Week 4

Question 1

Dividend vs. liquidating dividend:

Answer 1

Dividend - distribution of cash from earnings.
Liquidating dividend - distribution of capital.

Question 2

Types of dividends:

Answer 2

Regular cash dividend - cash payment on a regular basis.

Stock dividend - paying out dividends in terms of stock

Question 3

The amount paid can be expressed in what terms:

Answer 3

Dividend per share - currency per share
Dividend yield - dividend as a percentage of market price
Dividend payout - percentage of earnings per share.

Question 4

Timeline of dividend payment:

Answer 4

Declaration date - dividend is declared and becomes a liability of a company.

The date of record - is a list of recorded shareholders on that date

The ex-dividend date - two days before the date of record, when shares purchased after this date are no longer entitled to receive dividends. Before cum-dividend, after ex-dividend.

Date of payment - when checks are sent out to the shareholders entitled to dividends.

Question 5

Dividend irrelevancy:

Answer 5

1) The company with the same cash flow can pay larger dividends at P0 at the cost of dividends at P1. Therefore, an increase in dividends results in a price fall at the ex-dividend date by div1-div0.

2) Homemade dividends - individuals can achieve the same pay-off by reinvesting at date 0 and achieving a higher pay-off at date 1 or by selling shares at date 0 to achieve a higher pay-off at date 0 and lower at date 1.

Question 6

Three ways to repurchase shares:

Answer 6

1) Through open market purchase, where the firm does not reveal itself as a buyer.
2) Through a tender offer, where the firm announces to all its shareholders that it is willing to buy shares at a fixed higher price.
3) By a targeted repurchase, where the firm buys shares from a specific individual.

Question 7

Why repurchase over dividends:

Answer 7

1) Flexibility - firms are hesitant to reduce dividends, so share repurchase is more flexible
2) Executive compensation - managers with share options will receive a higher returns as after repurchase share price rises
3) Offset to dilution - buying back the shares can offset the dilution caused by share options.
4) Undervaluation - when shares are undervalued companies tend to believe that buyback is the best possible investment
5) Taxes - repurchase provides a tax advantage.

Question 8

Reasons why choose high dividend policy:

Answer 8

1) Individual desires current income.
2) The behavioral finance aspect - no need to sell shares to increase current cash flow, as the dividends are high. Selling shares could lead to a lack of self-control and selling too much.
3) Agency costs - managers can pay out dividends to keep the money from the bondholders (illegal and unethical).
4) Information content of dividend and dividend signalling - announcement of dividends increases share price, this is the information content effect. Increase in dividends signals increased future earnings and cash flows.
5) The board of directors can increase dividends to reduce the cash available to spendthrift managers.

Question 9

Clientele effect:

Answer 9

The factors that favor low or high dividend policy are likely to cancel each other out.

This is due to tax brackets and the preferences of individuals belonging to specific brackets.

Individuals in a high tax bracket will most likely prefer a low dividend policy, opposite of the tax-free institutions.

This theory implies that there is already an equilibrium of high dividend companies, and the company can boost its share price if an unsatisfied clientele exists.

Question 10

Catering theory of dividends:

Answer 10

Managers react to variations in demand for dividends in time periods. The change can observed by examining the dividend premium on shares.

Question 11

Dividend smoothing:

Answer 11

Dividend change = Div(1)-Div(0) = s * (tEPS(1) - Div(0))

s - is the speed of adjustment coefficient
t - target payout ratio