#15 & #16 Dividend Policy
-
Upload
dushyant-chaturvedi -
Category
Documents
-
view
215 -
download
0
Transcript of #15 & #16 Dividend Policy
-
8/2/2019 #15 & #16 Dividend Policy
1/27
Session
15Dividends and Other
CF-II (Term III 2012) Dr. Kulbir Singh (IMT-Nagpur)
16
-
8/2/2019 #15 & #16 Dividend Policy
2/27
Slide 2
1. Different Types ofDividends
Many companies pay a regular cash dividend.
Public companies often pay quarterly.
Sometimes firms will pay an extra cash dividend.
The extreme case would be a liquidating dividend.
Dr. Kulbir Singh (IMT-Nagpur)Term III (2012)
.
No cash leaves the firm.
The firm increases the number of shares outstanding.
Some companies declare a dividend in kind. Wrigleys Gum sends a box of chewing gum.
Dundee Crematoria offers shareholders discountedcremations.
-
8/2/2019 #15 & #16 Dividend Policy
3/27
Slide 3
2. Standard Method of Cash
Dividend
Ex-Dividend Date - Date that determines
Cash Dividend - Payment of cash by the firm
to its shareholders.
Dr. Kulbir Singh (IMT-Nagpur)Term III (2012)
Record Date Date on which company
determines existing shareholders.
whether a stockholder is entitled to a dividend
payment; anyone holding stock immediately
before this date is entitled to a dividend.
-
8/2/2019 #15 & #16 Dividend Policy
4/27
Slide 4
Procedure for Cash Dividend
25 Oct. 1 Nov. 2 Nov. 5 Nov. 7 Dec.
Declaration
Date
Cum-
dividendDate
Ex-
dividendDate
Record
Date
Payment
Date
Dr. Kulbir Singh (IMT-Nagpur)Term III (2012)
Declaration Date: The Board of Directors declares a payment
of dividends.
Cum-Dividend Date: Buyer of stock still receives the dividend.
Ex-Dividend Date: Seller of the stock retains the dividend.
Record Date: The corporation prepares a list of all individuals
believed to be stockholders as of 5 November.
-
8/2/2019 #15 & #16 Dividend Policy
5/27
Slide 5
Price Behavior
In a perfect world, the stock price will fall by theamount of the dividend on the ex-dividend date.
$P
-t -2 -1 0 +1 +2
Dr. Kulbir Singh (IMT-Nagpur)Term III (2012)
$P - div
Ex-
dividend
Date
The price drops
by the amount of
the cashdividend. Taxes complicate things a bit. Empirically, the
price drop is less than the dividend and occurs
within the first few minutes of the ex-date.
-
8/2/2019 #15 & #16 Dividend Policy
6/27
Slide 6
3. The Irrelevance of
Dividend Policy A compelling case can be made that dividendpolicyis irrelevant.
Since investors do not need dividends to
convert shares to cash; they will not pay
Dr. Kulbir Singh (IMT-Nagpur)Term III (2012)
higher prices for firms with higher dividends.
In other words, dividend policy will have noimpact on the value of the firm becauseinvestors can create whatever income streamthey prefer by using homemade dividends.
-
8/2/2019 #15 & #16 Dividend Policy
7/27
Slide 7
Example
Dr. Kulbir Singh (IMT-Nagpur)Term III (2012)
-
8/2/2019 #15 & #16 Dividend Policy
8/27
Slide 8
Example
After the imminent dividend is paid, the stockprice will immediately fall to
$9.09 (= $19.09 - $10).
Several members of Bristols board haveex ressed dissatisfaction with the current
Dr. Kulbir Singh (IMT-Nagpur)Term III (2012)
dividend policy and have asked you to analyze analternative policy.
-
8/2/2019 #15 & #16 Dividend Policy
9/27
Slide 9
Example: Alternative Policy
Another policy is for the firm to pay a dividend of$11 per share immediately - the extra $1,000must be raised in one of a few ways.
Issue $1,000 of bonds or stock now (at date 0).
Assume that stock is issued and the newstockholders will desire enough cash flow at date
Dr. Kulbir Singh (IMT-Nagpur)Term III (2012)
1 to let them earn the required 10 percent returnon their date 0 investment.
The new stockholders will demand $1,100 of the
date 1 cashflow, leaving only $8,900 to the oldstockholders. The dividends to the oldstockholders will be these:
-
8/2/2019 #15 & #16 Dividend Policy
10/27
Slide 10
Example: Alternative Policy
Date 0 Date 1Aggregate Dividends to OldShareholders
$11,000 $8,900
Dividends per Share $11.00 $8.90
Dr. Kulbir Singh (IMT-Nagpur)Term III (2012)
-
8/2/2019 #15 & #16 Dividend Policy
11/27
Slide 11
Homemade Dividends
Bianchi Inc. is a $42 stock about to pay a $2cash dividend.
Bob Investor owns 80 shares and prefers a $3dividend.
Bobs homemade dividend strategy:
Dr. Kulbir Singh (IMT-Nagpur)Term III (2012)
Sell 2 shares ex-dividend
homemade dividends
Cash from dividend $160Cash from selling stock $80
Total Cash $240
Value of Stock Holdings $40 78 =
$3,120
$3 Dividend
$240$0
$240
$39 80 =
$3,120
-
8/2/2019 #15 & #16 Dividend Policy
12/27
Slide 12
Dividend Policy is Irrelevant
In the above example, Bob Investor began witha total wealth of $3,360:
share
42$shares80360,3$ =
Dr. Kulbir Singh (IMT-Nagpur)Term III (2012)
240$share
39$shares80360,3$ +=
80$160$share
40$shares78360,3$ ++=
After a $3 dividend, his total wealth is still $3,360:
After a $2 dividend and sale of 2 ex-dividend shares, histotal wealth is still $3,360:
-
8/2/2019 #15 & #16 Dividend Policy
13/27
Slide 13Dividends and InvestmentPolicy
Firms should never forgo positive NPVprojects to increase a dividend (or to pay a
dividend for the first time).
Dr. Kulbir Singh (IMT-Nagpur)Term III (2012)
underlying the dividend-irrelevanceargument is: The investment policy of the
firm is set ahead of time and is not alteredby changes in dividend policy.
-
8/2/2019 #15 & #16 Dividend Policy
14/27
Slide 14
4. Repurchase of Stock
Instead of declaring cash dividends, firmscan rid themselves of excess cash through
buying shares of their own stock.
Dr. Kulbir Singh (IMT-Nagpur)Term III (2012)
,an important way of distributing earningsto shareholders.
-
8/2/2019 #15 & #16 Dividend Policy
15/27
Slide 15Stock Repurchase versusDividend
sheetbalanceOriginalA.
Equity&LiabilitiesAssets
Consider a firm that wishes to distribute $100,000 to its
shareholders.
Dr. Kulbir Singh (IMT-Nagpur)Term III (2012)
$10=/100,000$1,000,000=Price per share100,000=outstandingShares
1,000,000Value of Firm1,000,000Value of Firm
1,000,000Equity850,000AssetsOther
,
-
8/2/2019 #15 & #16 Dividend Policy
16/27
Slide 16Stock Repurchase versusDividend
dividendcashshareper$1AfterB.
Equity&sLiabilitieAssets
If they distribute the $100,000 as a cash dividend, the balance
sheet will look like this:
Dr. Kulbir Singh (IMT-Nagpur)Term III (2012)
$9=00,000$900,000/1=shareperPrice100,000=goutstandinShares
900,000FirmofValue900,000FirmofValue
900,000Equity850,000AssetsOther
,
-
8/2/2019 #15 & #16 Dividend Policy
17/27
Slide 17
Stock Repurchase versusDividend
Assets Liabilities & Equity
C. After stock repurchase
If they distribute the $100,000 through a stock repurchase, the
balance sheet will look like this:
Dr. Kulbir Singh (IMT-Nagpur)Term III (2012)
Cash $50,000 Debt 0
Other Assets 850,000 Equity 900,000
Value of Firm 900,000 Value of Firm 900,000
Shares outstanding= 90,000Price pershare = $900,000 / 90,000 = $10
-
8/2/2019 #15 & #16 Dividend Policy
18/27
Slide 18
Share Repurchase
Flexibility for shareholders
Keeps stock price higher..Executivecompensation Good for insiders who hold stock o tions
Dr. Kulbir Singh (IMT-Nagpur)Term III (2012)
Existing stock options have greater value dueto share repurchase...
As an investment of the firm(undervaluation)
Tax benefits
-
8/2/2019 #15 & #16 Dividend Policy
19/27
Slide 19
5. Personal Taxes and
Dividends To get the result that dividend policy is
irrelevant, we needed three assumptions: No taxes
No transactions costs
Dr. Kulbir Singh (IMT-Nagpur)Term III (2012)
In the United States, both cash dividends andcapital gains are taxed at a maximum rate of 15percent.
Since capital gains can be deferred, the tax rateon dividends is greater than the effective rate oncapital gains.
-
8/2/2019 #15 & #16 Dividend Policy
20/27
Slide 20
Firms without Sufficient Cash
Cash: stock issue
Investment Bankers The direct costs ofstock issuance willadd to this effect.
Dr. Kulbir Singh (IMT-Nagpur)Term III (2012)
In a world of personal taxes,firms should not issue stockto pay a dividend.
Firmoc
HoldersCash: dividends
Gov.
Taxes
-
8/2/2019 #15 & #16 Dividend Policy
21/27
Slide 21
Firms with Sufficient Cash
The above argument does not necessarilyapply to firms with excess cash.
Consider a firm that has $1 million in cash
after selecting all available positive NPV
Dr. Kulbir Singh (IMT-Nagpur)Term III (2012)
.
Select additional capital budgeting projects(by assumption, these are negative NPV).
Acquire other companies Purchase financial assets
Repurchase shares
-
8/2/2019 #15 & #16 Dividend Policy
22/27
Slide 22
Taxes and Dividends
In the presence of personal taxes:
1. A firm should not issue stock to pay adividend.
Dr. Kulbir Singh (IMT-Nagpur)Term III (2012)
.alternative uses for funds to reducedividends.
3. Though personal taxes mitigate against thepayment of dividends, these taxes are notsufficient to lead firms to eliminate alldividends.
-
8/2/2019 #15 & #16 Dividend Policy
23/27
Slide 23
6. Real-World Factors FavoringHigh Dividends
Desire for Current Income
Behavioral Finance
It forces investors to be disciplined.
Dr. Kulbir Singh (IMT-Nagpur)Term III (2012)
Tax Arbitrage
Investors can create positions in high dividendyield securities that avoid tax liabilities.
Agency Costs
High dividends reduce free cash flow.
-
8/2/2019 #15 & #16 Dividend Policy
24/27
Slide 24
7. The Clientele Effect Clienteles for various dividend payout
policies are likely to form in the followingway:
Group Stock Type
Dr. Kulbir Singh (IMT-Nagpur)Term III (2012)
High Tax Bracket Individuals
Low Tax Bracket Individuals
Tax-Free InstitutionsCorporations
Zero-to-Low payout
Low-to-Medium payout
Medium payoutHigh payout
Once the clienteles have been satisfied, a corporation is
unlikely to create value by changingits dividend policy.
-
8/2/2019 #15 & #16 Dividend Policy
25/27
Slide 25
8. What We Know and Do Not Know
Corporations smooth dividends..Lintners Study
Fewer companies are paying dividends.
Dividends provide information to the market
Dr. Kulbir Singh (IMT-Nagpur)Term III (2012)
earnings & dividends
Firms should follow a sensible policy:
Do not forgo positive NPV projects just to pay adividend.
Avoid issuing stock to pay dividends.
Consider share repurchase when there are few better
uses for the cash.
-
8/2/2019 #15 & #16 Dividend Policy
26/27
Slide 26
9. Stock Dividends
Pay additional shares of stock instead ofcash
Increases the number of outstanding shares
Small stock dividend
Dr. Kulbir Singh (IMT-Nagpur)Term III (2012)
Less than 20 to 25%
If you own 100 shares and the companydeclared a 10% stock dividend, you would
receive an additional 10 shares.
Large stock dividend more than 20 to 25%
-
8/2/2019 #15 & #16 Dividend Policy
27/27
Slide 27
Stock Splits
Stock splits essentially the same as astock dividend except it is expressed as aratio
For example, a 2 for 1 stock split is the sameas a 100% stock dividend.
Dr. Kulbir Singh (IMT-Nagpur)Term III (2012)
Stock price is reduced when the stocksplits.
Common explanation for split is to returnprice to a more desirable trading range.