w4 : payout policy Flashcards
what is payout policy?
way a firm chooses between alternative ways to distribute free cash flows to equity holders
what are the two options for a firm who retains their cash?
- use FCF to undertake positive NPV projects
- increase cash reserves (earn interest, gives flexibility to invest in future projects, creates fcf problem)
what are the two options for a firm who pays out their cash?
- dividends (distributing cash flow to equity holders)
- repurchase
what is a stock split?
mgt may believe that stock price is too high, no SH buying. stock split increases number of shares outstanding. doesnt change MV of firm, only price per share falls.
what is the declaration date?
date on which board of directors authorise payment of dividend
what is the record date?
when firm pays dividend, only SHs on record on this date receive dividend
what is the ex-dividend date?
date two days prior to record date, on or after which anyone buying stock will not be eligible for dividend
what is the distribution date?
date, generally within a month after record date, on which a firm pays out dividends
state the three types of share repurchase.
dutch auction
targeted repurchase
greenmail
define dutch auction.
type of share repurchase whereby firm lists different prices at which it is prepared to buy shares. existing SH then indicate how many shares willing to sell at each price.
define targeted repurchase.
type of share repurchase when firm purchases directly from specific SH at discount / premium
define greenmail.
type of share repurchase. allows firm to avoid threat of takeover by major SH by buying out the SH. often bought out at a large premium over current market price
what does an increase in dividends signal?
positive signals. for example, higher future earnings
what does a decrease in dividends signal?
negative signals. for example, speculate that firm may face future financial stress
what are the three perspectives on whether paying dividends change the value of the stock or if it is just a signal?
conservative - increase in dividend payout increases firm value
neutral - dividend policy doesnt affect firm value
radical - increase in dividend payout reduces firm value
explain the neutral perspective on dividend payout.
M&M irrelevance theory :
investors dont need divs to get cash in their hand. they can sell their stocks in the markets with no transaction costs (PCM), so investors not going to increase demand for those stocks that offer higher dividends
explain the radical perspective on dividend payout.
dividends taxed as IT which is higher rate than CGT, so firms should pay lower rates to protect SH.
what is the effective dividend tax rate?
measures the additional tax paid by the investor per dollar of after tax capital gains income that is received as a dividend
state the equation for effective dividend tax rate.
= (Td - Tg) / (1 - Tg)
Td = dividend tax rate
Tg = capital gains tax rate
if radical perspective is correct, then why do firms bother to pay dividends?
if companies regularly repurchase shares rather than pay dividends, HMRC may target loophole & treat as income. will be taxed at same rate as dividends, so repurchase tax advantage is ineffective.
what is the logic behind the conservative perspective?
graham & dodd argue that market is in favour of “liberal dividends” which is when investors prefer getting current dividend payments rather than later capital gain. investors will all demand high paying dividends, but if increased demand of high paying dividends not met, then in turn increases price of stock to meet demand. increases firm value.
stock market in favour of liberal dividends as opposed to niggardly ones.
