Payout Policy

Question 1

What does payout policy include?

Answer 1

• Dividends

- Share repurchases

Question 2

MM Irrelevance Proposition

Answer 2

In a world with perfect capital markets, payout policy is irrelevant

Question 3

What are the two Intuitions for this Proposition?

Answer 3

1. ) Firm’s value is just the sum of the NPV of all its projects - SHs don’t care how they get their cash as long as they get it
2. ) If a company’s investment policy is unaffected by dividend policy, then dividend policy has no impact on the value of the firm

Question 4

Dividends are reported in 3 equivalent ways: name them

Answer 4

1. ) Dividend per Share
2. ) Dividend Yield = DPS/Share Price
3. ) Payout Ratio = DPS/EPS

Question 5

What are the three methods of share repurchases?

Answer 5

1. ) Open-Market Repurchase
2. ) Fixed-Price Tender Offer
3. ) Dutch Auction Tender Offer

Question 6

What is an open-market repurchase?

Answer 6

• Firm announces plan to repurchase number of share over time period
• Most common method of share repurchase; price increases 2-3%

Question 7

What is a fixed price tender offer?

Answer 7

• firm offers to buy a specified number of shares at a fixed price during a specified period of time
• Pro Rata basis if more than maximum number of shares are tendered
• Typical premium 20% over market and stock rises 11% when announced

–Good for signaling

Question 8

What is a dutch auction tender offer?

Answer 8

• Company specifies number of shares it wants to buy and the price range for shareholders bids
• Repurchase price is the lowest price that allows the firm to acquire the number of shares
• Stock prices increase on average 8%

Question 9

What do companies generally do for payout policy?

Answer 9

• Few companies have fixed/stable dividend payout ratio
• Mgrs avoid increasing dividends if there is a possibility that the decision will need to be reversed.
• as a result, dividend changes are smaller than the change implied by the dynamics of earnings; managers smooth dividends

Question 10

What are the possible determinants of payout policies?

Answer 10

1. ) Transaction costs
   - - paying high dividend reduces transaction costs of creating home made dividends; unclear whether this has relevant impact
2. ) Taxes
   - Tax advantage for share repurchases => creates Tax Clienteles
3. ) Signalling
   - Dividends provide information to capital markets; won’t increase dividends until future earnings are sustainable
4. ) Agency Theory/Other
   - Dividend payments control management; tax costs of holding cash; costs of financial distress

Question 11

Which method is more efficient as Signaling Device?

Answer 11

–Diviends; require commitment for the future;

Share repurchases - strongest signal in fixed price tender, than dutch auction than open market share repurchase

Question 12

Since dividends are tax efficient, firms should only use share repurchases, right?

Answer 12

No, you fucking idiot. Firms are prohibited from using share repurchases as a sub for dividend payments; they will be taxed as though they are dividends;

legally, share repurchases should only be used to distribute extra cash flow

Question 13

What are two other effects of share repurchases?

Answer 13

Concentration of Ownership and Protection against Hostile Takeovers

Question 14

What type if investors do high dividend yields attract? Low?

Answer 14

High = institutional, low tax bracket individuals

Low = high tax bracket individuals

Question 15

what is an imputation tax system?

Answer 15

part of the corporate level tax is used as a prepayment of personal income tax = reduces the tax burden that arises from double taxation

tax at the personal level = personal tax rate -imputed tax rate (limited to 0)