payout policy Flashcards
1
Q
companies that distribute cash to their shareholders do so in 2 main ways?
A
- paying dividends
- repurchasing shares
2
Q
what 2 questions does the payout policy involve?
A
- how much cash, if any, to pay to shareholders
- the form of payment needs to be decided i.e. should the company pay dividends or repurchase shares?
3
Q
decisions on a company’s payout policy should be consistent with?
A
the company’s overall objective to maximise shareholders’ wealth
4
Q
how often do australian companies make dividend payments?
A
Companies in Australia typically make two dividend payments each year
5
Q
business decisions include
what is dividend policy?
A
investment, financing and dividend
dividend policy –> Determining how much of a company’s profit is to be paid to shareholders as dividends and how much is to be retained
6
Q
payout policy tree diagram
A
7
Q
who is responsible for the company’s dividend decisions
A
Provided that the legal requirements and the exchange’s listing requirements are met, a company’s dividend decisions are at the discretion of its directors.
8
Q
when do companies in Australia pay dividend?
A
In Australia, companies generally pay an interim dividend after the end of the first half of the financial year and a final dividend after the company’s Annual General Meeting.
9
Q
important dates for dividend
A
10
Q
what is the record date?
A
A company’s Board of Directors, when announcing a dividend, specific a ‘record date’.
- This is the day which the company’s ‘books’ will close for the purpose of determining who is currently a shareholder, and hence entitled to receive the dividend.
11
Q
what is the ex-dividend date?
A
For shares listed on the Australian Securities Exchange (ASX), the rules of the exchange specify an ex-dividend date, which is 4 days before the dividend’s record date
- date on which a share begins trading ex-dividend. a person who purchases on or after the ex-dividend date will not be eligible to receive dividends
12
Q
investors who purchase their shares before the ex-dividend date,
A
buy the shares cum-dividend and are entitled to receive the dividend.
13
Q
why is that those who purchases the shares ex-dividend are not elibible to receive the dividend?
A
it takes 3 days to be registered when purchasing a share
14
Q
what is a franked dividend?
A
dividend paid out of Australian company profits on which company income tax has been paid and which carries a franking credit
15
Q
When a dividend is declared, the company must state
A
the extent to which the dividend is franked. When a dividend is paid, the company is required to provide each shareholder with a dividend statement.
16
Q
what does the dividend statement contain?
A
This statement shows the
- amount of the dividend and the date of payment
- the amount of any franked and unfranked parts of the dividend
- if the dividend is fully or partially franked, the amount of the franking credit.
17
Q
what is repurchasing shares an alternative way of?
A
distributing cash to shareholders
18
Q
what is the payable date?
A
aka Distribution Date
A date, generally within a month after the record date, on which a firm mails dividend checks to its registered stockholders
19
Q
A company purchases its own shares on the stock market and then proceeds to
A
nto either cancel them (Australia) or retain them as treasury stock (US).
20
Q
legal requirements regarding buybacks
what is the general rule and what is the exception to sharebuybacks?
A
s. 259A of the Corporations Act generally precludes a company from purchasing its own shares.
Exceptions were introduced in 1989 and later revised in 1995
21
Q
legal rquirements regarding buybacks
how much can the company repurchase?
A
general companies are able to repurchase up to 10 per cent of their ordinary shares in a 12-month period
22
Q
share repurchases
what happens once the transfer of ownership has been processed
A
In each case, once the transfer of ownership has been processed the shares must be cancelled.
23
Q
is payout policy important to shareholders?
in many cases, a payment is inappropiate b/c
A
the company has attractive investment opportunities and shareholders are expected to receive a greater benefit if the company’s cash is used to take up these opportunities instead of paying it out now.
24
Q
is payout policy important to shareholders?
3 payout/dividend policies that might be adopted
A
- Residual dividend policy
- Smoothed dividend policy
- Constant payout policy
25
is payout policy important to shareholders?
what is residual dividend policy?
* pay out as dividends any profits that, in the opinion of management, cannot be invested profitably
26
is payout policy important to shareholders?
what is smoothed dividend policy?
* management sets a target dividend-payout ratio
* the target aims for dividends to equal the long-run difference between expected profits and expected investment needs
* The amount of each dividend is changed only when this long-run difference changes
27
is payout policy important to shareholders?
what is the dividend payout ratio?
target proportion of annual profits to be paid out as dividend.
28
is payout policy important to shareholders?
Smoothed dividend policy
give an example of how the dividend changes when the long run difference changes
* the dividend per share will be increased if there is an increase in profit that is regarded as sustainable, but it will not be changed in response to fluctuations in profit that are believed to be only temporary.
* Similarly, if profit falls, the dividend per share will be maintained unless the outlook for profits is so poor that the current dividend level is considered to be unsustainable.
29
what is the constant payout policy?
the dividend-payout ratio remains essentially the same each year (if managers are concerned to avoiding fluctuations in payout ratio)
30
the irrelevance of payout policy
Modigliani and Miller (MM) (1961) argued
that a company's dividend policy has no effect on shareholders' wealth was
31
the irrelevance of payout policy
Modigliani and Miller (MM) (1961) aruged that a company's dividend policy has no effect on shareholders' wealth
Their analysis demonstrated the irrelevance of dividend policy under the following assumptions:
1. The company has a given investment plan, and has determined how much of the assets to be acquired will be financed by borrowing.
2. There is a perfectly competitive capital market, with no taxes, transaction costs, flotation costs or information costs.
3. investors are rational so they always prefer more wealth to less and are equally satisfied with a given increase in wealth
4. investors are indifferent between receiving dividends or capital gains (increase in value of the shares they hold)
32
the irrelevance of payout policy
suppose that a company is to increase its dividend payment
To define dividend policy, suppose that a company is to increase its dividend payment.
* With the investment plan and the borrowing decision fixed, the extra funds used to pay the higher dividend can be replaced from only one source: a new share issue.
33
the irrelevance of payout policy
suppose that a company is to reduce its dividend payment
To define dividend policy, suppose that a company is to reduce its dividend payment.
* there is only one way that the surplus cash can be used—that is, to repurchase some shares
34
irrelevance of dividend policy
as illustrated by increasing/reducing dividends in the MM framework, the dividend policy involves
* in the MM framework,dividend policy involves a trade-off between higher or lower dividends and issuing or repurchasing ordinary shares.
* Using this approach, MM proved that dividend policy is irrelevant to shareholders' wealth
35
irrelevance of dividend policy
Essentially, MM's argument is that
the value of a company depends only on its investments - the earning power of its assets
36
irreleavance of dividend policy
essentially, mm's argument is that the value of company depends only on its investments
MM: Company issue new shares to pay dividends.
For old shareholders, increase in dividend = decline in per share value as future dividend is diverted to new shareholders
37
irrelevance of dividend payout policy
what happens when the investor does not want cash?
If dividends gets paid and the investor does not want the cash, they can reinvest dividends into new shares.
38
irrelevance of dividend payout policy
In perfect capital markets, investors can either
nreinvest dividends (to buy shares) or sell shares (to receive cash)
they can replicate either payout method on their own.
Thus, dividend policy does not matter for a firm.
39
irrelevance of dividend
give an example
The $15 000 cash has been reserved for an investment opportunity that has not yet been taken up. Suppose that management decides instead to use the cash to pay a dividend of $15 000, and then issues more shares to new shareholders to replace the cash and proceed with the new investment. What is the effect of these transactions on the value of the existing shares and shareholders' wealth?
the original shareholders have?
The original shareholders have suffered a capital loss of $15 000, exactly offsetting the dividend of $15 000, which is now cash in their hands.
* By having the ABC Company pay a dividend, its original shareholders have converted part of their stake in the company into cash of $15 000.
* Since the stake transferred to the new shareholders is also worth $15 000, the net change in the wealth of the original shareholders is zero.
40
irrelevance of payout policy
Paying a dividend and then issuing new shares to replace the cash paid out involves
Paying a dividend and then issuing new shares to replace the cash paid out involves a transfer of ownership between the ‘old’ and ‘new’ shareholders.
* Provided the terms of this transfer are fair, neither party gains nor loses—that is, the new shareholders receive shares that are worth the price paid for them and, for each dollar they receive in dividends, the old shareholders give up future dividends with a present value of $1, which reduces the value of their shares by $1.
41
why may dividends be a better way of reducing agency costs than share repurchases
both share repurchases and paying dividends can reduce agency costs of free cash flows, but paying dividends is better b/c it represents a stronger commitment to continuing to pay out cash
42
repurchasing shares
what is an open market repurchase
¡When a firm repurchases shares by buying shares in the open market
¡Open market share repurchases represent about 95% of all repurchase transactions.
43
repurchasing shares (open) market
describe tender offer
* A public announcement of an offer to all existing security holders to buy back a specified amount of outstanding securities at a pre-specified price (typically set at a 10%-20% premium to the current market price) over a pre-specified period of time (usually about 20 days
44
repurchasing shares (open) market
what happens when shareholders do not tender enough shares
If shareholders do not tender enough shares, the firm may cancel the offer and no buyback occurs.
45
repurchasing shares
what is a targeted repurchase
¡When a firm purchases shares directly from a
specific shareholder
46
repurchasing shares
targeted repurchase
what is greenmail
nWhen 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 premium over the current market price
47
Institutional Features of Dividends
list the 3 dividend types
1. cash dividend
2. stock dividend
3. special dividend
48
what is a stock dividend
¡Equivalent to a stock split
¡When a company issues a dividend in shares of stock rather than cash to its shareholders
49
what is a special dividend
A one-time dividend payment a firm makes, which is usually much larger than a regular dividend
50
Why repurchase shares?
1. dividend substitution
2. improved EPS
3. tax reasons why companies might prefer to pay dividends over repurchases, or vice versa
51
why repurchase shares?
describe dividend substitution
share repurchases have been substituted for dividends
52
A rapid growth of repurchases in Australia:
$770m in the 1995 financial year, up to $16b in 2010, but then declined to $13b in 2011 and $8.6b in 2012.
53
describe growth of share repurchases in the US
nIn 1999 and 2000, US industrial companies distributed more cash to shareholders through share repurchases than dividends.
54
describe the classical tax system
tax system that operates in the US and which operated in Australia until 30 June 1987; under this system company profits, and dividends paid from those profits, are taxed separately—that is, profit paid as a dividend is effectively taxed twice
55
In Australia, a classical tax system operated until
1 July 1987, when an imputation system was introduced.
56
australia uses an imputation tax system
as of 2010,
as of 2010, t0 = 30%
57
under the imputation tax system, what does the shareholder receive
* The shareholder receives a tax credit equal to the franking credit.
* The credit can be used to offset tax liabilities associated with any other form of income.
* The tax credit cannot be carried forward but excess or unused tax credits are refunded as of July 2000
58
Imputation and Dividend Policy (cont..)
how will this benefit resident investors?
1. The franking credits attached to franked dividends can be used to reduce investors’ personal tax liabilities
2. Since the alternative to dividends is capital gains, which are subject to company tax and CGT, higher dividends will mean that less CGT is payable by investors.
* If all franking credits are not paid out, the credits that are retained are potentially wasted as they have no value except when accompanying dividend payments. (At best, their value is discounted if they are used to offer franking credits on future dividends.)
59
what is the imputation tax system?
* system under which resident shareholders can use tax credits associated with franked dividends to offset their personal income tax. The system eliminates the double taxation inherent in the classical tax system
* resident shareholders are given a credit for the Australian income tax paid by a company on its taxable income.
60
what did the imputation tax system intend to do?
to eliminate the double taxation of company profits in the classical tax system
61
describe income company tax in the imputation tax system
* at the current company income tax rate of 30 cents in the dollar, $100 of company profit will result in $30 being paid in company tax. It is critical to understand that this amount of $30 is therefore both profit earned by the company and company tax paid.
* The imputation system recognises this dual nature by adding $30 to the shareholder's income and also giving shareholders credit for $30 of tax paid.
62
imputation tax system
if company income tax is 30c and company earns $100 profit where $30 is paid as company tax, what happens to franked dividends
* maximum franked dividend that could be paid is $70.
* Each dollar of franked dividend carries a franking credit equal to tc/(1 − tc).
* Therefore, a franked dividend of $70 will carry a franking credit of $70 × 0.30/(1 − 0.30) = $30.
* Shareholders who receive a franked dividend of $70 will include in their taxable income both the dividend received ($70) and the franking credit ($30). The shareholders' taxable income is thus $100.
63
when can a shareholder use credits to offset their personal liabilities?
shareholders are unable to use tax credits until franked dividends are paid
64
imputation and capital gains tax
how does payment of dividends affect shares and capital gains?
what if the company retains profits?
payment of dividends reduces the value of the share
reduces the potential for shareholders' to incur capital gains tax
by retaining profits, the prices of shares are likely to rise relative to companies that distribute their profits --\> giving ries to capital gains tax when shareholders' sell their share
65
In Australia, capital gains tax applies only to
gains on assets acquired on or after 20 September 1985, and is payable only when gains have been realised.
66
As of 21 September 1999, how is capital gains tax calculated on assets?
provided that the asset has been held for at least 12 months, the maximum rate of capital gains tax for an individual will be half the marginal tax rate on the individual's ‘ordinary’ income.
* for individuals, only 50% of the gain is taxed at their personal marginal tax rate
* capital gains earned over 12 months or longer are subject to CGT discounting.
67
describe the relationship between time value of money and capital gains tax
The time value of money means that the present value of any capital gains tax payable is lower, the longer that realisation of gains is delayed.
*
68
In the case of superannuation funds, the maximum rate of capital gains tax on long-term gains is
10 per cent compared with their normal income tax rate of 15 per cent.
69
describe why may an investor choose a different time to realize their capital gains?
investors are able to choose the time at which assets are sold and may therefore be able to realise gains at times when their marginal tax rate is low.
70
describe relationship between retaining profits and capital gain tax
retention of profits can involve double taxation: company income tax plus capital gains tax.
profits retained have alrady been taxed, any capital gains tax that is payable will be in addition to the tax already paid by the company.
71
Future capital gains tax can be reduced by the
payment of dividends, regardless of whether the dividend is franked or unfranked.
72
what do investors have a tax based preference for?
many investors will also have a tax-based preference for franked dividends rather than capital gains arising from retention of taxed profits.
73
effect of tax imputation system
on capital gains of resident individuals
assets acquired after 19 september 1985 are subject to capital gains tax
on or after 21 September 1999, the amount of capital gains realised on an asset held for at least 12 months maybe discounted by 50%
74
effect of tax imputation system
on capital gains of superannuation funds
from 21 September 1999, a 33.33% is allowed for capital gains realised on assets held for at least 12 months
75
effect of tax imputation system
on capital gains of non-resident individuals
from 21 september 1999, if the investor owns less than 10% of the shares in a resident company, they are exempt from capital gains tax
76
what does the imputation tax system effectively show?
it shows company profits paid out as franked dividends are effectively taxed once at the shareholder's marginal tax rate.
77
what is the alternative to paying dividends? what is this subject to?
retention of profits
this can involve double taxation: income tax paid by the company plus capital gains tax paid by the shareholder.
78
what does the imputation system favour?
the distribution of profits instead of retaining profits
retaining profits results to higher amount of capital gains tax paid --\> shareholder's after-tax income is lower
79
what does the imputation system favour?
what about long term capital gains?
ong-term capital gains are taxed at lower rates than ordinary income reduces the incentive for distribution and for some investors the effective rate of capital gains tax may be so low that they would prefer retention of profits
80
Overall, the combination of the imputation system and capital gains tax means that
investors could differ in their preferences for dividend income and capital gains: shareholders with low (high) marginal tax rates will tend to prefer companies that pay dividends (retain profits).
81
the imputation system creates an incentive to
to distribute profits as dividends—but only to the extent that the dividends can be franked. Where a company has profits that could be distributed as unfranked dividends, many investors will prefer that these profits be retained.
82
Many Australian companies have significant operations offshore.
what does this mean
* Profits that are earned and taxed outside Australia cannot be paid to investors as franked dividend
* s. Any dividends from these profits will be unfranked and therefore subject to tax at the shareholders' marginal income tax rate
83
Shareholders who are taxed at the same rate on ordinary income and capital gains
what will they prefer?
Do they have a tax-based preference for retention of profits or unfranked dividends
indifferent between payment of unfranked dividends and retention of profits.
- more likely for investors who hold onto shares for less than 12 months
84
Shareholders who are taxed at a lower rate on capital gains than on ordinary income.
what will they prefer?
Do they have a tax-based preference for retention of profits or unfranked dividends
prefer retention of profits rather than payment of unfranked dividends.
- more likely for investors who hold on shares for more than 12 months
85
Shareholders who are taxed at a higher rate on capital gains than on ordinary income.
what will they prefer?
Do they have a tax-based preference for retention of profits or unfranked dividends
prefer all profits to be distributed.
few investors fall in this
86
If all company shares were held by resident investors with marginal tax rates less than company tax rates, what is the optimal dividend policy
nthe optimal dividend policy for an Australian company is one that at least pays dividends to the limit of its franking account balance.
87
what is the argument against the imputation tax system?
Commonwealth Treasury and others proposing abolish the dividend imputation system.
The argument was that:
- It provides little benefit to non-residents; and
- It reduces government revenues.
88
Dividends versus Share Repurchase under Personal Taxes
\When personal tax payable on dividends is less than the personal tax payable on capital gains, shareholders will pay lower taxes if a firm uses dividends for all payouts rather than share purchases.
the optimal dividend policy is to structure all payouts as dividends, vice versa
89
Dividend policy can be relevant for non-tax reasons
Corporations signal to the market using payout policy
Also related to agency cost and corporate governance
90
Signalling with Payout Policy
Dividend signalling hypothesis:
the idea that dividend changes reflect managers’ views about a firm’s future earnings prospects.
91
Signalling with Payout Policy
Dividend signalling hypothesis:
what happens when a firm increases its dividends
¡When a firm increases its dividend, it sends a positive signal to investors that management expects to be able to afford the higher dividend for the foreseeable future.
92
Signalling with Payout Policy
Dividend signalling hypothesis:
what happens when a firm cuts its dividends
When managers cut the dividend, it may signal that they have given up hope that earnings will rebound in the near-term and so need to reduce the dividend to save cash
93
Signalling with Payout Policy
how can share purchases signal managers' info to the market?
Share repurchases are a signal that the shares are under-priced, because if they are overpriced a share repurchase is costly for current shareholders.
94
signally without payout policy
what is there empirical evidence of?
that announcements of large increases in dividends are often followed immediately by increases in share prices, and that reductions in dividends can result in decreases in share prices
95
signalling with payouts
why does the payout policy matter?
that the share market places a value on dividends—because investors value securities only for the payouts they are expected to provide
* higher (lower) share prices follow the announcement of higher (lower) payouts.
96
why may management deliberately use dividend policy to signal information to investors
Dividends may provide a credible signal about a company's value because the payment of dividends is evidence that the company
1. generates sufficient cash to be able to pay dividends
2. provides information on management's expectations as to the company's future profitability
instead of releasing a statement about the success of their new product, which may not be believed
97
agency costs and corporate governance
what are agency costs
separation of ownership and control of companies, there can be conflicts of interest between shareholders and managers
98
agency costs and corporate governance
what have various authors argued?
higher dividends can reduce agency costs
99
how can agency costs be reduced by higher dividends
if a firm need to raise more capital, increasing dividends:
1. Improves accountability to market.
2. Increases provision of information.
3. Increases monitoring of managers.
4. Managers more likely to act in interests of s/h.
100
describe how higher dividends can reduce agency costs in terms of capital raising
higher dividends will force a company to raise capital externally more frequently --\> more information is provided to investors underwriters and other capital market agents, particularly potential new investors --\> existing shareholders can monitor the performance of the managers --\> likely to act in shareholders' interests
101
agency costs and corporate governance
describe how the country's legal system can reduce agency costs
1. countries where investors’ interests are less well protected, dividends are likely to be a mechanism to reduce agency costs.
2. in countries where investors’ interests are well protected legally, high-growth companies pay lower dividends.
102
agency costs and corporate governance
describe what dividends may be a substitute for?
dividends can substitute for legal protection of shareholders
103
agency costs and corporate governance
why may dividends be a substitute for legal protection of shareholders?
insiders, who are interested in raising equity in the future, pay dividends to establish a reputation for favourable treatment of outside shareholders
104
agency costs and corporate governance
dividends can be a substitute for legal protection of shareholders
when is this most valued?
A good reputation will be of greatest value in countries where legal protection of minority shareholders is weak and such shareholders have little to rely on apart from a company's reputation.
105
agency costs and corporate governance
dividend payouts should be higher in \_\_\_
why?
dividend payouts should be higher in countries where legal protection of investors is weak.
because shareholders are well protected legally are prepared to wait for dividends provided that a company has good investment opportunities.
106
agency costs and corporate governance
Companies operating in countries where legal protection of investors is better
Companies operating in countries where legal protection of investors is better, pay higher dividends. There is a relationship between growth and dividends
Companies that are growing more rapidly, as measured by growth in sales, pay lower dividends than slow-growth companies.
107
Firm life cycle and payout policy
who and what did DeAngelo-DeAngelo (2006, 2007) challenge?
nDeAngelo-DeAngelo (2006, 2007) challenge the foundational bedrock of modern corporate finance theory (MM), by arguing that there is a “life cycle” of payout.
108
Firm life cycle and payout policy
## Footnote
nDeAngelo-DeAngelo (2006, 2007) challenge the foundational bedrock of modern corporate finance theory (MM), by arguing that there is a “life cycle” of payout.
describe
¡Trade-off between benefits and costs of retaining cash at different stage of the firm
109
Firm life cycle and payout policy
## Footnote
nDeAngelo-DeAngelo (2006, 2007) challenge the foundational bedrock of modern corporate finance theory (MM), by arguing that there is a “life cycle” of payout.
what happens at each stage
1. Start-up stage (no dividend)
2. Rapid growth (modest dividend to establish a track record)
3. Mature (dividend payout becomes important due to agency problem and NPV projects are harder to find)
* Cash payout typically increases as a firm matures and its investment shrinks
110
dividends tend to be paid at what stage and why?
Dividends tend to be paid by mature companies whose retained earnings far exceed their contributed equity, and not by early-stage companies, which are largely financed by capital infusions.
111
do dividends help to forecast future ownings?
changes in dividends are of little if any help in forecasting future earnings.
112
what does the signally theory predict?
a company will pay dividends when outside investors find it particularly difficult to assess the company's prospects
113
at what stage of the business life cycle may the signally theory be most useful?
young, small companies with good growth prospects that are not fully recognised by investors
- in reality, few of these companies pay dividends
114
even though signally theory i.e. paying dividends is most useful for small, young companies, when are dividends actually paid?
large, profitable, mature companies that have less information asymmetry than smaller ‘growth’ companies.
115
why may payment of dividends not be practical during the start up stage?
a new business with good growth prospects is started, capital requirements will generally be large and access to the capital markets will be restricted because outsiders know little about the company. Therefore, payment of dividends is usually not practical at this stage
116
what happens in the rapid growth stage?
rapid growth is experienced their more external funds need to be raised by borrowing and by making share issues
* modest dividends to establish a track record of payouts and to increase its appeal to institutional investors,
117
what happens during the maturity stage
1. positive NPV projects are harder to find
2. diluted ownership from raising equity capital --\> agency costs
3. ample amounts of cash generated --\> should be paid out through dividends and share buybacks unless it can be invested profitably by the company.
118
why is payment to shareholders important during the maturity stage?
the agency costs of free cash flow would be large if they allowed large amounts of cash to accumulate within the company.
119
Market reaction to Telstra’s announcement on distributing free-cash flow to S/H
describe
In June 2004, Telstra declared a payout of 80% of normal profits to its shareholders
-Return $1.5B through special dividends and/or share buyback
120
Market reaction to Telstra’s announcement on distributing free-cash flow to S/H
what happened to share prices
share price jumped by 4.6%.
* Due to reduction in agency cost
* 80% payout as opposed to 60% payout emits a good signal to the market
121
what are franking credits?
The tax paid by the company is passed on to shareholders by way of franking credits attached to the dividends they receive.
shareholders are also entitled to company tax paid
shareholders taxable income = franked dividends + franking credits
122
what is a franked dividend
franking credits are attached to these dividends (fully or partly)
123
what is an unfranked dividend
no franking credits are attached
124
can a non-australian resident use franking credit?
No, they cannot use franking credit attached to franked dividends to reduce the amount of tax payable on other Australian income
125
benefits of franking credits
can be used to reduce income tax paid on dividends
126
An investor who buys Dribnor shares just before they go ex-dividend will pay a price that reflects
the value of the company based on its expected future cash flows, plus the current dividend.
127
. An investor who buys immediately after the shares trade ex-dividend will pay a price that reflects
expected future cash flows, but not the current dividend.
128
Dividend reinvestment plan
a plan that allows shareholders to use their cash dividends to purchase additional newly-issued shares.
129
Full payout policy
policy of distributing the full present value of free cash flows to shareholders.
130
Progressive dividend policy:
policy where the aim is to steadily increase dividends over time as profits increase. In the event of a fall in profit the dividend would be maintained rather than reduced.
131
Dividend clienteles are likely to develop because
because a company’s payout policy suits the tax position and/or consumption needs of particular investors.
132
, if dividends are unfranked they will be taxed at
the same rate as short-term capital gains, while long-term capital gains will be taxed at much lower rates
133
when will residents prefer for the company to pay dividends?
only to the extent they can be franked.
134
what kind of payout policy do non-residents prefer?
Non-resident investors do not benefit directly from the dividend imputation system, and they would generally prefer capital gains to dividends, even if dividends were franked
135
. If a company has additional cash to distribute, resident investors will generally prefer
that it be distributed via share buy-backs that allow investors to receive returns as capital gains
136
Is maximising the payout of franked dividends an optimal dividend policy for all Australian companies
why?
Not necessarily
* Companies should also pay attention to non-resident investors who do not benefit directly from tax credits.
* The possibility of distributing additional cash through buying back shares should also be considered.
* For other companies, ***the amount of cash available for dividends may serve as a constraint on payment of cash dividends***, but any such constraint may be addressed by introducing a dividend reinvestment plan.
137
when may a dividend reinvestment plan be used?
when company has insufficient cash to distribute as dividends
138
Explain the likely effects on dividend-payout ratios of each of the following:
The imputation tax system is modified to allow investors only partial (50 per cent) credit for company tax paid.
The demand for dividends would fall, and dividend payout ratios could be expected to fall.
139
Explain the likely effects on dividend-payout ratios of each of the following:
Personal income (but not capital gains) tax rates are increased.
The demand for dividends would fall, and dividend payout ratios could be expected to fall.
140
Explain the likely effects on dividend-payout ratios of each of the following:
Capital gains tax is abolished.
Retention of profits would become more attractive and dividend payout ratios should fall.
141
Explain the likely effects on dividend-payout ratios of each of the following:
Interest rates increase substantially.
Profits would be expected to fall, but dividends are likely to be maintained so that payout ratios would increase
142
Explain the likely effects on dividend-payout ratios of each of the following:
Company profitability increases.
Dividends are likely to be increased, but the rate of increase would generally be lower than the rate of increase in profits. Therefore, dividend payout ratios would fall.
143
Explain the likely effects on dividend-payout ratios of each of the following:
Prospectus requirements are tightened, increasing the costs of share issues.
(f) The higher costs of raising capital by issuing shares would make retention of profits more attractive. Therefore, dividend payout ratios would be expected to fall.
144
difference between short-term and long-term capital gains tax
Short-term capital gains are taxed at income tax ratesl
long-term capital gains are taxed at much lower rates
145
when is person tax collected under the imputation tax system
at the company level
146
Usually the Board of Directors increases dividend per share only slowly in response to rising profits, and is even more reluctant to decrease dividend per share than to increase it.
Give reasons for this behaviour pattern
the empirical evidence suggests that investors derive information from an announcement of a change in dividends.
a decrease in dividends seems to **have a greater effect on share price** than an increase in dividends.
147
what effects will this have on the company's dividend policy?
The company issues cumulative preference shares carrying an entitlement to fully franked dividends.
ordinary dividends will be partially franked or, possibly, unfranked.
148
what effects will this have on the company's dividend policy?
The company receives a large unexpected fully franked dividend from another company.
pass the franking credits on to its own shareholders by paying a higher franked dividend.
Part of the dividend might be designated as ‘special’ to indicate that investors should not expect the higher dividend to be permanent.
149
what effects will this have on the company's dividend policy?
Owing to continued losses, retained profits have been reduced to almost zero.
Until the company returns to profitability, no more dividends should be paid because, legally, dividends can be paid only from profits.
150
what effects will this have on the company's dividend policy?
## Footnote
A large US investor recently acquired 40 per cent of the company's shares.
US investor will be unable to use franking credits.
To minimise the wasted tax credits, **the company might issue converting preference shares with an entitlement to fully franked dividends**. The US investor would be expected to sell their rights to the preference shares to Australian resident investors.
151
what effects will this have on the company's dividend policy?
## Footnote
The exploration division of the company has confirmed that several ore deposits are economically viable and ready for development into mines.
The company could reduce its dividends to provide more internally generated funds to finance the new mines.
However, ***it is likely to be very difficult to convince investors that the lower dividends do not reflect bad news.*** Therefore, dividends might be maintained and **funds raised by a share issue, and/or borrowing, to finance the mines.**
152
Allen and Michaely (2003) conclude that if company managers do use dividends to signal, ‘the signal is not about future growth in earnings or cash flows’.
any signal conveyed by dividend decisions appear to follow changes in profits rather than providing new information about future profits
153
possible explanations for the usual market responses to dividend announcements include
§ Increasing a company’s dividend may signa**l that past increases in earnings are expected to be maintained.**
154
The ‘maturity hypothesis’ has been proposed as an explanation for the nature of the information conveyed by dividend changes. Outline the key aspects of this hypothesis.
changes in dividends are not significantly related to future profitability, and that increases (decreases) in dividends are associated with decreases (increases) in _systematic risk._
It proposes that higher dividends are often an important indicator of a company’s transition to a ***lower growth (mature) phase characterised by lower risk.***
The reduction in risk can result in a significant decline in the _company’s cost of capital_ and, therefore, an **increase in share price** despite the reduced growth prospects.
155
The imputation system encourages payment of high dividends. Companies that do so may be left short of cash. Comment on this statement.
The problem of running short of cash can be overcome by introducing a dividend reinvestment plan and by paying dividends in the form of shares.
