Dividend Policy

Outline
‡ ‡ ‡ ‡ ‡ Cash Dividends Dividend Payment Timeline Dividend Payment Policies Other Dividends & Dividend Alternatives Dividend Theory

Cash Dividends
‡ Represent distribution of earnings to shareholders
± Paid out of cash (not retained earnings or net income)
‡ firm¶s can borrow to pay a dividend

± Net Earnings Restriction:
‡ Dividends limited to firm¶s retained earnings

± Capital Impairment Restriction:
‡ Cannot issue new stock to pay dividend

± Insolvency Restriction:
‡ Cannot pay dividend if Equity < 0

± Contract Clauses:
‡ Bond covenants, leases, loans may restrict dividends

Dividend Payment Timeline ‡ Declaration Date ± Board of directors announces future dividend ‡ Ex-dividend Date ± Must be last owner of stock prior to ex-div date to receive dividend ± 2 business days prior to Date of Record ‡ Date of Record ± Must be listed as Registered Shareholder by this date ‡ Payment Date .

Declaration Date 4/28 (Mon) Ex-Dividend Date 6/11 (Wed) Date of Record 6/13 (Fri) Payment Date 6/27 (Fri) .

08 ‡ Dividend yield = 2.‡ ³Q´ = quarterly dividend ± $0.65 per share per quarter ‡ $2.60 / 20.60 per year total ± Stock price = $20.08 = 12.95% .

11 (0.72 JOURNAL COMM INC (NYSE: JRN) Real-Time: 1.32 Q 2009-07-15 06-10 06-08 2009-07-16 06-25 06-23 Symbol % Yield New Old Period Payable Record Ex-Div Notes Market Reaction: OCCIDENTAL PET (NYSE: OXY) Real-Time: 56.. . April 30.0828 Q BLACK DECKER CP (NYSE: BDK) Real-Time: 40.19 0.33 .19 CLP 8.15 (9. ASCA .. ..40 0.27%) 9:38am ET ADVANCE AMERICA INC.34 SWY 2. (NYSE: AEA) Real-Time: 4.85%) 9:39AM ET .25 .37 Q S 2009-06-05 05-26 05-21 2009-06-15 06-03 06-01 BDK 1.25 Q Q 2009-06-26 06-12 06-10 2009-05-11 05-04 04-30 OXY 2.03 .48 (0.105 Q 2009-05-19 05-11 05-07 6. 2009 AMOUNT Company INCREASED Occidental Petro Safeway Inc REDUCED Black & Decker Colonial Prop INITIAL None REGULAR Advance Am Cash AEA Manpower Inc IRREGULAR Ameristar Casino SUSPENDED Journal CommunsA JRN .10 .68%) 9:36am ET .77 0.42 .0625 ..00 9:38am ET MAN 1.. Q ...15 .Dividend Announcements (WSJ) DIVIDEND DECLARATIONS Thursday.12 .29 ..

Constant payout ratio (%) .Payment Policies 1. Constant Cash Dividend ‡ ‡ 3. Residual Dividend Payment ‡ Earnings not used to finance capital investment are available for dividend payment Same $-dividend each quarter Constant % of earnings 2.

Capital u Wc t 100 0% y ent 0 40 0 0 60 40 0 20 Residu l ividend Ear i s Needed Equity issue stock di idend payment nst nt $ ividend ($ ) Earnings 20 Needed Equity 40 issue stock di idend payment nst nt % ividend ( Earnings Needed Equity issue stock di idend payment 0 10 %) 20 40 0 10 60 40 0 10 Stable Di idend with constant $ 60 40 10 30 Fluctuating di idend with Residual & Constant % .

Other Dividends & Dividend Alternatives ‡ Dividends ± Cash ± Stock ‡ Dividend Equivalents ± Stock repurchase ± Stock split .

Stock Dividend ‡ Payment of additional shares of stock ± 50% stock dividend would give you 1 extra share for every 2 you already own ‡ You own 100 shares @ $12 each ($1200) ‡ After the stock dividend you have 150 shares at $8 ($1200) .

Stock Split ‡ Change in number of shares outstanding ± 3 for 2 split ‡ You owned 100 shares at $12 each ($1200) ‡ After the split you have 150 at $8 each ($1200) ± Same impact as a stock dividend .

Equivalence of Splits and Stock Dividends SPLIT 2:1 3:2 5:4 11:10 STOCK DIVIDEND (2/1)-1 (3/2)-1 (5/4)-1 (11/10)-1 = 100% = 50% = 25% = 10% .

Stock Repurchase ‡ Firm uses excess cash to buy stock back from existing shareholders ‡ Substitute for a cash dividend ± Drives up stock price (capital gain) ± Increases firm leverage (less equity after repo) ‡ Method of altering firm¶s capital structure ± Considered by some to be a cheaper form of dividend payment ± Used also to avoid hostile takeovers .

Dilemma: Sho l the firm se retaine earnings for: a) Financing profitable capital in estments? b) Pa ing i i en s to stockhol ers? .

Dividend rs !  growth rate Stock Pr ice .‡ If we retain earnings for profitable in estments ± i i en iel will be zero ± b t the stock price will increase ± res lting in a higher capital gain.

‡ If we pa i i en s ± stockhol ers recei e imme iate cash rewar for in esting ± b t this cash oesn¶t get in este in the firm ± so the capital gain will ecrease Dividend rs !  growth rate Stock Pr ice .

i i en polic reall in ol es 2 ecisions: 1.So. Amo nt of earnings that sho l be istrib te to sharehol ers as i i en s 2. How m ch sho l be retaine for capital in estment? .

Dividend Theories ‡ Dividends are irrelevant ‡ Dividends matter ± Low payout optimal ± High payout optimal ‡ Clientele effects ‡ Dividends provide a signal .

trading costs. Dividend yields ± But total return is unaffected . etc« ± Dividend payments affect the distribution of returns between 1.Dividend Irrelevance ‡ Assuming perfect markets ± Same stuff as MM I assumed: ‡ No taxes. Capital gains 2.

D g r! MP D ! Dividend Yield MP g ! Capital gains yield D ! EPS (1  b ) b ! Plowback ratio g ! ROE x b .

000 Common stock outstanding (S) = 100.000 Equity (E) = $10.000 Stock price (P) = $100 .000.Example ‡ ‡ ‡ ‡ Net income (NI) = $1.000.

000 Common stock outstanding (S) = 100.10 = 0 + .000 Equity (E) = $10.000 Stock price (P) = $100 ‡ b = 1.0 ‡ g = ROE x b = (1/10)(1) = 10% ‡ rS = (D/P) + g = (0/100) + .1 = 10% .Case A ± No Dividend ‡ ‡ ‡ ‡ Net income (NI) = $1.000.000.

000 Equity (E) = $10.000 Stock price (P) = $100 ‡ b = 50% (div = .000 Common stock outstanding (S) = 100.Case B ± Partial Dividend ‡ ‡ ‡ ‡ Net income (NI) = $1.000.5 x $1mil / 100k = $5 per sh) ‡ g = ROE x b = (1/10)(.05= 10% .05 = .05 + .000.5) = 0.05 ‡ rS = (D/P)+g = (5/100)+0.

0= 10% .000.10 + .0 ‡ rS = (D/P)+g = (10/100)+0.000.000 Stock price (P) = $100 ‡ b = 0% (div = 1 x $1mil / 100k = $10 per sh) ‡ g = ROE x b = (1/10)(.000 Equity (E) = $10.0) = 0.000 Common stock outstanding (S) = 100.0 = .Case C ± All Earnings Paid as Dividends ‡ ‡ ‡ ‡ Net income (NI) = $1.

Summary of Example CASE A B C b 100% 50% 0% Div $0 $5 $10 G + DY 10% + 0% 5% + 5% 0% + 10% r 10% 10% 10%  r unaffected by b  Dividend Policy is irrelevant ! .

High Dividend Payouts Optimal ‡ Dividends provide a stable. the firm¶s cost of capital will decline . low risk source of cash flow to investors ± Capital gains (changing stock prices) are much more uncertain ‡ Required returns would be lower with high dividend payouts ± With lower equity costs.

and its cost of capital .Low Dividend Payout Optimal ‡ Dividends taxed in year received ‡ Capital gains ± Taxed only when the stock is sold ± And usually at a lower rate than that for dividends ‡ So investors should pay more for a stock with a low dividend payout ± This will lower the cost of equity for the issuing firm.

Clientele Effects ‡ Different investors have different investment needs ± Some have more immediate cash flow needs. higher expected return stocks with little or no dividends (growth stocks) . or may desire lower risk of dividend paying stocks (value stocks) ± Others have years before retirement and might prefer higher risk.

less equity ± Positive signal (capital structure chapter) .Signaling ‡ Dividend payments provide investors signals about information that insiders hold ± Increasing a constant $ dividend signals the firm¶s belief that future cash flows will be permanently higher ± Paying out more dividends (cash) or doing a stock repurchase will ‡ Lower cash (asset) ‡ Lower equity ‡ Alters capital structure towards relatively more debt.

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