Week 6

Question 1

What is the winner’s curse

Answer 1

Winner’s Curse can help explain IPO underpricing
* Here we will consider different IPO candidate firms that differ in their value (adverse selection)
* Some informed investors have superior information about which firms are good or bad, so they only buy shares in good firms
– As a result, IPOs in bad firms are under-subscribed, good firms over-subscribed.
– Uninformed investors will end up receiving more shares in bad firms (= Winner’s curse)
* Lower share price compensates uninformed investors

Question 2

Why may investors like dividends?

Answer 2

• Transactions costs: Homemade dividends require time and fees involved in selling stock.
• Mental accounting: Spend the interest (dividends), save the principal.
• Agency costs: Committing to dividends keeps managers from spending excess cash on themselves or investing in pet projects.

Question 3

What is the Different Tax Treatment around repurchase and dividends?

Answer 3

• On cash received through dividend payments, investors pay dividend tax
• If investors sell shares during a repurchase, they pay capital gains taxes
• On cash received through dividend payments, investors pay dividend tax
• If investors sell shares during a repurchase, they pay capital gains taxes

Question 4

Given the tax disadvantage, why do firms pay dividends?

Answer 4

Dividend Signalling Hypothesis: dividend changes reflect managers’ views about a firm’s future earnings prospects
* If firms smoothen dividends, the firm’s dividend choice will
contain information regarding management’s expectations of future earnings
* Dividend increase: positive signal that management expects to be able to afford a higher dividend in the future
* Dividend decrease: management has given up hope that earnings will rebound in the near term and need to reduce the dividend to save cash à negative signal

Question 5

What is cum-dividend share price?

Answer 5

The cum-dividend share price is the price of a company’s stock when it is trading with the dividend included. This means that if you purchase shares of a company while it is cum-dividend, you are entitled to receive the declared dividend for that period.

The concept of cum-dividend is important in the context of dividend distributions because there is a specific date, known as the ex-dividend date, which determines whether the buyer of a stock will receive the upcoming dividend payment. If you buy the shares when they are cum-dividend (before the ex-dividend date), you will receive the next dividend payment. However, if you buy the shares on or after the ex-dividend date, you will not be eligible for the next dividend payment; the seller retains the right to the dividend.

Question 6

Why would dividend not matter?

Answer 6

A compelling case can be made that dividend policy is irrelevant.
* Investors do not need dividends to convert shares to cash
→ they will not pay higher prices for firms with higher dividends.
* In other words, dividend policy will have no impact on the value of the firm because investors can
create whatever income stream they prefer by using homemade dividends.

Question 7

What is the difference in treatment between dividends and share repurchase

Answer 7

• On cash received through dividend payments, investors pay dividend tax
• If investors sell shares during a repurchase, they pay capital gains taxes
• Capital gains are often taxed less than dividends
• In NL there is currently no capital gains tax (box 3 wealth tax instead – new system from 2025/26)
• Dividendenbelasting 15%

Even if capital gains and divdend taxes were equal, share repurchases still have a tax advantage:
* Investors can time the sale of their stock when most advantageous from a tax perspective
* For example, sell when gains can be offset against losses

Question 8

Two reasons that explain why repurchases may have a tax advantage over dividends

Answer 8

“Different tax rates: dividends are taxed at dividend tax, repurchases at capital gains
tax”
Timing: investors can time the realization of capital gains when it is advantageous

Question 9

How can firms signal with Repurchases?

Answer 9

Repurchases are perceived as a more flexible way of making payouts
* In contrast to dividends, investors do not perceive repurchases as a strong commitment that firms maintain a level of payout (no smoothening)

Repurchases may be seen as a signal that management believes the firm is under-valued
* “Inverse” of logic for share issuance (see #6-3 on Pecking Order)