Intermediate Finance Ch. 15

Other Dividend Policy Theories

"Bird in the Hand" - Bhattacharya (1979) -Investors might think dividends (i.e., the-bird-in-the-hand) are less risky than potential future capital gains on the stock.... (you get the dividend, but capital gains in the future are unknown, so you get your money and no worry) -High payouts help reduce agency costs.. (agency costs are the costs you have from the separation of ownership and control) -In this scenario, investor value high payout firms more, thereby reducing their required rate of return. (Since they are less risky, their stock should be less) Catering Theory - Baker and Wurglers (2004) -Firms cater to the time-varying dividend demands of investors, in hopes to receive a price premium. (Maybe demand for dividends vary over time.) Clientele Theory - Allen, Bernardo, and Welch (2000) -Shareholder composition influences dividend policy Tax Effect Theory -Investor prefer capital gains tax to dividend tax. Why? (because there is a different on tax rates based on if you have a qualified or non qualified dividends.) -How does this affect the required rate of return on a stock? (If people prefer dividends, that stock would have less risk and lower returns. In this case, it would be flipped) Signaling Theory - Spence (1973) -What does changing or initiating a dividend signal to investors? (If a firm is able to pay or increase a dividend, this signals to investors that it the company is positive.) (Example: college, the diploma signals to employers that you are knowledgable and can offer value.)

Stock Splits

-Essentially the same as a stock dividend except it is expressed as a ratio (-)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." (-) Example: Apple!

The Residual Distribution Model

-Find the reinvested earnings needed for the capital budget. -Pay out any leftover earnings (the residual) as either dividends or stock repurchases -This policy minimizes flotation and equity signaling costs, thereby minimizing WACC.

Reasons to not sell shares back to a company

-Have to pay capital gains tax -When dividends are paid, you have to pay capital gains tax... So, taxes can influence shareholder preference for dividends versus share repurchases

Stock Dividends

-Pay additional shares of stock instead of cash -Increases the number of outstanding shares -Small stock dividend... Less than 20 to 25%. If you own 100 shares and the company declared a 10% stock dividend, you would receive an additional 10 shares. -Large stock dividend is more than 20 to 25%

Free Cash Flow: Distributions to Shareholders

-Paying a dividend -Repurchasing Stock

What do CEO's Think Payout Policy in the 21st Century - Brav, Graham, Harvey, Michaely (2005)

-Survey 384 financial executives to identify the factors that drive dividend and share repurchase decisions. -CEO's view maintaining a dividend level as important and repurchases are made from residual cash flows after investment spending. -Managers prefer repurchases due to their flexibility and market timing capabilities. -Companies are likely to repurchase when good investments are hard to find, when their stock's float is adequate, and when they wish to offset option dilution. -Clientele theory has little effect on their payout policy decisions. -Executives appear to pay little attention to taxes.

Dividend Stock Price Impact

-The price drops by the amount of the cash dividend In a perfect world, the stock price will fall by the amount of the dividend on the ex-dividend date. -Empirically, the price drop is more often less than the dividend -This price drop occurs in the first few minutes of trading on the ex-date

Procedure for Cash Dividend

1. Declaration Date: The Board of Directors declares a payment of dividends. 2. Cum-Dividend Date: Buyer of stock still receives the dividend. 3. Ex-Dividend Date: Seller of the stock retains the dividend. 3. Record Date: The corporation prepares a list of all individuals believed to be stockholders as of a date.

What's Really Going On?

1. Disappearing Dividends - Fama French (2001) -Document a decline in the propensity of firms to pay a dividend over the time period 1978 to 1999. This lower propensity to pay is regardless of firm characteristics and the study itself is primarily descriptive. 2. Substitution Effect - Grullon and Michaely (2002) -Document a significant decline in dividend from 1980 to 2000 and a significant increase in repurchases over this same time period. Find that the increase in repurchases has been financed by potential increases in dividends, suggesting that these payout methods are substitutes.

Firm Payout Policy

Firms often establish a payout policy for investors that gives information about distributions. These distributions consist of: 1. Cash dividend -Public companies often pay quarterly. -Sometimes firms will pay an extra cash dividend. -The extreme case would be a liquidating dividend. 2. Stock Dividends -No cash leaves the firm -The firm increases the number of shares outstanding. 3. Dividend in Kind -Oculus "Rift" 4. Stock Repurchase

Stock Repurchase

How can a firm repurchase shares? -Purchase shares in the open market -Tender Offer: Announce to all existing shareholders the number of share to repurchase and at what price -Targeted Repurchase: Buy share from particular shareholders

Advantages of a Share Repurchase

Note that the only way for investors to be indifferent between dividends and share repurchase is if the market is frictionless (i.e. no taxes, uncertainty, and the like). When frictions are present, repurchase is generally preferred due to the following: 1. Flexibility 2. Smooth out the dividend policy 3. Offset for executive compensation delution 4. Market Timing 5. Raise Earnings per share 6. Taxes

Apple versus Carl Icahn

Other Alternatives for Apple 1. Pay a dividend2. Repurchase shares3. Buy another company4. Take on more positive NPV projects5. Build and awesome spaceship?

"The Dividend of the Month Premium" Hartzmark and Solomon (2013) JFE

We find an asset pricing anomaly whereby companies have positive abnormal returns in months when they are predicted to issue a dividend. Abnormal returns in predicted dividend months are high relative to other companies and relative to dividend-paying companies in months without a predicted dividend, making risk-based explanations unlikely. The anomaly is as large as the value premium, but less volatile. The premium is consistent with price pressure from dividend-seeking investors. Mea- sures of liquidity and demand for dividends are associated with larger price increases in the period before the ex-day (when there is no news about the dividend) and larger reversals afterward. What are the implications of this for payout policy? -Firms should all pay dividends and ignore repurchases in this case -Could you take advantage of this? -Everyone starts doing this once they hear about it, so prices rise -Markets are fairly efficient on average, so most likely no you could not take advantage of this.

Argument for Dividend Irrelevance

When a firm has a predetermined investment policy, what are some compelling reasons for dividend policy to be irrelevant? -Liquidity need of investors can be satisfied in many other ways than through dividends (Dividend premium should not exist) -Homemade Dividends

Modigliani-Miller Theorem

suggests dividend policy choice is irrelevant and should not affect firm value. What about the Dividend of the Month Premium? -There is none, this theory relies on the assumptions of no tax or commissions