Ch 14.

Dividends
© Kelly D. Welch 14-1

 Stock dividends and stock splits

• Increase shares outstanding and reduce price per share
• No cash impact, but might improve liquidity
 Cash dividends
• On ex-dividend date, stock price drops by nearly the dividend amount
• At announcement, price reacts to unexpected news
• Investors pay personal income taxes on dividends
 Share repurchases
• Company buys back its own shares, paying out cash to shareholders
• Reduces shares outstanding, with only a mild effect on share price
• Announcement may signal managers’ view that stock price is too low
• Investors pay capital gains tax rate, and only those that sell
 Aggregate dividends and stock repurchases are
• Massive and have increased steadily
• Heavily concentrated among a few, large firms
 Dividend Policy
© Kelly D. Welch 14-2

 Dividend policy decisions are whether, when, and how to pay

out cash versus retaining funds to reinvest in the firm
• Dividends do matter: stock value = PV of expected future dividends
• Dividend policy may not matter: In theory, if the firm reinvests capital
now, it will grow and can pay higher dividends in the future

 Paying out cash

• Resolves uncertainty whether future higher dividends will materialize
• Uses internal funds, may incur flotation costs if need external funds
• Provides steady income for clienteles, like trusts and retirees
 But investors can create ‘homemade dividends’
• Incurs personal taxes, but not relevant to tax-exempt institutions
• Reduces agency costs, showing that managers act in owners’ interest
• Signals managers’ positive views about firm’s prospects
 Markets react negatively and more strongly to dividend cuts


 Ch 15. Raising Capital
© Kelly D. Welch 15-3

 Venture Capital for startup companies

 Private equity investors actively participate in decisions
 A few firms are able to go public in IPOs
 Initial Public Offerings
 Often underwritten by a syndicate of investment banks for ~7% spread
 Usually with a firm commitment, occasionally best efforts or Dutch auction
 Register with SEC, ~3% accounting and legal fees
 Distribute red-herring prospectus with a price range
 Determine price in tombstone ad on effective date when selling begins
 Green shoe overallotment allows syndicate to purchase an extra 15%
 Usually 180-day lock-up restricting insiders from selling shares
 Underpriced ~19% on average
 Seasoned Equity Offerings
 Price falls ~3% when announced, signals overvalued or at debt capacity
 Bond issues and Private Placements are cheaper to issue
 Shelf Registrations sold in portions over the next 2 years
Tombstone and Issues in WSJ Monday 10/18/10
© Kelly D. Welch 15-4