Dividend

Policy

11/19/07

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Learning Objectives
 Factors that influence dividend policy
 How dividends are paid
 Major dividend theories
 Alternatives to cash dividends
 Stock Dividends
 Stock Splits
 Stock Repurchases

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 Factors that affect Dividend Policy
 Company projects low growth, has excess funds,
may = large dividends (PG & E)
 Management expects high growth, high need for
cash; may = high retained earnings and low or no
dividends (high tech firms)
 Stockholders’ preferences
Capital gains vs ordinary income

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Factors that affect dividend policy
 Restrictions on dividend payments
Bond indenture agreements
Lack of retained earnings
 Availability of cash

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Dividend Payment Procedures

On August 25, 2002 Southside Bankshares

announced a quarterly dividend of $1 per share
to be paid to shareholders of record September 9,
2002. Dividend will be paid on Sept. 15, 2002

Each dividend must be declared (approved) by the Board

of Directors.
This is usually done at the quarterly Board meetings.

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Dividend Payment Procedures

On August 25, 2002 Southside Bankshares

announced a quarterly dividend of $1 per share
for shareholders of record as of Sept. 9, 2002, and
payable to shareholders on Sept. 15, 2002

25 31 1 5 9
August 15 September
August September

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6
Dividend Payment Procedures

On August 25, 2002 Southside Bankshares

announced a quarterly dividend of $1 per share
for share holders of record as of September 9, 2002,
and to be paid on September 15, 2002

25 31 1 5 9
August 15 September
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7
Dividend Payment Procedures

On August 25, 2002 Southside Bankshares

announced a quarterly dividend of $1 per share
for shareholders of record September 9, 2002, and
to be paid on September 15, 2002

25 31 1 7 9
August 15 September
August September

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Dividend Payment Procedures

On August 25, 2002 Southside Bankshares

announced a quarterly dividend of $1 per share
for shareholders of record September 9, 2002, and to
be paid on September 15, 2002

25 31 1 7 9
August 15 September
August September

Ex-Dividend
Ex-DividendDate
Date
Declaration
DeclarationDate
Date Payment
Date
Dateof
ofRecord
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9
Dividend determination methods

 Dividend Rate. Most companies use a fixed

dollar amount per share. This amount is
determined by the Board of Directors
 Dividends tend to stay the same or increase
slightly each year; shows stability, positive
future
 Decreases in dividends can severely impact
the stock price
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Leading Dividend Theories
 Clientele Dividend Theory
 Some investors, such as elderly people on

fixed incomes, tend to prefer to receive

dividend income.
 Others, such as young investors often

prefer growth, and tend to like their

income in the form of capital gains rather
than as dividend income.

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 Alternatives to Cash Dividends
 Stock Dividends
 Existing shareholders receive additional shares
of stock instead of cash dividends
 Stock dividends represent a distribution of stock
of less than 25% of total shares outstanding
 Done usually if the firm wants to conserve cash

 The number of shares is expressed as a

percentage of current stock holdings.

e.g. if there is a 10% stock dividend, you

would receive one additional share for
every 10 that you currently own.
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 Stock Dividend
 A stock dividend is recorded at the current
market price of the stock
 For example, if the market price of the stock is
$21, and the par value of the stock is $1, then
stock dividend of 20,000 shares would be
recorded as:
 Retained Earnings 420,000
Common Stock (at $1 par) 20,000
Capital in excess of par 400,000

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Stock Dividends Impact on Balance
Sheet (Market price $21 per share)
BEFORE 10% Stock DIVIDEND
Common Stock (200,000 shares, $1 par) $200,000
Capital in Excess of Par $1,800,000
Retained Earnings $10,000,000
TOTAL COMMON STOCK EQUITY $12,000,000

AFTER 10% STOCK DIVIDEND (Stock price = $21)

Common Stock (220,000 shares, $1 par) $220,000
Capital in Excess of Par $2,200,000
Retained Earnings $9,580,000
TOTAL COMMON STOCK EQUITY $12,000,000
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Alternatives to Cash Dividends
 Stock Splits
 If total shares will increase by more than

25%, the company will usually declare a

stock split.
 Expressed as a ratio to original shares.

e.g. a 2-1 split means that each investor

will end up with twice as many shares as
they had prior to the split.
Link to Reuters
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Stock split
 Typically signals good news, in that the
company expects to grow and increase stock
price
 Keeps stock price affordable for the greatest
number of potential investors
 Gives something of value to the shareholder
without using up cash
 Has no impact on the capital structure of the
company

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Stock Splits Impact on Balance Sheet
BEFORE SPLIT
Common Stock (200,000 shares, $1 par) $200,000
Capital in Excess of Par $1,800,000
Retained Earnings $10,000,000
TOTAL COMMON STOCK EQUITY $12,000,000

AFTER THE 2 to 1 STOCK SPLIT

Common Stock (400,000 shares, $.50 par) $200,000
Capital in Excess of Par $1,800,000
Retained Earnings $10,000,000
TOTAL COMMON STOCK EQUITY $12,000,000
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Impact of Stock Splits and Dividends on
Stock Price
 The book argues that no significant economic
event has taken place and that the price of
the stock will drop in proportion to the size of
the increase in shares
 I disagree. Stock splits especially are an
indication that the company believes the
stock price will continue to grow.
 As a result, shareholder wealth typically
increases as the result of a split
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Impact of Stock Split on Shareholder
 Before Split
100 shares x $10 = $1,000 value
 After 2 for 1 Split
 Per book argument (no increase in value)

 200 shares x $5 = $1,000 value

 Investor positive reaction (value increases

to $11.00 per share prior to split)

 200 shares x $5.50 = $1,100 value

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 Stock Repurchases
 A firm buys back its own stock on the open market
 A very common occurrence recently
 By reducing the number of shares outstanding,
earnings per share are increased
 Rather than payout a dividend, which would have
immediate tax consequences for the investor, a
stock repurchase increases the share price
 Stock repurchase reverses the impact of dilution

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Stock Repurchase Effect
 Serves as a perfect replacement for a
dividend payment to shareholders
 Example: stock worth $60 per share pays $4
dividend. Shareholder has a Stock worth $60
and must pay tax on the $4 dividend
 If dividend money used to repurchase stock
instead, shareholder ends up with stock worth
$64 with no immediate recognition of income

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