versa. But not all dividend cuts are bad news.

Question 8

What does a repurchase stock announcement mean for investors?

Answer 8

Less strongly correlated than announcement of dividend change.

Signals:
1) not wasting resources on perks or poor investment decisions.
2) Confident about firms future and that stock is undervalued.

Implies stock repurchasing positive correlation with share price.

Question 9

How does Payout policies affect stock value of firm?

Answer 9

Lots of time its not the payout policy itself but the information it signals that causes a change in stock value, e.g. announcement of increasing dividends or announcement of repurchasing stocks.

Question 10

What is the Miller-Modigiliani theorem?

Answer 10

The value of a company is based on its future earnings while its capital structure is irrelevant.

Proof that dividend policy value is irrelevant in a perfect market without taxes and transactions costs. This is because investors don’t need dividends to convert their shares into cash so they will not pay higher prices for firms with higher dividend payouts.

Question 11

What are the three opposing views on the effect of payout policy on shareholder value?

Answer 11

Dividends are preferred, repurchasing is preferred, MM: payout policy is irrelevant.

Question 12

Why do some investors prefer dividends and what is one criticism of dividends?

Answer 12

Dividends provide regular certain income and signal financial health.

Criticism is that they are often less tax efficient to repurchasing leading to higher tax on shareholders.

Question 13

What is Payout policy irrelevance?

Answer 13

If markets are efficient firms payout policy leaves total value of firm unaffected. The wealth of shareholders unaffected.

Implies shareholders should be indifferent to payout policy.

This was proved by Miller-Modigliani theorem.

Question 14

How can share repurchases signal management’s view on the company’s stock?

Answer 14

Repurchases can signal that management believes the company’s stock is undervalued, potentially boosting investor confidence and stock price.

Question 15

What is a potential downside of share repurchases?

Answer 15

They may reflect a short-term focus and can deplete cash reserves, potentially compromising the company’s financial stability.

Question 16

Why might different investors have different preferences for dividends vs. repurchases?

Answer 16

Different investors may have varying needs, such as seeking regular income (dividends) or preferring tax efficiency and flexibility (repurchases).

Question 17

According to the MM theorem, how can investors manage their own cash flow needs regardless of the company’s payout policy?

Answer 17

Investors can create “homemade dividends” by selling shares if they need cash, making the company’s payout policy irrelevant to their wealth.

Question 18

How do transaction costs challenge the MM theorem?

Answer 18

Transaction costs: In the real world, buying and selling shares incurs costs, making it expensive for investors to create “homemade dividends” and thus affecting their preference for dividends or repurchases.

Question 19

What role does asymmetric information play in challenging the MM theorem?

Answer 19

Asymmetric information: Investors and managers often have different information, which can lead to signaling effects where dividends or repurchases convey information about a company’s financial health.

Question 20

What is the impact of agency costs on the MM theorem?

Answer 20

Agency costs: Conflicts between managers and shareholders can influence payout policy, with managers potentially preferring policies that benefit themselves rather than maximising shareholder value.

Question 21

According to MM, what should firms focus on to increase valuation?

Answer 21

Firms should focus on investing in positive net present value (NPV) projects to increase valuation, as investment decisions are the primary driver of firm value according to MM.