SLIDE CHINH SACH C T C - Slideshare - VN Lecture Business Finance Chapter 12 Dividend and Share Repurchase Decisions

Chapter 12:
Dividend and Share

Repurchase Decisions
Copyright 2006 McGraw-Hill Australia Pty Ltd

PPTs t/a Business Finance 9e by Peirson, Brown, Easton, Howard and Pinder 121
Prepared by Dr Buly Cardak
Learning Objectives
Define dividend policy and understand some
institutional features of dividends and share
repurchases.
Explain why dividend policy is irrelevant to

shareholders wealth in a perfect capital market
with no taxes.
Outline the imputation and capital gains tax

systems and explain their effects on returns
to investors.

Learning Objectives (cont.)
Identify the factors that may cause dividend policy
to be important.
Be familiar with the nature of share buybacks,

dividend reinvestment plans and dividend election
schemes.
Outline the main factors that influence companies

dividend policies.

Dividend Policy
Business Decisions
Investment
Financing
Dividend
Dividend Policy
Determining how much of a companys profit is to be
paid to shareholders as dividends and how much is to
be retained.

Is there an Optimal Dividend Policy?
In a perfect capital market, dividend policy has no
impact on shareholders wealth and is, therefore,
irrelevant.
Introducing capital market imperfections, the

following views exist:
Dividend policy does not matter.
A high dividend policy is best.
A low dividend policy is best.

Institutional Features of Dividends
Dividend Declaration Procedures
Interim and final
In Australia, if dividends are paid, we typically find two sorts,
a final dividend is paid after the end of the accounting or
reporting year.
An interim dividend can be paid any time before the final
report is released, usually after the half-yearly accounts
are released.
Cum-dividend period
Period during which the share purchaser is qualified
to receive a previously announced dividend.
Ex-dividend date
Shares purchased on or after the ex-dividend date do not
include a right to the forthcoming dividend payment.

Institutional Features of Dividends (cont.)
Declaration Date
Date board of directors pass a resolution to pay a dividend.
Record (Books Closing) Date
The date on which holders of record are designated
to receive a dividend.
This is 4 days after the ex-dividend date.
The idea is that if shares are traded cum-dividend, brokers
have time to notify the share register to ensure the new
shareholder receives the dividend.
Date of Payment
Date dividend cheques are mailed or dividends are paid
electronically.

Legal Considerations
Dividends can only be paid out of profit and are not
to be paid out of capital.
A dividend cannot be paid if it would make the company
insolvent.
Dividend restrictions may exist in covenants in trust
deeds and loan agreements.
Franked dividend carries credits for tax paid by the
company.
Under imputation, if a company has the capacity to pay
a franked dividend then, as a general rule, it must do so.
New Zealand also operates an imputation system
for dividends.

Dividend Imputation
Franked dividend
Carries a credit for income tax paid by the company.
Franking credit
Credit for Australian company tax paid which, when distributed
to shareholders, can be offset against their tax liability.
Withholding tax
Tax deducted by a company from the dividend payable to
a non-resident shareholder.
franking account
Account that records Australian tax paid on company profits,
this identifies the total amount of franking credits that can be
distributed to shareholders in the form of franked dividends.

Repurchasing Shares
Over the past decade, popularity of Australian
companies buying back their own shares has
grown as a means of returning excess capital
to shareholders.
Types of share buyback
Equal access buyback pro-rata to all shareholders.
Selective buyback repurchase from specific, limited
number of shareholders.
On-market buyback repurchase through normal stock
exchange trading.
Employee share scheme buyback.
Minimum loading buyback buy back small parcels of
shares (transaction costs).

Dividend Policies
Residual dividend policy
Pay out as dividends any profit that management does
not believe can be invested profitably.
Smoothed dividend policy

Target proportion of annual profits to be paid out as
dividend. Aim for dividends to equal the long-run
difference between expected profits and expected
investment needs.
Constant payout policy.

Managers and Dividend Decisions
Dividends are an active decision variable
(Lintner).
Lintner found:
Companies have a long-term target payout ratio.
Managers focus on change in payout.
Dividends are smoothed relative to profits.
Managers avoid changes in dividends that may have
to be subsequently reversed.

Irrelevance Theory
Value of firm is determined solely by the earning
power of the firms assets, and the manner in
which the earnings stream is split between
dividends and retained earnings does not affect
shareholders wealth.

Modigliani and Miller (1961)
Given the investment decision of the firm, the
dividend payout ratio is a mere detail. It does not
affect the wealth of shareholders.
Assumptions
No taxes, transaction costs, or other market
imperfections.
A fixed investment or capital budgeting program.
No personal taxes investors are indifferent between
receiving dividends or capital gains.

MMs Conclusion
Dividend policy is a trade-off between retaining
profit, paying dividends and making new share
issues to replace cash paid out.
Paying a dividend and issuing new shares to

replace the cash:
Does not change the value of the company; and
Does not change the wealth of the old shareholders,
because the value of their shares falls by an amount
equal to the cash paid to them.

MMs Conclusion (cont.)
If a company increases its dividends, it must
replace the cash by making a share issue.
Old shareholders receive a higher current

dividend, but a proportion of future dividends must
be diverted to the new shareholders.
The present value of these forgone future

payments is equal to the increase in current
dividends.

MMs Conclusion (cont.)
The MM dividend irrelevance proposition is valid
in a perfect capital market with no taxes.
Therefore, if dividend policy is important in

practice, the reasons for its importance must relate
to factors that MM excluded from their analysis.

Dividends and Taxes
Differential tax treatment of dividend income
versus capital gains arising from retained
profits can either favour or penalise payment
of dividends.
This difference in tax treatment is understood

by comparing a classical tax system with an
imputation tax system.

Classical Tax System
In a classical tax system:
Company profits are taxed at the corporate tax rate, tc,
leaving (1 tc) to be distributed as a dividend.
Dividends received by shareholders are then taxed at
the shareholders personal marginal tax rate, tp.
The consequence is that, from a dollar of company profit,
the shareholder ends up with (1 tc)x (1 tp) dollars of
after-tax dividend in a classical tax system.
The result is that profit paid as a dividend is effectively
taxed twice.
In Australia, a classical tax system operated

until 1 July 1987, when an imputation system
was introduced.
Imputation Tax System
A system under which Australian resident equity
investors can use tax credits associated with
franked dividends to offset their personal tax.
The system eliminates the double taxation inherent

in the classical tax system.
Company tax is assessed on the corporate profits

in the normal way, at the corporate tax rate (tc).
As of 2002, tc is 30%.

Imputation Tax System (cont.)
For each dollar of franked dividends paid by the
company, resident shareholders will be taxed at
their marginal rate (tp) on an imputed dividend of
$D / (1 tc).
This is referred to as the grossed-up dividend.
The grossed-up dividend is equal to the dividend
plus the franking credit.
Franking credit is given by:
dividend tc
Imputationcredit
1 tc

The shareholder receives a tax credit equal
to the franking credit.
The credit can be used to offset tax liabilities

associated with any other form of income.
The tax credit cannot be carried forward but

excess or unused tax credits are refunded as
of July 2000.

The result is that franked dividends are effectively
tax-free to Australian residents, if the investors
marginal tax rate is equal to the corporate tax rate.
If the investors marginal tax rate is less than the

corporate rate, then the investor will have excess
tax credits which can be used to reduce tax on
other income, or refunded if they cannot be used.

If the investors marginal tax rate is greater than
the corporate rate, some tax will be payable by the
investor on the dividend.
Investors pay tax, at their marginal rate, on any

unfranked dividends received.
Since 1 October 2003, Australian and New Zealand

companies have been able to distribute all franking
credits to Australian and NZ resident shareholders.

Imputation and Capital Gains Tax
If companies retain profits, their share price is likely
to rise relative to companies that distribute profits,
giving rise to capital gains tax liabilities for
shareholders if and when the shares are sold.
Capital gains receive preferential tax treatment

compared to ordinary income.
Capital gains tax (CGT) applies only to short-term

gains and to long-term real capital gains on assets
acquired on or after 20 September 1985, and is
payable only when gains have been realised.

Imputation and Capital Gains Tax (cont.)
As of 21 September 1999, capital gains earned

over 12 months or longer are subject to CGT
discounting.
For individuals, only 50% of the gain is taxed

at their personal marginal tax rate.
For superannuation funds, the discount is 33.33%,

so 66.66% of the capital gain is subject to CGT.

Imputation and Capital Gains Tax (cont.)
Consequently, effective rates of CGT are likely
to be relatively low for many investors.
However, where a capital gain arises from

retention of profits which have been taxed, any
CGT that is payable will be in addition to the tax
already paid by the company.
In other words, retention of profits can involve

double taxation as franking credits cannot be
transferred to shareholders through capital gains.

Imputation and Dividend Policy
If all company shares were held by resident
investors with marginal tax rates less than
company tax rates, then the optimal dividend
policy for an Australian company is one that at
least pays dividends to the limit of its franking
account balance.

Imputation and Dividend Policy (cont.)
This policy will benefit resident investors in two ways:

The franking credits attached to franked dividends can be
used to reduce investors personal tax liabilities.
Since the alternative to dividends is capital gains, which are
subject to company tax and CGT, higher dividends will mean
that less CGT is payable by investors.
If all franking credits are not paid out, the credits that
are retained are potentially wasted as they have no
value except when accompanying dividend payments.
(At best, their value is discounted if they are used to
offer franking credits on future dividends.)

Imputation and Dividend Policy (cont.)
Complicating factors for optimal dividend policy:
Shares are held by both resident and non-resident
individuals.
Many individuals have personal marginal tax rates that are
greater than the company tax rate and may have a tax-
based preference for retention of profits.
Since July 2000, resident investors that are tax-exempt
have excess franking credits refunded.
Overall, the interaction of CGT and the imputation

system means that shareholders with low (high)
marginal tax rates prefer profits to be paid out as
dividends (retained, leading to capital gains).
Imputation Clienteles
Clientele effect
Investors choosing to invest in companies that have
policies meeting their particular requirements.
For example: Investors who require high current income
may choose to invest in companies that have high
dividend payouts.
Also, companies paying fully-franked dividends would
attract shareholders who receive the greatest value
from tax credits (i.e. Australian residents, possibly with
low personal tax rates who can receive a refund of
franking credits).

Value of Franking Credits
The argument that investors will prefer tax credits
to be distributed rather than retained assumes that
tax credits are valuable to investors.
Supporting evidence from the dividend drop-off

ratio:
Drop-off ratio: ratio of the decline in the share price
on the ex-dividend day to the dividend per share.

Value of Franking Credits (cont.)
Walker and Partington (1999) study drop-off ratios:
1 January 1995 1 March 1997, when ASX allowed
trading in cum-dividend shares after the ex-dividend date.
Find a drop-off ratio of 1.23, implying that $1 of
fully-franked dividends is worth more than $1.
Some variability because of different individual marginal
tax rates.

Value of Franking Credits (cont.)
Cannavan, Finn and Gray (2004) also study
drop-off ratios:
Use futures contracts on dividend paying shares
to compare with actual shares.
Futures contract does not entitle holder to dividends so
difference should reflect market value of dividend and
associated franking credit.
Tax rules change requiring shares to be held 45 days in
order to claim franking credits.
Prior to introduction of this rule, franking credits had some
value franking credits were easily transferable from those
that could not use them to those that could.
After this rule, franking credits appear to be worthless.

Non-Tax Reasons for the Relevance of
Dividend Policy
Information effects and signalling to investors:

Evidence suggests share price changes around the time
of the announcement of dividend changes are positively
related to the change in the dividend.
MM claim that this does not invalidate irrelevance theory.
The price change is the result of the information content
associated with the dividend announcement.

Dividend Policy (cont.)
Three implications of dividend information and

signalling hypothesis:
Unanticipated dividend changes should be followed by
share price changes in the same direction.
Empirical support for this implication found in US studies
by Grullon, Michaely and Swaminathan (2002), Michaely,
Thaler and Womack (1995), and Healy and Palepu (1988).
Australian evidence supports this implication as well:
Balachandaran and Faff (2004).
Special dividend announcements provide mean abnormal
returns of 5.44% over a 3-day period.


signalling hypothesis (cont.):
Unanticipated dividend changes should be followed by
market revision of expectations of future earnings in the
same direction.
Empirical evidence also supports this implication, for
example Ofer and Seigel (1987).
Analysts revisions of earnings forecasts are positively
related to dividend changes.
Grullon and Michaely (2004) find that analysts revise
profit forecasts downwards during the month of a share
repurchase announcement.

Changes in dividends should be followed by changes
in earnings in the same direction.
Evidence on this implication is mixed and does not
strongly support it.
Watts (1973) and Penman (1983) find little support for
implication.
Healy and Palepu (1988) find support when focusing
on companies that initiate and omit dividends.
Benartzi, Michaely and Thaler (1997), and Grullon,
Michaely and Swaminathan (2002) find link between
increased dividends and recent earnings but no link
between increased dividends and future increases
in earnings.
Three implications of dividend information and signalling
hypothesis (cont.):
Changes in dividends should be followed by changes in
earnings in the same direction.
De Angelo, De Angelo and Skinner (1996) also find no link
between dividend increases and future positive profit surprises.
Signalling argument, the third implication, is not supported
by empirical evidence.
Signal is not of continued dividend growth but rather of

permanence of current increase in dividend.
Alternatively, increased dividend may signal reduced risk

associated with profits and cash flows, thereby reducing
discount rate and raising share price.


Alternative interpretations of information conveyed.
Benartzi, Michaely and Thaler (1997) argue that the
signal is not of continued dividend growth but of
permanence of current increase in dividend.
Alternatively, Grullon, Michaely and Swaminathan (2002)
argue that an increased dividend may signal reduced
risk associated with profits and cash flows, thereby
reducing discount rate and raising share price.

Agency costs and corporate governance

Agency costs can be reduced by paying higher dividends.
Increased capital-raising required:
Accountability to market.
Increases provision of information.
Increases monitoring of managers.
Managers more likely to act in interests of shareholders.

Agency costs and corporate governance (cont.)

Lie (2000) and Grullon, Michaely and Swaminathan (2002)
provide empirical evidence that increased payouts either
as special dividends, increased ordinary dividends or a
share repurchase program signal reduced opportunity to
over invest, free cash flow hypothesis.
Firms with limited investment opportunities exhibit a
bigger abnormal return to the announcement of such
initiatives.
In Australia, Telstras announcement in June 2004 that
they intend to focus on a higher dividend payout rate of
80% and to initiate $1.5b worth of capital management
programs (special dividends and / or repurchases) was
greeted with a 4.6% increase in share price.


La Porta, Lopez-De-Silanes, Shleifer and Vishny (2000)
provide empirical evidence that in countries where
investors interests are relatively well protected, dividends
are less likely to be a mechanism to reduce agency
costs.
Well-protected investors are willing to forgo dividends
now in return for growth.
High-growth companies pay lower dividends
in economies where investors are relatively
well-protected legally.


Correia Da Silva, Goeregen and Renneboog (2004)
argue that dividend policy may be influenced by
corporate governance regimes.
Market based and block-holder based regimes of
corporate governance.
The presence of large (block) shareholders reduces
the impetus to pay out dividends (consider News Corp.
in Australia, large block holder, low dividends).
Controlling interest is a substitute for dividends as a
monitoring mechanism, while agency costs are less
of an issue as shareholder is potentially insider or
even a manager.

Investment opportunities
Differences in the nature of investment opportunities
will influence corporate financial decisions,
including dividends.
Lots of investment opportunities low dividends.
Jones and Sharma (2001) rank Australian companies

on basis of growth opportunities between 1991
and 1998.
Find low-growth companies have lower dividend

yields than high-growth companies.

Shareholders preference for current income
Need for shares to yield current income.
MM support irrelevance stance, given shareholders can

create homemade dividends.
Issue and transaction costs

Company can avoid incurring costs associated with share
issue by reducing dividends.
This means that more financing requirements can be met

internally, out of retained profits.

Dividend clienteles
Groups of investors who choose to invest in companies
that have dividend policies which meet their particular
requirements.
If equilibrium exists in terms of the supply and demand

for particular dividend policies, the price of a companys
shares will be independent of its dividend policy.
This is because there are always other companies

with the same (or a similar) dividend policy that can
act as substitutes.

Share Repurchases
A share buyback is when a company purchases its own shares
on the stock market and then proceeds to either cancel them
(Aust.) or retain them as treasury stock (US).
There are legal requirements associated with buybacks,

but generally companies can repurchase up to 10%
of their ordinary shares in a 12-month period.
Rapid growth in repurchases in Australia, $770m in the 1995

financial year, up to $7.7b in the 12 months to June 2004.
In 1999 and 2000, US industrial companies distributed

more cash to shareholders through share repurchases
than dividends.

Why Repurchase Shares?
Dividend substitution
If capital gains are taxed more favourably than dividends.
Some supporting evidence from the US, where dividend
payout ratios have been falling in the 1980s and 1990s.
Improved performance measures

EPS may rise, but if cash is returned rather than used to
retire debt, financial risk is increased and PE ratio along
with share price may fall.
Return of funds that cannot be profitably used will
raise share price.

Why Repurchase Shares? (cont.)
Signalling and undervaluation
Managers buying back company stock indicates that
they believe the stock is undervalued by the market.
Alternatively, a buyback announcement could be
accompanied by some new information, e.g. sale of
unprofitable asset/division.
Resource allocation and agency costs

Share repurchase returns capital to shareholders, who can
reallocate funds into profitable activities through the capital
market.
Reduces the potential for managers to inefficiently use free
cash (i.e. reduces agency costs).
Why Repurchase Shares? (cont.)
Financial flexibility
Payment of dividends is a long-term commitment and
sudden major changes (especially decreases) in dividend
policy are unappreciated by market.
buybacks offer an alternative way to make distributions
that may not be permanent.
Employee share options

Unlike paying dividends, share repurchases do not lead
to the ex-dividend price drop-off.
Option holders (typically management) prefer a share
repurchase to a dividend payout as a means of
distributing profits to shareholders.

Share Repurchases in Australia
Five categories of share buyback:
Equal access buyback pro-rata to all shareholders.
Selective buyback repurchase from specific, limited
number of shareholders.
On-market buyback repurchase through normal stock
exchange trading.
Employee share scheme buyback.
Minimum holding buyback buy back small parcels of
shares (transaction costs).

Share Repurchases in Australia
Off-market buybacks can be structured to provide significant
tax advantages with a large dividend and franking component.
(see for example Finance in Action: CBAs 2004 off-market
share buyback.)
Key point is that receipt of such a dividend is at the discretion

of the shareholder who sells the shares back to the company.
ASX requires companies to justify buyback many on-market

buybacks are justified on the basis that the market undervalues
the companys shares.
Otchere and Ross (2002) find positive abnormal returns for

companies, citing undervaluation as justification of a buyback.

Dividend Reinvestment Plans (DRPs)
Definition
DRPs offer shareholders the option to apply all or part
of their cash dividends to the purchase of additional shares
in the company (in some cases at a discount price).
The number of listed companies which operate dividend

reinvestment plans increased from just 5 in late 1982
to 14% of all listed companies by 1999.
In 2003/04, $5.2b of total $29.8b of dividends declared

by listed companies were reinvested through DRPs.
The imputation system has played a large part in

this increased popularity, providing an incentive
to increase payouts.

DRPs (cont.)
Benefits to the company:
Cheap and effective means of raising capital and
conserving cash
Promotes good shareholder relations and stability of
ownership
Disadvantages to the company:

Administration costs
Promotion of the plan
Excessive capital raising
Dilution of EPS

DRPs (cont.)
Benefits to investors:
Taxation benefits.
Flexibility.
Savings program.
Shares are generally issued at a discount to market
price and are free from brokerage and stamp duty.
Disadvantages to investors:
Need to keep substantive and comprehensive records
throughout the period of ownership of assets affected
by capital gains tax.
Familiarisation with plan and its tax consequences.
No control over the reinvestment price.
Discount disadvantages shareholders who do not
participate in the DRP.

Dividend Election Schemes
Allow shareholders the option of receiving their
dividends in one or more of a number of forms.
For example, as bonus shares (deferring tax),

or as dividends from overseas subsidiaries
(foreign tax credits).
Tax effectiveness of dividend streaming via

such schemes has been restricted.

Establishing a Dividend Policy
Schools of thought:
Dividend policy does not matter (MM).
A high dividend policy is best (agency costs, preference for
current income and imputation tax system).
A low dividend policy is best (issue costs, transaction costs
and tax considerations).
Lease et al. (2000) conclude that shareholders wealth is

affected by dividend policy due to market imperfections such
as taxes, agency costs and asymmetric information.
Policy should be devised on a firm by firm case, depending

on imperfections that have the greatest impact on the firm.

Dividend Policy Under Imputation
Strong incentives for tax-paying companies to pay
franked dividends.
The benefits of doing so are greatest for resident.
shareholders subject to marginal tax rates that are
lower than the company tax rate.
On the other hand, shareholders with marginal tax

rates that are higher than the company tax rate may
prefer that companies retain profits (subject to the
magnitude of the CGT).

Dividend Policy Under Imputation (cont.)
If the company tax rate and top personal tax rate

were equal, then the optimal dividend policy for
Australian companies owned by resident
shareholders would be to pay the maximum
possible franked dividends and adopt a DRP
to limit the outflow of cash.

Dividend Policy Under Imputation (cont.)
In practice, the situation is more complex for
three main reasons:
Many companies have both tax-paying resident
shareholders who can use franking credits, and
non-resident shareholders who cannot use them.
Equality between the company tax rate and the top

personal tax rate no longer exists.
Factors other than tax:

Information effects of dividends.
DRPs may create free cash flows that cannot
be invested profitably.

Agency Costs
Payment of dividends has a role in reducing
agency costs pay out of excess cash reduces
opportunities for managers to destroy value
by over-investing.
High-growth companies require capital, and

dividend policy should account for positive
NPV investment opportunities, with a low
payout policy.
Conversely, mature companies with limited

growth opportunities should pay out surplus cash
with a higher payout policy.
Asymmetric Information
Dividend and share repurchase announcements
have information content.
Market responds to changes in dividends,

special dividends, reductions in and suspensions
of dividends.
Increased ordinary dividends signal permanent

increase in earnings and ability to maintain
dividend level.

Asymmetric Information (cont.)
Special dividend or buyback indicates release
of temporary free cash flow.
Managers are cautious and will not excessively raise

ordinary dividends for fear of having to reduce
dividend in future, a strong negative signal.
Instead, a special dividend may accompany an

ordinary dividend to indicate a temporary increase
in dividend.

Dividend Policy and Firm Life Cycle
A companys dividend payout policy may need
to change as it moves through its life cycle.
A new business with good growth prospects is likely

to require capital and unlikely to payout dividends.
As the firm matures and has limited growth

prospects and scarce positive NPV projects,
excess free cash flow should be paid out as
dividends to minimise agency costs.

Summary
Dividend policy is about the trade-off between
retaining profit and paying out dividends.
Does not affect shareholders wealth in a

perfect capital market.
Dividend policy becomes important when we

consider taxes and agency costs.
Imputation system does eliminate double taxing

of dividend income and encourages higher
dividend payout ratios.

Summary (cont.)
Dividend policy environment has been changed
by recent alteration to capital gains tax laws,
favouring capital gains over dividends.
Share buybacks have become an increasingly

popular way to distribute cash to shareholders.
Profits earned overseas can be distributed

more tax-effectively to shareholders through
share buybacks.

Summary (cont.)
Dividends and share repurchases have a role
in reducing agency costs.
Share repurchase and dividend announcements

have significant effects on share prices
Combined impact of agency costs, information

effects and other imperfections leads to a payout
policy that needs to change as the firm moves
through its life cycle.


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Chapter 12:

Dividend and Share

Copyright 2006 McGraw-Hill Australia Pty Ltd

Explain why dividend policy is irrelevant to

Outline the imputation and capital gains tax

Copyright 2006 McGraw-Hill Australia Pty Ltd

Be familiar with the nature of share buybacks,

Outline the main factors that influence companies

Copyright 2006 McGraw-Hill Australia Pty Ltd

Copyright 2006 McGraw-Hill Australia Pty Ltd

Introducing capital market imperfections, the

Copyright 2006 McGraw-Hill Australia Pty Ltd

Copyright 2006 McGraw-Hill Australia Pty Ltd

Copyright 2006 McGraw-Hill Australia Pty Ltd

Copyright 2006 McGraw-Hill Australia Pty Ltd

Copyright 2006 McGraw-Hill Australia Pty Ltd

Copyright 2006 McGraw-Hill Australia Pty Ltd

Smoothed dividend policy

Copyright 2006 McGraw-Hill Australia Pty Ltd

Copyright 2006 McGraw-Hill Australia Pty Ltd

Copyright 2006 McGraw-Hill Australia Pty Ltd

Copyright 2006 McGraw-Hill Australia Pty Ltd

Paying a dividend and issuing new shares to

Copyright 2006 McGraw-Hill Australia Pty Ltd

Old shareholders receive a higher current

The present value of these forgone future

Copyright 2006 McGraw-Hill Australia Pty Ltd

Therefore, if dividend policy is important in

Copyright 2006 McGraw-Hill Australia Pty Ltd

This difference in tax treatment is understood

Copyright 2006 McGraw-Hill Australia Pty Ltd

In Australia, a classical tax system operated

The system eliminates the double taxation inherent

Company tax is assessed on the corporate profits

Copyright 2006 McGraw-Hill Australia Pty Ltd

Copyright 2006 McGraw-Hill Australia Pty Ltd

The credit can be used to offset tax liabilities

The tax credit cannot be carried forward but

Copyright 2006 McGraw-Hill Australia Pty Ltd

If the investors marginal tax rate is less than the

Copyright 2006 McGraw-Hill Australia Pty Ltd

Investors pay tax, at their marginal rate, on any

Since 1 October 2003, Australian and New Zealand

Copyright 2006 McGraw-Hill Australia Pty Ltd

Capital gains receive preferential tax treatment

Capital gains tax (CGT) applies only to short-term

Copyright 2006 McGraw-Hill Australia Pty Ltd

As of 21 September 1999, capital gains earned

For individuals, only 50% of the gain is taxed

For superannuation funds, the discount is 33.33%,

Copyright 2006 McGraw-Hill Australia Pty Ltd

However, where a capital gain arises from

In other words, retention of profits can involve

Copyright 2006 McGraw-Hill Australia Pty Ltd

Copyright 2006 McGraw-Hill Australia Pty Ltd

This policy will benefit resident investors in two ways:

Copyright 2006 McGraw-Hill Australia Pty Ltd

Overall, the interaction of CGT and the imputation

Copyright 2006 McGraw-Hill Australia Pty Ltd

Supporting evidence from the dividend drop-off

Copyright 2006 McGraw-Hill Australia Pty Ltd

Copyright 2006 McGraw-Hill Australia Pty Ltd

Copyright 2006 McGraw-Hill Australia Pty Ltd