Chapter 15

Information content = Signaling content

A theory that holds that investors regard dividend changes as "signals" of management forecasts. Thus, when dividends are raised, this is viewed by investors as recognition by management of future earnings increases. Therefore, if a firm's stock price increases with a dividend increase, the reason may not be investor preference for dividends but rather expectations of higher future earnings. Conversely, a dividend reduction may signal that management is forecasting poor earnings in the future.

Dividend reinvestment plans (DRIPs)

Allows stockholders to automatically purchase shares of common stock of the paying corporation in lieu of receiving cash dividends. There are two types of plans: one involves only stock that is already outstanding; the other involves newly issued stock. In the first type, the dividends of all participants are pooled and the stock is purchased on the open market. Participants benefit from lower transaction costs. In the second type, the company issues new share to the participants. Thus, the company issues stock in lieu of the cash dividend.

Bird in the hand theory

Assumes that investors value a dollar of dividends more highly than a dollar of expected capital gains, because a certain dividend is less risky than a possible capital gain. This theory implies that a high-dividend stock has a higher price and lower required return, all else held equal.

Stock split

Current shareholders are given some number (or fraction) of shares for each stock share owned. Thus, in a 3-for-1 split, each shareholder would receive three new shares in exchange for each old share, thereby tripling the number of shares outstanding. Stock splits usually occur when the stock price is outside of the optimal trading range.

Low-regular-dividend-plus-extras policy

Dividend policy in which a company announces a low regular dividend that it is sure can be maintained; if extra funds are available, the company pays a specially designated extra dividend or repurchases shares of stock.

Dividend irrelevance theory

Holds that dividend policy has no effect on either the price of a firm's stock or its cost of capital.

Holder-of-record date

If a company lists the stockholder as an owner on the holder-of-record date, then the stockholder receives the dividend.

Residual distribution model

In this model, firms should pay dividends only when more earnings are available then needed to support the optimal capital budget.

Stock dividends

Increases the number of shares outstanding but at a slower rate than splits. Current shareholders receive additional shares on some proportional basis. Thus, a holder of 100 shares would receive 5 additional shares at no cost if a 5% stock dividend were declared.

Stock repurchases

Occurs when a firm repurchases its own stock. These shares of stock are then referred to as treasury stock.

Target distribution ratio

Percentage of net income distributed to shareholders through cash dividends or stock repurchases.

Target payout ratio

Percentage of net income paid as a cash dividend.

Reverse split

Situation in which shareholders exchange a particular number of shares of stock for a smaller number of new shares.

Clientele effect

The attraction of companies with specific dividend policies to those investors who's needs are best served by those policies. Thus, companies with high dividends will have a clientele of investors with low marginal tax rates and strong desires for current income. Conversely, companies with low dividends will have a clientele of investors with high marginal tax rates and little need for current income.

Payment date

The date on which a firm actually mails dividend checks.

Declaration date

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

Ex-dividend date

The date when the right to the dividend leaves the stock. This date was established by stockbrokers to avoid confusion, and it is 2 business days prior to the holder-of-record date. If the stock sale is made prior to the ex-dividend date, then the dividend is paid to the buyer; if the stock is bought on or after the ex-dividend date, the dividend is paid to the seller.

Optimal distribution policy

The distribution policy that maximizes the value of the firm by choosing the optimal level and form of distributions (dividends and stock repurchases).

Distribution policy

The policy that sets the level of distributions and the form of the distributions (dividends and stock repurchases).