8a. Dividend Relevance - Freeashta.free.fr/Teaching Handouts/Finance/Financial Decisions... · 8a....
Transcript of 8a. Dividend Relevance - Freeashta.free.fr/Teaching Handouts/Finance/Financial Decisions... · 8a....
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Financial Decisions
8a. Dividend RelevanceDoes Dividend Polcy matter?
1. Dividend Policy is irrelevant 2. Dividend Polciy is relevant
Instructor: A. Ashta
References: Ross, Westerfield Jordan: Ch. 14Emery, Finnerty & Stowe: Ch. 17
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1. MM Dividend Irrelevance Proposition
In perfect capital markets, in the
absence of taxes and transaction
costs, dividend policy is
irrelevant in the sense that it
cannot effect shareholder value.
The effect of any dividend policy
can be offset by management
adjusting the sale of new stock
or by investors adjusting their
dividend stream through stock
purchases or sales.
Dans un March parfait, en
absence des impts et aucun
cot de transaction, la politique
de dividende est inutile : aucun
effet sur le valeur dactionnaire.
Leffet de toute politique du
dividende peut tre compense
par lemission des nouvelles
actions par la socite ou par
lachat et vente des actions par
les actionnaires
Modigliani-MillerInutilit de dividende
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Dividend irrelevance
Three cases to explain M-M irrelevancy proposition: dividends do not effects firmvalue:
1.Firm has necessary cash for dividend
2.Firm sells new shares to generatethe cash needed to pay the dividends
3.Firm does not pay any dividendsand the shareholder wants cash
First two cases are from firm view-point and last one from shareholderview-point
3 faons dexpliquer le proposition de M-M : la politique de dividende est inutile :
1.La socit a des disponibilits
2.La socit met des nouvelles actions
3. La socit ne paie pas de dividende mais lactionnaire a besoin de cash.
Les premiers deux cas sont de point de vue de la socit tandis que le dernire est celui de lactionnaire
Inutilit de dividende
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Case1.Firm has necessarycash to pay the dividend
Cash balance decreaseswhen dividend is paid
Equity account is alsoreduced
Only financial asset and financial liability changes
Net Operating assetsremain unchanged
Therefore, firm value remains unchanged
Trsorie diminue quand dividede pay
Capitaux propres rduit autant
Que les actifs financiers et passifs financirs ont t modifs
Les actifs dexploitation nont pas t modifi
Donc, la valeur de la socit est le mme
Cas1: Le dividende est vers de la trsorie
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Case 2: A firm issues new sharesto finance the dividend
The sale of new sharesincreases the firmsfinancial value
The payment of dividends decreases the firms financial value
As long as shares are sold at their fair marketvalue, the two effectsoffset each other
Firm value remainsunchanged
Les nouvelles actions augmentes la valeur financier
Le paiement des dividendes rduit le valeur financier
Tant que les actions ont t mit a leur valeur intrinsique correcte, les deux effets sont compensatoires
La valeur de la socitest le mme
Cas 2: Le dividende est fainancpar lemission des nouvelles
actions
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Dividend Irrelevance: Case 2 illustrated MicroGeneral
Balance Sheet (Market Values)
Cash $ 2,000 Debt $ 4,000Fixed Assets $ 5,000Growth Opportunities* $ 3,000 Equity $ 6,000
Total Assets $10,000 Value of Firm$10,000
*The value of future opportunities to invest in posi tive NPV projects
Equity consists of 100 shares
Dividende Inutile: Cas 2 illustrMicroGeneral
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Dividend Irrelevance -MicroGeneral
MicroGeneral needs $2,000 in cash to invest
in growth opportunities. Each share is worth
$___. Suppose management decides to pay
a dividend of $10 a share for a total of $____.
Total assets drop to $_____ giving the firm a
net worth of $_____. The new price of the
stock is $___ a share, a decline of $____ a
share.
Dividende Inutile: MicroGeneral
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Dividend Irrelevance - MicroGeneral
Holding capital structure constant, MicroGeneral
must raise $______ in new equity by issuing ____
new shares at ____ a share for a total of $_____.
MicroGenerals new balance sheet will look identica l
to the old except that the equity account will list
____shares. MicroGenerals old stockholders
wealth position remains the same since the value of
their shares $_____ plus the dividend of $______
equals their original position.
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Case 3: HomemadeDividends
If the firm does not issue dividends and the shareholder wants cash The shareholder can sell
her shares to anotherinvestor
This creates homemadedividends
If the shares are sold atfair market value, neitherthe buyer nor seller gain
Firm value is unchanged
Cas 3: Dividendes fabriqus
Si la socit ne distribue pas de dividende et lactionnaire en veux Lactionnaire peut vendre
ses actions une autre personne
Ceci cre des dividendes fabriqus maison
Si les actions sont vendu leur prix correct, ni le vendeur ni lacheteur nont profit.
La valeur de la socitna pas chang
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Quiz: True or False
If there is perfect competition and thereare no taxes
Dividends are irrelevant
Dividend policy is irrielevant
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2. In the real world, dividendsare Relevant
A. Taxes
B. Transactions Cost
C. Legal Constraints
D. Risks
E. Agency Theory
2. En pratique, les dividendes sont utiles
A. Impts
B. Cots de transaction
C. Contraintes lgales
D. Risque
E. Thorie dagence
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A. Dividends and Taxes - An Example
Suppose that tax on dividend income for the highest earning individual is 40%, whereas, capital gains are taxed at 20%. What are the differences in valuation for a firm that pays no dividends, and one that pays out all of its earnings in dividends?
Si le taux dimpt sur les dividendes est de 40% tandis que les plus values sont impos 20%, quelle sera la diffrence en valeur dune socitqui ne paie pas de dividende dune socitqui versent tout en dividendes.
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Dividends and Taxes - An Example
CompanyA B
Dividend Payout Ratio 0% 100%
Income Available to Shareholder E E
Investors After Tax Return
After-Tax Required Return on Equity r r
Market Value of the Equity
As Equity is valued _______ times higher
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B. Transaction Costs
For a firm Floatation Costs for new
equity to finance dividends This reduces profit and firm
value Firms prefer not to pay
dividends
For individuals Brokerage Costs This reduces capital gains Individual prefers dividends
B. Cots de transaction
Socit Cots dmission des actions Impliquent rduction du
rsultat et du valeur de la socit
Socits prfrent de ne pas payer de dividendes
Individus Courtage Implique rduction des plus-
values Individus prfrent
dividendes
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Dividends, Transaction costs and Taxes
Dividends help those investors who need current income and would incur transaction costs to sell off part of their holdings.
Each investor, therefore, trades off the transaction cost benefits of dividends against the tax disadvantages.
Dividendes, cots de transaction et impts
Les dividendes sont avantageux aux actionnaires qui ont besoin de revenu courant et qui auront de cots de transaction si ils cdent leurs actions.
Chaque investisseur doit valuer les bnfices de moindre cots de transaction associs avec des dividendes contre les pertes fiscales.
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C. Legal Restrictions on Dividend Payments
Restrictive covenants in bond indentures, loan agreements, and preferred stock agreements
Designed to prevent excessive payments of dividends.
No Dividends Unless Earnings or Net Assets reach certain levels
Net profit rule or Capital impairment rule Cant pay out of capital
In some States only par value considered, in others capital surplus (premium) also cannot be eroded
Insolvency rule: insolvent firms cannot pay dividends
C. Restrictions lgales sur versement des dividendes
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D. Risk and Bird-in-the-Hand Argument
An argument for paying dividends based on the
idea that since investors are risk-averse, they pre fer
a stream of relatively certain dividends over
uncertain capital gains.
This argument confuses the investment and
dividend decision.
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E. Agency Theory
This conjecture is based on the notion that the market will oversee otherwise not perfectlyenforceable contracts.
Therefore, taking excess cash (whatever thatmight be) out of the firm will force management to go to the market place and compete for funds.
The idea is then to siphon out as much cash as possible in the form of dividends.
E. Thorie dagence
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Dividends and the Real World
A low payout is better if one considers: Flotation costs Taxes Indenture restrictions
A high payout is better if one considers: The need for current income Uncertainty resolutionthe bird-in-
hand argument Taxes Agency Theory
Who is right? Resolving the issue ---
Clientele effects Signaling or Information Effect
Une distribution basse est prfrablesi on considre: Cots dmission Impts Restrictions des contrats de
dette
Une distribution haute est prfrablesi on considre: Le besoin du revenu courant La rsolution dincertitude Impts Thorie dagence
Qui a raison?
Leffet des Clienteles Leffet des signaux ou
dinformation
Dividendes en pratique
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The Clientele Case for Tax Neutrality of Dividends
Investors sort themselves into three clienteles: those that prefer dividends
those that are indifferent towards dividends
those that are averse to dividends
Thus, companies dont have to worry about their
payout policy since clienteles will select the payo ut
policy that serves them best.
So high-tax bracket individuals would invest in lowor no-
dividend-paying firms, and vice versa.
Le cas clientle pour la neutralit fiscale des
dividendes
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Signaling With Dividends
Dividend changes may have communications value if
investors believe the change contains useful inform ation
Talk is cheap but dividends are backed by cash
Especially in countries where corporate information is
not reliable
A dividend cut would give a negative signal about future earnings
A dividend increase would give a positive signal about future
earnings
Criticism : Dividend cut may reflect growth opportunities.
Dividend increase may reflect firm cant use money!
Signalisation par Dividendes
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Psychological/ Sociological Explanations
hard cold cash has more power than anythingelse.
The dividend payment is a ritual meant to strengthen the bond between the owners and the stewards of the firm, a reinforcementnecessary because of the separation of ownership from management.
Seem to resemble Bird in Hand and AgencyTheory
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Homework
Read Ross ch 14 (sections 14.1 to 14.3)
Try Questions 14.1 16 and 17
Devoir
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References
The Bird in Hand explanation Gordon and Shapiro [1956], Gordon [1963] and Walter [1963].
The tax effect explanation (see, for example, Miller and Scholes [1978], Litzenberger and Ramaswamy [1982],
Lakonishok and Vermaelen [1983], and Masulis and Trueman [1988]).
The clientele effect explanation, which is closely relat ed to the tax effect (see Elton and Gruber [1970], Pettit [1977], Fung [1981], Booth and Johnston [1984], and
Bajaj and Vijh [1990]).
The agency theory explanation (see Rozeff [1982], Easterbrook [1984], Jensen [1986], Crutchley and Hansen [1989], and
Dempsey and Laber [1992]).
The signaling model explanation (see Bhattacharya [1979, 1980], John and Williams [1985], Asquith and Mullins [1986], and
Bar-Yosef and Huffman [1986]).
The psychological/sociological explanation (see Shefrin and Statman [1984], Shiller [1986], and Frankfurter and Lane [1992]).
Source: George Frankfurter, Arman Kosedag, Hartmut Schmidt a nd Mihail Topalov: The Perception of Dividends By Management, The Journal of Psychology and Financial Markets 2002, Vol. 3, No. 4, 202217