Dividend Theories and Policies

Dividend Theories & Policies

• Dividends:
• earnings distributed to shareholders
• Types of Dividends
• Cash Dividends
• Regular
• Extra
• Special
• Stock Dividends
• Liquidating Dividends
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Dividend Payment
• How? & When?
• Chronology of Dividend Payment:
• Declaration Date
• Ex-dividend Date
• Date of Record
• Date of Payment

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Does Dividend Policy Matter?

• Dividend Policy: Schools of Thoughts

• Dividends matter –
• the value of the stock is based on the present
value of expected future dividends
• Dividend policy may not matter –
• Dividend policy is the decision to pay dividends
versus retaining funds to reinvest in the firm
• In theory, if the firm reinvests capital now, it
will grow and can pay higher dividends in the
future 4

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Irrelevance Theory & the M&M
Argument
• If Ds  without  anything else  Firm  in Value
• However, there is a trade-off b/n paying higher
Dividends & doing other things in the firm.
• The irrelevance argument says:
• The trade-off is essentially a zero-sum game, &
• Choosing one dividend policy over the other will
not impact the stock price
• Homemade Dividends
• Dividends are relevant. However, dividend policy 5
is irrelevant
Argument for Dividend Policy
Relevance
Real World Factors Favoring a Low Dividend Payout
• Taxes-timing of payment
• Floatation costs
• Threats due to selling of stock
• Investment opportunities cannot be missed
• Dividend Restrictions: Bond Indentures

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Argument for Dividend Poli…
Real World Factors Favoring a High Dividend Payout
• Desire for Current Income
• Stock Market Reaction
• Clientele Effects
• Retired investors
• Widowed
• Orphans
• Risk Reductions
• Tax Benefits
• Corporate investors 7

• Tax-exempt investors
Establishing Dividend Policy
• Resolution on Dividend Real-World Factors
• Ds  when:
• Management believes it can be sustained
• Expectations of Higher Future Ds,  PV
• Signal of a healthy, growing firm
• Ds  when:
• Management believes it can no longer sustain
• Expectations of Lower Ds indefinitely,  PV
• Signal of a firm that has financial difficulty
• Information Content of Dividends
• The Clientele Effect 8
Special Issues Related to Dividends
Stock Dividends
• Issuance of additional shares to existing
shareholders
• Inadequate Cash Position
•  RE   Common Stock & Additional PIC
• No Change in SHE
•  No. of Shares Held  But, No ∆ in % of Interest
Illustration – Assume Mr. Jote owns 200 shares in a
company that has outstanding shares of 10,000.
What would happen to the % of interest if there is a
stock dividend of 10%? 9
Special Issues…

Stock Split
• Issuance of substantial amount of additional
shares & reducing the par value of the stock on a
proportional basis
• To reduce market price/share & make easier for
small investors
Illustration – A firm has 1,000 shares of Br. 20 par
value common stock and issued a 4 for 1 stock split.
What would result in the number of shares
outstanding and the par value after the split? 10
Special Issues… Stock Repurchases
• Purchasing back previously issued stock
• Alternative to paying dividends
• Outstanding shares   EPS    Stock Price
Illustration – A firm decided to use 20% of its Br. 2.5
million net income to purchase treasury stock. There
were 400,000 shares outstanding with a market price of
Br. 18 a share. The firm intends to buy back 25,000
shares through a tender offer of Br. 20/share.
Determine: 1. The EPS before & after the purchase
2. The P/E Multiple before the purchase, &
3. The expected price after the purchase 11
maintaining the same P/E Ratio
Determinants of Dividend Payout
• Company Growth Rate
• Restrictive Covenants
• Profitability
• Earnings’ Stability
• Maintenance of Control
• Degree of Financial Leverage
• Ability to Finance Externally
• Uncertainty
• Age and Size
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• Tax Penalties
Chapter
Ends

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