Payout Policy

Dividends and Buybacks represent payments made by a firm to shareholders as a distribution of profits.
They’re allocated as a fixed amount per share: shareholders receive them in proportion to shareholding.

- Regular Dividend → public companies usually pay dividend quarterly.

- Stock Dividends → no cash leaves the firm, but it increases the number of shares.

- Dividend in Kind → firms offers shareholders extra offers or programmes.

In a perfect world, the stock price will fall by the amount of the dividend on the ex-dividend date:

- Declaration Date → the board of Directors declares a payment of dividends.

- Cum Dividend Date → the last day that the buyer of a stock is entitled to the dividend.

- Ex Dividend Date → the first day that the seller of a stock is entitled to the dividend.

- Record Date → corporation prepares a list of all individuals believed to be stockholders as of date.

Price Behaviour

In a perfect world, the stock price will fall by the amount of the dividend on the ex div date.

Despite the price drop of the shares, we have the Dividend Irrelevance Proposition of MM:
the firms’ total market value is going to be independent from the company’s dividend policy.

- Investors do not need divs to convert shares into cash, hence, they have no impact on firm value.

- Investors don’t need divs to convert shares into cash, hence they won’t pay more high payout firms.

- Firms should never forgo positive NPV projects to increase a dividend: NPV>0 investments comes first.

Consider an investor with total wealth of X given by stocks, how does it change afer dividends?

P
- Wealth=held shares ×
total shares
P−¿
- Wealth=held shares × +( ¿× held shares)
total shares
P−¿
- Wealth=( held shares−sold shares ) × + ( ¿ ×held shares ) + sell price
total shares
The investor’s total wealth does not change in any of the three cases.
Stock Buybacks

In the presence of personal taxes paying Dividends is costly as they are highly taxed.
Therefore, instead of declaring cash divs, firms can buy their stock (with limitations):

- Managers have an incentive to seek alternative uses for funds to reduce dividends.

- Many tax authorities treat shares buybacks as capital gains (no income tax on them).

- Buybacks do not produce a decline in prices of shares, like dividends do.

- Didivends give a bad signal to the market, are hard to sustain, if not sustained lead to negative rets.

- Open Market Buyback → firm announces that it will repurchase some shares in the market as market
conditions allows it and maintains the option of deciding whether, when, and how much to repurchase.

- Fixed Price tender Buyback → firm specifies in advance a single purchase price, the number of shares,
and the duration of the offer. Shareholders decide whether or not to participate, and number of shares

- Dutch Auction → firm specifies a price range within which the shares will ultimately be purchased.
Shareholders are invited to tender their stock, if they desire, at any price within the stated range.
The purchase price is the lowest price that allows the firm to buy the number of shares sought.
Buybacks in Real World

Usually CEOs according to their performance: they get bonuses based on the yearly level of EPS.
Share repurchases reduce the number of shares oustanding, hence increasing earnings per share:

- EPS=EBIT /(shares)

In a period of very low interest rates, opportunistic CEOs lead companies to issue new debt
to buyback more shares, but increasing in this way the leverage and therefore the financial risk.

Dividends in Real World

With personal income taxes, firms should not pay dividends, but they still do because of:

- Clienteles → different groups of stockholders prefer higher dividend payout policies.

In fact, some investors prefer high payouts (retirees, pension funds, university funds
are in a low or zero tax bracket, and have a need for current cash income given by divs.
Emprirical data shows that older, poorer and low taxed investors prefer high dividends.

- Asymmetric Information → dividends can be signals to the market you believe that you
have good CF prospects in the future. Dividend cuts are followed by negative stock returns.
Managers hate to cut dividends, so they won’t raise them unless they think it is sustainable.
So, investors view dividend increases as signals of management’s view of the future.
Hence, price increases at time of the div increase could reflect high expectations for future.

- Agency Costs → If there’s no investment opportunities firms should disburse cash to shareholders.
Divs are a disciplining tool: used by shareholders to make managers pay cash if there’s no opportunity.

The high diffusion Small Public Firms of low reported earning and high growth that do not pay dividends
can be one of the motives also explained the diseappearing of dividends, besides shares repurchases.

Profitability and Dividends

What is the relationship between profitability and dividends?

- Private Firms: Positive and statistically significant for current and profitability.

- Public Firms: positive, and statistically significant for current and profitability.

The coefficients on private firms are always larger than the coefficients on public firms (more buybacks).

Public firms have share prices. If they cannot credibly raise dividends, a subsequent div cut will result in
low share prices. Therefore, they prefer to change dividends only when they are sure they can maintain
high dividend levels. This generates a low correlation between earning changes and dividend changes.

Private firms do not have share prices. If they suddenly raise divs and then suddenly cut them again,
they won’t be punished bymarkets. In this way, their divs are more strongly correlated with earnings.