DIVIDEND POLICY

Dividend
A dividend is a payment made by a corporation
to its shareholders, usually as a distribution of
profits.

In other words, dividend is that part of the net

earnings of a corporation that is distributed to
its stockholders. It is a payment made to the
equity shareholders for their investment in the
company.
Dividend Policy
Determines the ultimate distribution of the
firm’s earnings between retention and cash
dividend payments of shareholders

In other words, dividend policy is the firm’s

plan of action to be followed when dividend
decisions are made
Types of Dividends
Cash dividend
- most common form of dividend
- A corporation will send out a cash payment in the
form of a check directly to the stockholders.

Stock dividend
- payment made in form of additional shares

Property dividend
- payable in assets
Types of Dividend Policy Theory

The Residual Theory of Dividend

Policy
- holds that firms pay dividends out of earnings
that remain after it meets its financing needs. 
- primary focus is investment
- dividend policy is irrelevant
The Residual Theory of Dividend Policy

Advantages: Minimizes new stock issues and

flotation costs.
Disadvantages: Results in variable dividends,
sends conflicting signals, increases risk, and
doesn’t appeal to any specific clientele.
Conclusion: Consider residual policy to help
set their long-run target payout ratios, but not
as a guide to the payout in any one year.
Types of Dividend Policy Theory

Dividend Irrelevancy Theory

- it asserts that dividend policy has no effect on
either the price of the firm or its cost of capital

- only the company's ability to earn money

and riskiness of its activity can have an impact
on its value.
Types of Dividend Policy Theory

The Bird in the Hand Theory

- based on the logic that “what is available at
present is preferable to what may be available
in the future

- hence, dividend policy is relevant and does

affect the share price of a firm
Types of Dividend Policy Theory

Tax Differential Theory

- simply concludes that since dividends are
taxed at higher rates than capital gains,
investors requires higher rate of return as
dividend yields increases

- investors prefer a low payout, hence growth

Steps for Setting Dividends
Stock Repurchases
 re-acquisition by a company of its own stock. It
represents a more flexible way (relative to dividends) of
returning money to shareholders.

Methods:
1. open market repurchase – the firm acquires stock on the
market, often buying a relatively small number of shares
every day, at the going market price
2. tender offer – formal offer of the company to buy a
specified number of its shares at a stated price
Stock Repurchases
Reasons for Repurchase
As an alternative to distributing cash as
dividends.
To dispose of one-time cash from an
asset sale.
To make a large capital structure
change.
Advantages of Repurchases
Stockholders can sell or not. With a cash
dividend, stockholders must accept the
payment and pay the taxes.
Helps avoid setting a high dividend that cannot
be maintained.
Repurchased stock can be used in take-overs or
resold to raise cash as needed.
Income received is capital gains rather than
higher-taxed dividends.
Stockholders may take as a positive signal--
management thinks stock is undervalued.
Disadvantages of Repurchases
IRS could impose penalties if
repurchases were primarily to avoid
taxes on dividends.

Selling stockholders may not be well

informed, hence be treated unfairly.

Firm may have to bid up price to

complete purchase, thus paying too
much for its own stock.