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Dividend Policy": Term Paper - I On Corporate Financial Management
Dividend Policy": Term Paper - I On Corporate Financial Management
“Dividend Policy”
Term Paper – I
On
Corporate Financial
Management
Part A
Dividend Policy
Dividends are cash payments made to stockholders. Decisions
about when and how much of earnings should be paid as
dividends are part of the firm’s dividend policy. Earnings that are
paid out as dividends cannot be used by the firm to invest in
projects with positive net present values—that is, to increase the
value of the firm. The dividend policy that maximizes the value of
the firm is said to be the optimal dividend policy.
Clientele effect
Investors might choose a particular stock due to the firm’s
dividend policy—that is, some investors prefer dividends and
others do not. If such a clientele effect does exist, then we would
expect that a firm’s stock price will change when its dividend
policy is changed.
risk, which implies a lower overall WACC and a higher firm value.
In practice, more firms actually follow some form of this dividend
policy.
Payment procedures
Dividends are usually paid quarterly. The following dates are
important when establishing a dividend policy:
Declaration date
The date the board of directors states that a dividend will be paid
to stockholders. A dividend is not a liability to the firm until it is
declared.
Holder-of-record date
The date the firm “opens” its ownership books to determine who
will receive dividends. Persons whose names appear in the
ownership books after the holder-of-record date, which is also
termed the date of record, but prior to the date the dividend is
paid will not receive a dividend payment.
Ex-dividend date
Two working days before the holder-of-record date. Ex dividend
means without dividend; so, on the ex-dividend date, the stock
begins to sell without the right to receive the next dividend
payment. In essence, the stock sells without the right to receive
the dividend payment because there is not enough time for the
names of new stockholders to be registered before the holder-of-
record date.
Payment date
The date the firm mails the dividend checks.
Investment opportunities
Firms that need great amounts of funds for positive NPV
investments usually pay relatively lower amounts of dividends
than firms with few positive NPV investments.
Stock splits
An action taken by a firm to change the number of outstanding
shares of stock. Many firms believe their stock has an optimal
price range within which their stock should trade. If the price of
the stock exceeds the price range, then the firm will execute a
stock split. If a firm initiates a 2-for-1 stock split, each existing
stockholder will receive two shares of stock for each one share he
or she now owns. This action should cut the market price of the
stock exactly in half. But, there is evidence that shows the price
of the stock actually settles above one half the pre-split price.
Perhaps the reason this occurs is because investors believe the
split provides positive information; specifically that the firm
expects the price of the stock to increase further above the
optimal range in the future. In any event, there really is no
specific economic value associated with a stock split. As an
investor, unless the market reacts positively or negatively to the
split, the only effect the split has is to increase the number of
Stock dividends
Dividends paid in the form of stock rather than cash. Like stock
splits, a stock dividend does not have specific economic value;
rather, it increases the total number of shares of stock each
stockholder owns. At the same time, the stock price per share
decreases because investors have not provided any funds for the
additional shares of stock. A firm might use a stock dividend to
keep the price of its stock within a particular range.
Price effects
Even though both stock splits and stock dividends only increase
the number of outstanding shares of stock, studies have shown
that the market price of the stock affected by such actions might
change—if investors expect future earnings and cash dividends to
increase (decrease), then the price will increase (decrease) above
the relative price associated with the stock split or the stock
dividend. For example, if investors believe a firm initiated a 2-for-
1 stock split because its future earnings will cause the price of the
stock to increase well above its optimal range, then their reaction
to the split will cause the post-split price of the stock to be
greater than one half the pre-split price. If the future expectations
do not pan out, however, the price of the stock will eventually
settle at about one half the pre-split price.
Part B
Part C