Distribution to Shareholders: Dividends and Share Repurchases

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1. Target Payout Ra- The target percentage of net income paid out as cash
tio dividends

2. Optimal Dividend The dividend policy that strikes a balance between current
Policy dividends and future growth and maximizes the firm's
stock price

3. Dividend Irrele- The theory that a firm's dividend policy has no effect on
vance Theory either its value or its cost of capital. (Professor Merton
Miller and Franco MOdigliani (MM))

4. Bird-in-the-Hand MM's name for the Gordon-Lintner theory that a firm's

Fallacy value will be maximized by setting a high dividend payout
ration.

5. Reasons some 1) While dividends reduce transactions costs for investors

Investors prefer who are looking for steady income from their investments,
capital gains dividends increase transactions costs for other investors
who are less interested in income and more interested in
saving money for the long-term future.
2)The Tax Code encourages many individual investors to
prefer capital gains to dividends. The taxed must be paid
on dividends the year they are received, but taxes on
capital gains are not paid until the stock is sold.

6. Information (Sig- The theory that investors regard dividend changes as

naling) Content signals of management's earnings forecasts.

7. Clienteles Different groups of stockholders who prefer different divi-

dend payout policies.

8. Clientele Effect The tendency of a firm to attract a set of investors who like
its dividend policy.

9. Catering Theory A theory that suggests investors' preferences for dividends

vary over time and that corporations adapt their dividend
policies to cater to the current desires of investors.

10. What to consider 1) The overriding objective is to maximize shareholder

when a firm is de- value
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 Distribution to Shareholders: Dividends and Share Repurchases
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ciding how much 2) The firm's cash flows really belong to its shareholders,
cash to distribute so management should not retain income unless they
to stockholders can reinvest those earnings at higher rates of return that
shareholders can earn themselves

11. Residual Divi- A model in which the dividend paid is set equal to net
dend Model income minus the amount of retained earnings necessary
to finance the firm's optimal capital budget (4 Factors).
Dividends = Net Income - Retained Earnings required to
help finance new invetments = ((net equity ratio) (total
capital budget))

12. Optimal Payout 1) Management's opinion about its investors' preferences

Ration depends for dividends versus capital gains
on 4 factors 2) Availability of Cost of External Capital (retail earnings
vs. opportunity cost)
3) Investment Opportunities
4) Target Capital structure of the firm

13. Disadvantages of Following the residual dividend policy would almost cer-
the Residual Div- tainly lead to fluctuating, unstable dividends.
idend Model Possible strategy:
1) Estimate earnings and investment opportunities, on
average, over the next 5 or so years.
2) Use the forecasted information to find the average
dividends that would be paid using the residual model
(and the corresponding payout ratio) during the planning
period.
3) Set a target payout policy based on the projected data.
Thus, firms should use the residual policy to help set their
long-run target payout ratios, but not as a guide to the
payout in any one year.

14. Low-Regural-Div- The policy of announcing a low, regular dividend that can
idend-Plus-Ex- be maintained no matter what and then, when ties are
tras good, paying a designated "extra" dividend.

15. Primary determi- cash flows are actually more important than earnings
nat of dividends

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16. Declaration Date The date on which a firm's directors issue a statement
declaring a dividend

17. Hold- If the company lists the stockholders as an owner on this

er-of-Record date, then the stockholder receives the dividend
Date

18. Ex-Dividend Date The date on which the right to the current dividend no
longer accompanies a stock; it is usually two business
days prior to the holder-of-record date

19. Payment Date The date on which a firm actually mails dividend checks

20. Dividend Rein- Plans that enable stockholders to automatically reinvest

vestment Plan dividends received back into the stocks of the paying firms
(DRIPs)

21. Constraints on 1) Bond indentures

Dividend Pay- 2)Preferred stock restrictions
ments 3)Impairment of capital rule
4)Availability of cash
5)Penalty tax on improperly accumulated earnings

22. Investemt Oppor- 1)Number of profitable investment opportunities

tunities 2)Possibility of accelerating or delaying projects

23. Availability and 1) Cost of selling new stock

cost of alterna- 2) Ability to substitute debt for equity
tive sources of 3) Concerns about maintaining control
capital

24. Stock Split An action taken by a firm to increase the number of shares
outstanding, such as doubling the number of shares out-
standing by giving each stockholder two new shares for
each one formerly held.
Price of a company's stock rises shortly after it announces
a stock split.

25. Stock Dividens A dividend paid in the form of additional shares of stock
rather than in cash.
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26. Effects of Stock 1) Price of a company's stock rises shortly after it an-
Split and Stock nounces a stock split or dividend
Dividends on 2) May lead to higher prices because investors often take
Stock Prices stock splits and dividends as signals of higher future earn-
ings.
3) Will drop during down again the next few months if it
does not announce an increase in earnings and dividends.
That supports the signaling effect discussed earlier.
4) May also increase the stock's liquidity. This tends to
increase the firm's value.
5) Evidence that it changes the mix of shareholders. The
proportion of trades by individual investors tends to in-
crease after a stock split, whereas the proportion of trades
made by institutional investors tends to fall.

27. When use Stock Stock splits are generally used after a sharp price run-up
Split and when a to reduce a large price reduction. Stock dividends used on
Stock Dividend a regular annual basis keep the stock price more or less
constrained.

28. Stock Repur- Transactions in which a firm buys back shares of its own
chases stock, thereby decreasing shares outstanding, increasing
EPS, and, often, increasing the stock price.
1)the firm has cash available for distribution to its stock-
holder
2)the firm concludes that its capital structure is too heavily
weighted with equity, and it sells debt and uses the pro-
cedes to buy back its stock
3)the firm has issued options to employees, and it uses
open market repurchases to obtain stock for use when the
options areexercised

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