term 2 lecture 8 payout policy 2 Flashcards
when the tax rate on dividends is greater than the tax rate on capital gains what occurs:
what is the bird in hand argument mean about the value of a firm that pays cash dividend compared to uncertain capital gains?
what does the bird in hand argument mean about value of firms that choose higher current dividends?
what does the preference for share repurchase rather than dividends depend on?
it depends on the difference between the dividend tax rate and the capital gains tax rate : tax rates vary by income, by jurisdiction and by whether the stock is held in retirement account. given these differences, firms may attract different groups of investors depending on their dividend policy
what is the formuala for the capital loss for before tax and after tax?
what is the formula for the effective dividend tax rate?
what is the effective dividend tax rate?
It measures the additional tax paid by investors per dollar of after-tax capital gains income that is instead received as a dividend
why does the effective dividend tax rate differ across investors?
differences in : income level, investment horizon, tax jurisdiction, and the type of investor or investment account
as a result of their different tax rates, investors will have varying preferences regarding divdends
what did baker and wurgler (2004) find evidence for about clientele?
Baker and Wurgler (2004) found evidence that managers cater to investors by paying dividends when investors put a stock price premium on payers and by not paying when investors prefer non payers
what is dividend capture theory?
the theory that in absence of transaction costs, investors can trade shares at the time of the dividend so that non taxed investors receive the dividend
what is an implication of dividend capture theory?
we should see large trading volumes in a stock market around the ex dividend day, as high tax investors sell and low tax investors buy the stock in anticipation of the dividend, and then the reverse those trades just after the ex dividend date
in a perfect capital market, when is a firm indifferent between saving and paying out cash
once a firm has taken all positive NPV investments, they are indifferent between saving excess cash and paying it out
what is the MM payout irrelevance statement?
in perfect capital markets, if a firm invests excess cash flows in financial securities, the firms choice of payout versus retention is irrelevant and does not affect the initial share price
when the capital market is imperfect, is there a tradeoff between retention and payout?
with capital market imperfections, there is a tradeoff. retaining cash can reduce the costs of raising capital in the future but it can also increase taxes and agency costs
how does taxes impact cash retention?
corporate taxes make it costly for a firm to retain excess cash. cash is equivalent to negative leverage so the tax advantage of leverage implies a tax disadvantage to holding cash
generally why do firms retain cash balances?
they retain cash balances to cover potential future cash shortfalls, despite the tax disadvantage of 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
the cost of holding cash to cover future potential cash needs should be compared to the reduction in transaction and agency costs of raising new capital through new debt or equity issues
what is the agency costs of retaining cash?
when firms have excessive cash, managers may use the funds inefficiently by paying excessive executive perks, overpaying for aqcuistions etc
how can you reduce the agency costs of retaining cash?
paying out excess cash through dividends or share repurchases rather than retaining cash, can boost the stock price by reducing the managers ability and temptation to waste resources
what type of industry do firms retain and accumulate large amounts of cash?
the tech and biotechnology firms tend to retain and accumulate large amounts of cash
what is dividend smoothing?
the pratice of maintaining relatively constant dividends, firms change dividends infrequently and dividends are much less volatile than earnings
how can dividends singal the managements expectations of future earnings?
the idea that dividend changes reflect managers views about a firms future earning prospects is the dividend signalling hypothesis. if a firm smoothes dividends, its dividend choice will contain information regarding management expectations of future earnings. 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. 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.
how might dividends signal about investment opportunities?
how might dividends signal about share repurchases?
what else impacts payout policy in pratice?
industry norms: managers often consult industry norms when setting dividend policies, dividend payout ratios varies by industries. business risk and investment opportunities of the industry are important factors in payout decision. software companies pay no or small dividend. utility and financial companies pay a large dividend
what occurs with a stock dividend?
firm does not pay out cash to shareholders. therefore, total market value of firms equity is unchanged, only the number of shares outstanding changes. the stock price will therefore fall
how would a company which paid a 50% stock dividend rather than a cash dividend impact a shareholder who owns 100 shares originally with a portfolio worth 4200 pounds?
what is the impact of stock dividends?
the stock dividends are not taxedm so from both the firms and shareholders perspectives, there is no real consequence to a stock dividend. the number of shares is proportionally increased and the price per share is proportionally reduced so that there Is no change in value
what is the advantage of stock dividends?
what is a reverse split?
when the price of companys stock falls too low, and the company reduces the number of outstanding
what are the two advantages of spin offs?
they avoid the transaction costs associated with a subsidiary sale
the special dividend Is not taxed as a cash distribution
what is a spin off?
this is where a firm rather than using cash or its stock to pay dividends, distributes shares of a subsidiary instead. non cash special dividends used to spin off assets or a subsidiary as a separate company
