Unit 3: Part 3- Payout Policy Flashcards
What are cash dividends?
A cash dividend is the money paid to stockholders as part of the corporation’s current earnings or accumulated profits.
What is a repurchase/buybacks?
Buy-Back is where a company buys back its shares from the existing shareholders at a price higher than market price. When it buys back, the number of shares outstanding in the market reduces. The firm reinvests in themselves.
What do shareholders & investors prefer?
Shareholders who focus on income tend to prefer dividends. Investors who focus on capital gains might prefer share price increases than receiving cash they do not need
What is dividend smoothing?
Investors prefer stable dividends as management desires to maintain a long-term target level of dividends as a fraction of earnings. Target ratios are low if it has many positive NPV projects & high if few positive NPV projects.
What is the Lintner (1956) model?
Lintner (1956) model reflects that management focus on dividend changes than actual dividend levels themselves (everyone wants stable dividends) (change in dividend= s(zEPS1-Div0))
What are the determinants of z (target payout ratio) & s (adjustment ratio)?
For target payout ratio (z) then investment opportunities (projects), volatility of earnings (stable earning companies can afford to have much higher payout ratio). For adjustment ratio (s) then volatility of earnings, liquidity position of the company
What is an alternative to paying a dividend?
Repurchases are an alternative to paying a dividend & are very beneficial from a tax perspective
What are the 3 approaches to repurchases?
open market, tender offer (firm announces to all its shareholders it is willing to buy a fixed number of shares at a fixed price, offer premium to incentivise shareholders to sell shares) or targeted repurchase (firms might repurchase shares form a certain shareholder)
What is the payout controversy of dividends vs. repurchases?
Miller & Modigliani in 1961 published proof that dividend policy is value-irrelevant in a world without taxes, transaction costs & other market imperfections.
What happens when you keep the firm’s assets, investments & borrowing policy as fixed?
By keeping the firm’s assets, investments & borrowing policy fixed: increase cash for dividends (sell more shares) or opt to repurchase (reduce cash for dividends & cash saved can be used to buyback existing shares). Any change in dividend payout must be offset by the sale or repurchase of shares.
What happens under MM 1961?
Under MM 1961, firms are going to be indifferent between cash flows & new issues to finance investments
What is the dividends & investment policy?
All of this assumes that firms do not make changes to their investment policy i.e. they do not forego positive NPV projects in order to fund a cash dividend increase. failing to accept positive NPV projects will lead to a reduction in the value of the firm. ‘The investment policy of the firm is set ahead of time & is not altered by changes in dividend policy’.
What are homemade dividends?
MM’s propositions put forward the concept of creating homemade dividends where investor wishes to receive income at t0 but company foregoes dividends to invest in +NPV project. Investor can undo dividend policy by selling sufficient no. of shares to replicate desired dividend payout
Does dividend policy matter?
Some researchers suggest the dividend policy is irrelevant, in theory, because investors can sell a portion of their shares or portfolio if they need funds.
What is dividend signalling in a world of information asymmetry?
dividends are used to signal permanent shifts in operating cash flows, analysts increase forecast for current years earnings (Ofer & Siegal, 1987), increase in share price for firms announcing dividend increases & significant decrease in prices for firms announcing cuts
