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Dividend Policy

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Dividend Fundamentals
Relevant dates for dividend payments
Announcement date
The day the firm announces the dividend, dividend record, and payment dates

Date of record

All persons recorded as stockholders on this date receive the declared dividend. The persons that buy the stock before ex dividend date will receive the current dividend. Several business days before date of record

Ex dividend date

Maximum Amount a Firm Can Pay in Cash Dividends

Where legal capital defined as par value of common stock, maximum payout is $340,000 (Paid-in capital + RE).
Alpha Corporations Stockholders Equity Common stock at par Additional paid-in capital Retained earnings Total stockholders equity $100,000 200,000 140,000 $440,000

In states where legal capital includes all paid-in capital, maximum payout is $140,000 (only Retained Earnings).

Types of Dividends
Cash dividends Types of dividend policies Stock dividends and stock splits
Regular Cash Dividend Special Cash Dividend National differences in payment methods Constant payout ratio policy Constant nominal payments (standard worldwide) Low regular and extra dividend Stock dividend: payment of a dividend in the form of stock Stock splits affect firms shares similarly to stock dividends. Buying shares on the market Tender Offer to Shareholders Private Negotiation (Green Mail)

Stock repurchases

Patterns In Dividend Policies Worldwide

Distinct national patterns Pronounced industry patterns
Companies in common law countries have higher payouts than those from civil law countries. US companies are now near global average. The same worldwide Profitable firms in mature industries tend to pay out much larger fractions of their earnings.

Within industries, dividend payout tends to be directly related to asset intensity and the presence of regulation. Almost all firms maintain constant nominal dividend payments per share for long periods of time.

Aggregate Dividend Payout Ratio for U.S. Corporate Sector


90 80 70 60 50 40 30 20 10 0 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 2000

Source: Statistical Abstract of United States, U.S department of Commerce, various issues (1972-2001)

Dividend Payout Ratios For Selected U.S. Industries

Industry Biotechnology Airlines Computer software Semiconductors Computer hardware Commcl Transportation Prop & cas Insurance Aerospace & defense Paper & forest products Telecommunications

Payout Ratio Industry 0% 0 2 7 14 15 20 28 28 39 Household non-durables Industrial metals Pharmaceuticals Banking Basic chemicals Foods & non-alcohol bev Autos & auto parts Electric utilities Alcohol bev & tobacco Oil & gas product & mktg

Payout Ratio 41% 46 47 47 48 51 42 65 70 75

Source: Standard & Poors Industry Reports, various issues (2001)

Patterns Observed In Dividend Policies Worldwide

The stock market reacts positively to dividend increases and negatively to decreases or cuts. Taxes influence dividend payouts, but the net effect is ambiguous. Firms paid dividends before and after income tax. Empirical evidence shows that tax increases lead to higher payouts, rather than lower.

It is unclear how dividends affect the required return on a firm's common stock.

Models Of Dividend Payments

Several competing theories are advanced to explain observed patterns in dividend policies.

The Agency Cost / Contracting Model

The Signaling Model

Mainstream favorite: the agency cost/contracting model The signaling model of dividends: firms pay dividends to burn money, separate from weaker rivals

The Agency Cost / Contracting Model Of Dividend Payments

Dividends exist to overcome agency problems between managers and shareholders.

Managers commit to paying out free cash flow as dividends.

Based on ownership structure: private and closely held firms rarely pay dividends; big public firms have high payouts.

Based on investment opportunity set: mature firms have high payout; high-growth firms have low payouts.

Dividend Policy Irrelevance In A World Without Market Imperfections

Miller & Modigliani (1961) showed dividend policy cannot impact firm value in a world without market frictions.

Miller & Modigliani showed this the same way that they proved that capital structure was irrelevant. Value is determined solely by investment policy and profitability of the firms assets.

Investors can sell shares to mimic the dividend policy.


Dividend Policy Irrelevance In A World Without Market Imperfections

An example....

Adams Construction and Feldon Home Builders

Two identical companies, except their dividend policy. Both have 4 millions shares outstanding. Both companies have assets worth $40 million. Expected net cash inflow is $6 million next year.

Adams Construction
Return on investment Price per share 15% $10

Feldon Home Builders

15% $10

Both firms anticipate an investment opportunity next year that will require $6 million. How will the two firms finance this opportunity?

Adams Construction
Pays out 100% of next years cash inflows as dividends. Earns and distributes $1.50/share Will raise $6 million in a new equity offering to finance the new investment opportunity
600,000 shares at $10 each
Today Tomorrow

Assets worth $40 million 4 million shares $10 per share


Assets worth $46million 4.6 million shares $10 per share

Adams Construction original shareholders earn 15% return in the form of dividend.

Feldon Home Builders

Retains next years $6 million cash inflows; invest $6 million in the new investment opportunity
Today Tomorrow

Assets worth $40 million 4 million shares $10 per share

Assets worth $46million 4 million shares $11.5 per share

Shareholders earn required return of 15% in the form of stock price increase.
Firm value for both firms is the same, regardless of the dividend payout policy!


Real-World Influences On Dividends

Personal taxes on dividends
Should discourage payments Empirical evidence is ambiguous. Dividends paid before 1936 (no taxes) and after 1936 (dividends taxed) Some evidence of positive relation between payout and tPS Should discourage payments. If costly to issue new stocks and bonds, firm should retain cash. This factor argues in favor of dividends. Cost of selling shares for income has fallen steadily.

Security issuance costs Investor trading costs


Real-World Influences On Dividends

Dividends might be a residual after funding investments.
But dividends are most stable of all CF series.

Dividends may convey information in markets with info asymmetries.

But what specific information? Isnt there a cheaper way to signal? Latest empirical evidence: dividends signal the past, not the future.

How Do Corporations Set Dividend Payments?

Managers believe investors value steady dividend payments. Managers seem to have target payout ratio, but only over time.

Will allow payout to vary in the short term to keep $ dividends the same. Will only raise $ dividend if permanent earnings increase. Will only cut $ dividend if firm facing financial disaster.


Managerial reluctance to change nominal dividend payment gives rise to partial adjustment model.

What Do We Know About Dividends?

We can explain inter-industry differences in dividend payout. We know that ownership matters greatly and roughly how. We are convinced that dividends exist because of flaws in human ability to communicate and commit, not flaws in how markets work. Dividends convey information. Initiations and increases convey good news, decreases convey catastrophic news. Common law countries have higher payouts than civil law.

What Dont We Know About Dividends?

Exactly how do taxes impact dividends? Exactly what information is conveyed by dividends? Most puzzling: why has fraction of firms paying dividends declined in the US, but not elsewhere?