Dividend policy

Prof. Balagopal Gopalakrishnan

Indian Institute of Management Kozhikode

EPGP - October 2020

Key Concepts and Skills
Understand dividend types and how they are paid.
Key Concepts and Skills
Understand dividend types and how they are paid.

Understand the issues surrounding dividend policy decisions.

Key Concepts and Skills
Understand dividend types and how they are paid.

Understand the issues surrounding dividend policy decisions.

Understand why share repurchases are an alternative to dividends.

Key Concepts and Skills
Understand dividend types and how they are paid.

Understand the issues surrounding dividend policy decisions.

Understand why share repurchases are an alternative to dividends.

Understand the difference between cash and stock dividends.

Different Types of Payouts
Many companies pay a regular cash dividend.
Different Types of Payouts
Many companies pay a regular cash dividend.

I Public companies often pay quarterly.

Different Types of Payouts
Many companies pay a regular cash dividend.

I Public companies often pay quarterly.

I Sometimes firms will pay an extra cash dividend.

Different Types of Payouts
Many companies pay a regular cash dividend.

I Public companies often pay quarterly.

I Sometimes firms will pay an extra cash dividend.

I The extreme case would be a liquidating dividend.

Different Types of Payouts
Many companies pay a regular cash dividend.

I Public companies often pay quarterly.

I Sometimes firms will pay an extra cash dividend.

I The extreme case would be a liquidating dividend.

Companies will often declare stock dividends.

Different Types of Payouts
Many companies pay a regular cash dividend.

I Public companies often pay quarterly.

I Sometimes firms will pay an extra cash dividend.

I The extreme case would be a liquidating dividend.

Companies will often declare stock dividends.

I No cash leaves the firm.

Different Types of Payouts
Many companies pay a regular cash dividend.

I Public companies often pay quarterly.

I Sometimes firms will pay an extra cash dividend.

I The extreme case would be a liquidating dividend.

Companies will often declare stock dividends.

I No cash leaves the firm.

I The firm increases the number of shares outstanding.

Different Types of Payouts
Many companies pay a regular cash dividend.

I Public companies often pay quarterly.

I Sometimes firms will pay an extra cash dividend.

I The extreme case would be a liquidating dividend.

Companies will often declare stock dividends.

I No cash leaves the firm.

I The firm increases the number of shares outstanding.

Some companies declare a dividend in kind.

Different Types of Payouts
Many companies pay a regular cash dividend.

I Public companies often pay quarterly.

I Sometimes firms will pay an extra cash dividend.

I The extreme case would be a liquidating dividend.

Companies will often declare stock dividends.

I No cash leaves the firm.

I The firm increases the number of shares outstanding.

Some companies declare a dividend in kind.

Other companies use stock buybacks.

Standard methods of cash dividends
Payment of cash by the firm to its shareholders.
Standard methods of cash dividends
Payment of cash by the firm to its shareholders.

Declaration Date: The Board of Directors declares a payment of dividends.

Standard methods of cash dividends
Payment of cash by the firm to its shareholders.

Declaration Date: The Board of Directors declares a payment of dividends.

Cum-Dividend Date: Buyer of stock still receives the dividend

Standard methods of cash dividends
Payment of cash by the firm to its shareholders.

Declaration Date: The Board of Directors declares a payment of dividends.

Cum-Dividend Date: Buyer of stock still receives the dividend

Ex-Dividend Date: Date that determines whether a stockholder is entitled to a

dividend payment; anyone holding stock immediately before this date is entitled
to a dividend.
Standard methods of cash dividends
Payment of cash by the firm to its shareholders.

Declaration Date: The Board of Directors declares a payment of dividends.

Cum-Dividend Date: Buyer of stock still receives the dividend

Ex-Dividend Date: Date that determines whether a stockholder is entitled to a

dividend payment; anyone holding stock immediately before this date is entitled
to a dividend.

Record Date: Date on which company determines existing shareholders.

Nomenclature for payouts
Dividend rate: Dividend paid as a percentage of the face value of the share
Nomenclature for payouts
Dividend rate: Dividend paid as a percentage of the face value of the share

Payout ratio: Dividend paid as a ratio of total earnings (net income)

Nomenclature for payouts
Dividend rate: Dividend paid as a percentage of the face value of the share

Payout ratio: Dividend paid as a ratio of total earnings (net income)

Dividend yield: Dividends paid as as proportion of the price of the stock

Dividend payout in India

Source: Dixit, B. K., Gupta, N., & Saurabh, S. (2020). Dividend policy in India: reconciling theory and evidence.
Managerial Finance.
Dividend yields in India
Yields (as of March 2020)
200
150
Frequency
100
50
0

0 10 20 30 40 50
Dividend yield (%)

Source: CMIE Prowess (Of the sample of 788 firms which is invested by Mutual funds, 177 firms have not paid
dividends)
The Irrelevance of Dividend Policy
Since investors do not need dividends to convert shares to cash, they will not
pay higher prices for firms with higher dividends.
The Irrelevance of Dividend Policy
Since investors do not need dividends to convert shares to cash, they will not
pay higher prices for firms with higher dividends.

In other words, dividend policy will have no impact on the value of the firm
because investors can create whatever income stream they prefer by using
homemade dividends.
Homemade Dividends
Naturals Ltd. is a |42 stock about to pay a |2 cash dividend.
Homemade Dividends
Naturals Ltd. is a |42 stock about to pay a |2 cash dividend.

An investor owns 8000 shares and prefers a |3 dividend.

Homemade Dividends
Naturals Ltd. is a |42 stock about to pay a |2 cash dividend.

An investor owns 8000 shares and prefers a |3 dividend.

Can this investor have a homemade dividend strategy ?

Homemade Dividends
Naturals Ltd. is a |42 stock about to pay a |2 cash dividend.

An investor owns 8000 shares and prefers a |3 dividend.

Can this investor have a homemade dividend strategy ?

Sell 200 shares ex-dividend

Homemade Dividends
Naturals Ltd. is a |42 stock about to pay a |2 cash dividend.

An investor owns 8000 shares and prefers a |3 dividend.

Can this investor have a homemade dividend strategy ?

Sell 200 shares ex-dividend

In the above example, show that the total wealth to the investor remains the
same in all scenarios.
Dividends and Investment Policy
Firms should never forgo positive NPV projects to increase a dividend (or to
pay a dividend for the first time).
Dividends and Investment Policy
Firms should never forgo positive NPV projects to increase a dividend (or to
pay a dividend for the first time).

One of the KEY assumptions underlying the dividend-irrelevance argument is:

“The investment policy of the firm is set ahead of time and is not altered by
changes in dividend policy.”
Repurchase of Stock
Instead of declaring cash dividends, firms can rid themselves of excess cash
through buying shares of their own stock.
Repurchase of Stock
Instead of declaring cash dividends, firms can rid themselves of excess cash
through buying shares of their own stock.

Recently, share repurchase has become an important way of distributing

earnings to shareholders.
Repurchase of Stock
Instead of declaring cash dividends, firms can rid themselves of excess cash
through buying shares of their own stock.

Recently, share repurchase has become an important way of distributing

earnings to shareholders.

Buybacks can be done through open market repurchase programs, tender offers,
or auctions. In India the first two are the modes of buybacks.
Repurchase of Stock
Instead of declaring cash dividends, firms can rid themselves of excess cash
through buying shares of their own stock.

Recently, share repurchase has become an important way of distributing

earnings to shareholders.

Buybacks can be done through open market repurchase programs, tender offers,
or auctions. In India the first two are the modes of buybacks.

SEBI - Buybacks database is a gold mine of information on share buybacks

Repurchase of Stock
Instead of declaring cash dividends, firms can rid themselves of excess cash
through buying shares of their own stock.

Recently, share repurchase has become an important way of distributing

earnings to shareholders.

Buybacks can be done through open market repurchase programs, tender offers,
or auctions. In India the first two are the modes of buybacks.

SEBI - Buybacks database is a gold mine of information on share buybacks

SEBI 2013 notification on controlling cheap talk in repurchase

Repurchase of Stock
Instead of declaring cash dividends, firms can rid themselves of excess cash
through buying shares of their own stock.

Recently, share repurchase has become an important way of distributing

earnings to shareholders.

Buybacks can be done through open market repurchase programs, tender offers,
or auctions. In India the first two are the modes of buybacks.

SEBI - Buybacks database is a gold mine of information on share buybacks

SEBI 2013 notification on controlling cheap talk in repurchase

Dayanandan et.al (2020) finds that average abnormal return on announcement

day is 2.07 percent
Stock repurchase vs. dividend
Consider a firm that wishes to distribute $100,000 to its shareholders
Stock repurchase vs. dividend
Consider a firm that wishes to distribute $100,000 to its shareholders
Stock repurchase vs. dividend
Consider a firm that wishes to distribute $100,000 to its shareholders

Assets Liabilities & Equity

Cash 150,000 Debt 0
Other Assets 850,000 Equity 1,000,000
Value of firm 1,000,000 Value of firm 1,000,000
Shares outstanding is 100,000
Stock repurchase vs. dividend
Consider a firm that wishes to distribute $100,000 to its shareholders

Assets Liabilities & Equity

Cash 150,000 Debt 0
Other Assets 850,000 Equity 1,000,000
Value of firm 1,000,000 Value of firm 1,000,000
Shares outstanding is 100,000

Price per share is

Stock repurchase vs. dividend
Consider a firm that wishes to distribute $100,000 to its shareholders

Assets Liabilities & Equity

Cash 150,000 Debt 0
Other Assets 850,000 Equity 1,000,000
Value of firm 1,000,000 Value of firm 1,000,000
Shares outstanding is 100,000

Price per share is

Stock repurchase vs. dividend
Consider a firm that wishes to distribute $100,000 to its shareholders

Assets Liabilities & Equity

Cash 150,000 Debt 0
Other Assets 850,000 Equity 1,000,000
Value of firm 1,000,000 Value of firm 1,000,000
Shares outstanding is 100,000

Price per share is $10

Stock repurchase vs. dividend
If the firm distributes $100,000 as cash dividend, what happens to the balance
sheet?
Stock repurchase vs. dividend
If the firm distributes $100,000 as cash dividend, what happens to the balance
sheet?
Stock repurchase vs. dividend
If the firm distributes $100,000 as cash dividend, what happens to the balance
sheet?

Assets Liabilities & Equity

Cash 50,000 Debt 0
Other Assets 850,000 Equity 900,000
Value of firm 900,000 Value of firm 900,000
Shares outstanding is 100,000
Stock repurchase vs. dividend
If the firm distributes $100,000 as cash dividend, what happens to the balance
sheet?

Assets Liabilities & Equity

Cash 50,000 Debt 0
Other Assets 850,000 Equity 900,000
Value of firm 900,000 Value of firm 900,000
Shares outstanding is 100,000

Price per share is

Stock repurchase vs. dividend
If the firm distributes $100,000 as cash dividend, what happens to the balance
sheet?

Assets Liabilities & Equity

Cash 50,000 Debt 0
Other Assets 850,000 Equity 900,000
Value of firm 900,000 Value of firm 900,000
Shares outstanding is 100,000

Price per share is

Stock repurchase vs. dividend
If the firm distributes $100,000 as cash dividend, what happens to the balance
sheet?

Assets Liabilities & Equity

Cash 50,000 Debt 0
Other Assets 850,000 Equity 900,000
Value of firm 900,000 Value of firm 900,000
Shares outstanding is 100,000

Price per share is $9

Stock repurchase vs. dividend
If the firm distributes $100,000 through stock reourchase, what happens to the
balance sheet?
Stock repurchase vs. dividend
If the firm distributes $100,000 through stock reourchase, what happens to the
balance sheet?
Stock repurchase vs. dividend
If the firm distributes $100,000 through stock reourchase, what happens to the
balance sheet?

Assets Liabilities & Equity

Cash 50,000 Debt 0
Other Assets 850,000 Equity 900,000
Value of firm 900,000 Value of firm 900,000
Shares outstanding is 90,000
Stock repurchase vs. dividend
If the firm distributes $100,000 through stock reourchase, what happens to the
balance sheet?

Assets Liabilities & Equity

Cash 50,000 Debt 0
Other Assets 850,000 Equity 900,000
Value of firm 900,000 Value of firm 900,000
Shares outstanding is 90,000

Price per share is

Stock repurchase vs. dividend
If the firm distributes $100,000 through stock reourchase, what happens to the
balance sheet?

Assets Liabilities & Equity

Cash 50,000 Debt 0
Other Assets 850,000 Equity 900,000
Value of firm 900,000 Value of firm 900,000
Shares outstanding is 90,000

Price per share is

Stock repurchase vs. dividend
If the firm distributes $100,000 through stock reourchase, what happens to the
balance sheet?

Assets Liabilities & Equity

Cash 50,000 Debt 0
Other Assets 850,000 Equity 900,000
Value of firm 900,000 Value of firm 900,000
Shares outstanding is 90,000

Price per share is $10

Share Repurchase
Flexibility in payouts
Share Repurchase
Flexibility in payouts

Keeps stock price higher: Good for insiders who hold stock options
Share Repurchase
Flexibility in payouts

Keeps stock price higher: Good for insiders who hold stock options

As an investment of the firm (undervaluation)

Share Repurchase
Flexibility in payouts

Keeps stock price higher: Good for insiders who hold stock options

As an investment of the firm (undervaluation)

Tax benefits
Dividend - Practice questions
A firm that 12,000 outstanding shares is planning to offer a DPS of 1.9. The
price per share today is $ 41.92. The firm is all equity financed and currently
has a cash balance of $ 58,000. What is the cash balance and price per share
after the dividend payout?
Dividend - Practice questions
A firm that 12,000 outstanding shares is planning to offer a DPS of 1.9. The
price per share today is $ 41.92. The firm is all equity financed and currently
has a cash balance of $ 58,000. What is the cash balance and price per share
after the dividend payout?

If the firm changes the policy and plans to use the same cash proceeds to
repurchase shares, what is the cash balance and the price per share ?
Dividend - Practice questions
A firm that 12,000 outstanding shares is planning to offer a DPS of 1.9. The
price per share today is $ 41.92. The firm is all equity financed and currently
has a cash balance of $ 58,000. What is the cash balance and price per share
after the dividend payout?

If the firm changes the policy and plans to use the same cash proceeds to
repurchase shares, what is the cash balance and the price per share ?

An all equity firm started and run by couple of EPGP students has a value of
|65.5 lakhs. The number of shares issued by the firm is 22,000. In the AGM,
the board approved for a stock dividend of one stock for every four stocks held
by the shareholders. What should be the old and new share price of this firm?
Taxes and Dividends
In the presence of personal taxes
Taxes and Dividends
In the presence of personal taxes

I A firm should not issue stock to pay a dividend

Taxes and Dividends
In the presence of personal taxes

I A firm should not issue stock to pay a dividend

I Managers have an incentive to seek alternative uses for funds to reduce

dividends.
Taxes and Dividends
In the presence of personal taxes

I A firm should not issue stock to pay a dividend

I Managers have an incentive to seek alternative uses for funds to reduce

dividends.

I Though personal taxes mitigate against the payment of dividends, these

taxes are not sufficient to lead firms to eliminate all dividends.
Real-World Factors Favoring High Dividends
Desire for Current Income
Real-World Factors Favoring High Dividends
Desire for Current Income

Behavioral Finance argument - Forces self-discipline

Real-World Factors Favoring High Dividends
Desire for Current Income

Behavioral Finance argument - Forces self-discipline

Tax arbitrage
Real-World Factors Favoring High Dividends
Desire for Current Income

Behavioral Finance argument - Forces self-discipline

Tax arbitrage

Agency costs
The Clientele Effect
Clienteles for various dividend payout policies are likely to form in the following
way
The Clientele Effect
Clienteles for various dividend payout policies are likely to form in the following
way
The Clientele Effect
Clienteles for various dividend payout policies are likely to form in the following
way
The Clientele Effect
Clienteles for various dividend payout policies are likely to form in the following
way

Group Stock type - Payout type

High tax bracket individuals Zero-to-low payout
Low tax bracket individuals Low-to-medium payout
Tax free institutions Medium payout
Stock splits
Stock splits – essentially the same as a stock dividend except it is expressed as
a ratio
Stock splits
Stock splits – essentially the same as a stock dividend except it is expressed as
a ratio

I For example, a 2 for 1 stock split is the same as a 100% stock dividend.
Stock splits
Stock splits – essentially the same as a stock dividend except it is expressed as
a ratio

I For example, a 2 for 1 stock split is the same as a 100% stock dividend.

Stock price is reduced when the stock splits.

Stock splits
Stock splits – essentially the same as a stock dividend except it is expressed as
a ratio

I For example, a 2 for 1 stock split is the same as a 100% stock dividend.

Stock price is reduced when the stock splits.

Common explanation for split is to return price to a “more desirable trading

range.”
What We Know
Corporations “smooth” dividends.
What We Know
Corporations “smooth” dividends.

Fewer companies are paying dividends.

What We Know
Corporations “smooth” dividends.

Fewer companies are paying dividends.

Dividends provide information to the market.

What We Know
Corporations “smooth” dividends.

Fewer companies are paying dividends.

Dividends provide information to the market.

Firms should follow a sensible policy

What We Know
Corporations “smooth” dividends.

Fewer companies are paying dividends.

Dividends provide information to the market.

Firms should follow a sensible policy

I Do not forgo positive NPV projects just to pay a dividend

What We Know
Corporations “smooth” dividends.

Fewer companies are paying dividends.

Dividends provide information to the market.

Firms should follow a sensible policy

I Do not forgo positive NPV projects just to pay a dividend

I Avoid issuing stock to pay dividends

What We Know
Corporations “smooth” dividends.

Fewer companies are paying dividends.

Dividends provide information to the market.

Firms should follow a sensible policy

I Do not forgo positive NPV projects just to pay a dividend

I Avoid issuing stock to pay dividends

I Consider share repurchase when there are few better uses for the cash
Putting It All Together
Aggregate payouts are massive and have increased over time
Putting It All Together
Aggregate payouts are massive and have increased over time

Dividends are concentrated among a small number of large, mature firms -

maybe lifecycle effect
Putting It All Together
Aggregate payouts are massive and have increased over time

Dividends are concentrated among a small number of large, mature firms -

maybe lifecycle effect

Managers are reluctant to cut dividends

Putting It All Together
Aggregate payouts are massive and have increased over time

Dividends are concentrated among a small number of large, mature firms -

maybe lifecycle effect

Managers are reluctant to cut dividends

Managers smooth dividends

Putting It All Together
Aggregate payouts are massive and have increased over time

Dividends are concentrated among a small number of large, mature firms -

maybe lifecycle effect

Managers are reluctant to cut dividends

Managers smooth dividends

Stock prices react to unanticipated changes in dividends.

Dividend payout - empirical observations
Investment Opportunities: More investment opportunities - Lower dividends
Dividend payout - empirical observations
Investment Opportunities: More investment opportunities - Lower dividends

Stability in earnings: More stable earnings - Higher dividends

Dividend payout - empirical observations
Investment Opportunities: More investment opportunities - Lower dividends

Stability in earnings: More stable earnings - Higher dividends

Alternative sources of capital: More alternative sources - Higher dividends

Dividend payout - empirical observations
Investment Opportunities: More investment opportunities - Lower dividends

Stability in earnings: More stable earnings - Higher dividends

Alternative sources of capital: More alternative sources - Higher dividends

Constraints: More constraints imposed by bondholders and lenders - Lower

dividends
Dividend payout - empirical observations
Investment Opportunities: More investment opportunities - Lower dividends

Stability in earnings: More stable earnings - Higher dividends

Alternative sources of capital: More alternative sources - Higher dividends

Constraints: More constraints imposed by bondholders and lenders - Lower

dividends

Signaling Incentives: More options to supply information to financial markets -

Lower need to pay dividends as signal
Dividend payout - empirical observations
Investment Opportunities: More investment opportunities - Lower dividends

Stability in earnings: More stable earnings - Higher dividends

Alternative sources of capital: More alternative sources - Higher dividends

Constraints: More constraints imposed by bondholders and lenders - Lower

dividends

Signaling Incentives: More options to supply information to financial markets -

Lower need to pay dividends as signal

Stockholder characteristics: Older, poorer stockholders - Higher dividends