Chapter 17

Dividends and Payout Policy

 PhD, Phan Hong Mai

 School of Banking and Finance
 National Economics University
 hongmai@neu.edu.vn
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Chapter Outline

17.1 Cash Dividends

17.2 Does Dividend Policy Matter?

17.3 Stock Dividends and Stock Splits

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Dividends

 Any direct payment by the corporation to the

shareholders may be considered a dividend
or a part of dividend policy.
 Dividends usually come in two different
forms: cash dividends and stock dividends.

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 17.1 Cash Dividends
Four basic type of cash dividends:
 Regular cash dividend: cash
payments made directly to stockholders,
usually each quarter. reduces
 Extra cash dividend: indication that corporate
cash
the “extra” amount may not be repeated
and
in the future. retained
 Special cash dividend: similar to extra earnings
dividend, but definitely will not be
repeated.
 Liquidating dividend: some or all of reduces
capital
the business has been sold. 17-4
 17.1 Cash Dividends


The

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 17.1 Cash Dividends

Dividend Payment
 Declaration Date: The date on which the board of
directors passes a resolution to pay a dividend.
 Date of Record: The date by which a holder must be
on record to be designated to receive a dividend.
 Ex-dividend Date: The date two business days
before the date of record. If you buy on this date
or after, the previous owner will get the dividend.
 Date of Payment: The date on which the dividend
checks are mailed.

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 17.1 Cash Dividends

Dividend Payment
On January 15, the board of directors passes a
resolution to pay a dividend of $1 per share on
February 16 to all holders of record as of January 30.

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 17.1 Cash Dividends

Dividend Payment
Price Behavior around the Ex-Dividend Date
for a $1 Cash Dividend

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17.2 Does Dividend Policy Matter?

 Dividend policy is the decision to pay

dividends versus retaining funds to reinvest in
the firm and pay them out later.
 Dividend policy, therefore, is the time pattern of
dividend payout.
 Dividend question: “Should the firm pay out a
large percentage of its earnings now or a small
(or even zero) percentage?

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17.2 Does Dividend Policy Matter?

 Dividends matter: the value of the stock is based

on the present value of expected future dividends.
So higher dividends will make a firm more
valuable, all else equal. The firm can improve
dividends by increasing productivity, tax savings,
product marketing, or cash flow…
 Dividend policy MAY NOT matter: in theory, if
the firm pay out a small (or even zero) percentage
and reinvests capital now, it will grow and can pay
higher dividends in the future.
-> in the simple world, choosing one dividend
policy will not impact the stock price.
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17.2 Does Dividend Policy Matter?

 Suppose a firm has considered two dividend

policies: (1) Pay out dividends of $10,000 per
year for each of the next two years or (2) Pay
$9,000 this year, reinvest the other $1,000
into the firm and then pay $11,120 next year.
 If investors require a 12% return, does
dividend policy matter to the market value of
the firm?

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 17.2 Does Dividend Policy Matter?
Real-World factors favoring a HIGH dividend
payout
 Desire for current income: Individuals that need
current income (for immediate consumption). Some
groups (trust funds and endowment funds) that are
prohibited from spending principal.
 Uncertainty resolution: no guarantee that the
higher future dividends will materialize.
 Taxes: although dividends taxed at the personal rate,
there are some investors who do not receive
unfavorable tax treatment from holding high–dividend
yield.
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 17.2 Does Dividend Policy Matter?

Real-World factors favoring a LOW dividend

payout
 Taxes: Individuals in upper income tax brackets
might prefer lower dividend payouts, given the
immediate tax liability, in favor of higher capital gains
with the deferred tax liability.
 Flotation costs: low payouts can decrease the
amount of capital that needs to be raised, thereby
lowering flotation costs.
 Dividend restrictions: in some cases, debt
contracts might limit the percentage of income that
can be paid out as dividends. 17-13
17.2 Does Dividend Policy Matter?

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17.3 Stock Dividends and Stock Splits

 Stock dividend: A payment made by a firm to its

owners in the form of stock.
 The effect of a stock dividend is to increase the
number of shares that each owner holds, so each
share is simply worth less.
-> diluting the value of each share outstanding.
 A stock dividend is commonly expressed as a
percentage; for example, a 20 percent stock
dividend means that a shareholder receives one new
share for every five currently owned.
20%= 20 vs 100 = 1 vs 5
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17.3 Stock Dividends and Stock Splits

 Stock split: An increase in a firm’s shares

outstanding without any change in owners’
equity.
 A split is expressed as a ratio instead of a
percentage. When a split is declared, each share
is split up to create additional shares. For
example, in a three-for-one (3-1) stock split,
each old share is split into three new shares.
-> A Stock split increases the number of shares
outstanding and also reduce the value per share.
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17.3 Stock Dividends and Stock Splits

Stock dividend:
 Number of new shares = Number of old shares x (1
+ percent stock dividend)
 Price of a new share = Price of an old share / (1 +
+ percent stock dividend)
Stock split: Left / Right

 Stock split ratio = New / Old (three-for-one -> ratio = 3/1)

 Number of new shares = Number of old shares x
Stock split ratio
 Price of a new share = Price of an old share / Stock
split ratio
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 Summary and Conclusions
 Dividends are paid in cash, and cash is something
that everybody likes. In theory, dividend policy is
irrelevant.
 Desire for current income, Uncertainty resolution
and Taxes are real-world considerations that favor
a high dividend payout.
 Individual shareholder income taxes and new issue
flotation costs are real-world considerations that
favor a low dividend payout.
 Stock dividend and Stock split all increase the
number of shares outstanding and reduce the
value per share. 12-18
HOMEWORKS

Concepts review: 1, 3, 5, 6, 9

Question and Problems: 1, 2, 3, 4

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