Ch 18 Dividend Policy and Retained Earnings

corporate stock repurchase

A corporation may repurchase its shares in the market as an alternative to paying a cash dividend. Earnings per share will go up, and, if the price-earnings ratio remains the same, the stockholder will receive the same dollar benefit as through a cash dividend. A corporation may also justify the repurchase of its stock because it is at a very low price or to maintain constant demand for the shares. Reacquired shares may be used for employee options or as part of a tender offer in a merger or acquisition. Firms may also reacquire part of their shares as a protective device against being taken over as a merger candidate.

life cycle

A curve illustrating the growth phases of a firm. The dividend policy most likely to be employed during each phase is often illustrated.

stock dividend

A dividend paid in stock, rather than cash. A book transfer equal to the market value of the stock dividend is made from retained earnings to the capital stock and paid-in-capital accounts. The stock dividend may be symbolic of corporate growth, but it does not increase the total value of the stockholders' wealth.

stock split

A division of shares by a ratio set by the board of directors—two for one, three for one, three for two, and so on. Stock splits usually indicate the company's stock has risen in price to a level that the directors feel limits the trading appeal of the stock. The par value is divided by the ratio set, and the new shares are issued to the current stockholders of record to increase their shares to the stated level. For example, a two-for-one split would increase holdings from one share to two shares.

reverse stock split

A firm exchanging with stockholders fewer shares for existing shares with the intent of increasing the stock price.

ordinary dividend

A share of a company's profits passed on to the shareholders on a periodic basis.

qualified dividend

A subset of an ordinary dividend that is taxed at a lower rate.

residual theory of dividends

A theory of dividend payout stating that a corporation will retain as much of its earnings as it may profitably invest. If any income is left after investments, the firm will pay dividends. This theory assumes that dividends are a passive decision variable.

net investment income tax

An extra 3.8% tax on investment income above a certain amount, created by Congress to help fund the Affordable Care Act.

dividend yield

Dividends per share divided by market price per share. Dividend yield indicates the percentage return that a stockholder will receive on dividends alone.

dividend reinvestment plans

Plans that provide the investor with an opportunity to buy additional shares of stock with the cash dividends paid by the company.

holder-of-record date

Stockholders owning the stock on the holder-of-record date are entitled to receive a dividend. In order to be listed as an owner on the corporate books, the investor must have bought the stock before it went ex-dividend.

marginal principle of retained earnings

The corporation must be able to earn a higher return on its retained earnings than a stockholder would receive after paying taxes on the distributed dividends.

dividend payment date

The day on which a stockholder of record will receive his or her dividend.

dividend payout ratio

The percentage of dividends to earnings after taxes. It can be computed by dividing dividends per share by earnings per share.

information content of dividends

This theory of dividends assumes that dividends provide information about the financial health and economic expectations of the company. If this is true, corporations must actively manage their dividends to provide the market with information.

ex-dividend date

Two business days before the holder-of-record date. On the ex-dividend date the purchase of the stock no longer carries with it the right to receive the dividend previously declared.