Corporate finance ch 14
When a firm pays a dividend what 2 messages does it send to the market?
1. Ability to keep paying at new dividend level 2. Managers avoiding "agency problems" by returning this money to owners
What are the 3 philosophical positions on dividends?
1. Based on homemade dividend argument, dividend policy is irrelevant 2. bc of tax effects for individual investors and new issues costs, a low dividend policy is best 3. bc of the desire for current income and related factors, a high-dividend policy is best
What are the mechanisms of a cash dividend payment?
1. Declaration date 2. Ex-dividend date 3. Date of record 4. Date of payment
Real world factors favoring a high payout
1. Desire for current income 2. Tax and legal benefits from high dividends
Tax and legal benefits from high dividends Theory says:
1. Dividends are taxed unfavorably for individual investors 2. The tax on dividends is a powerful argument for a "low" payout
Tax and legal benefits from high dividends What the real world dictates:
1. Infinite number of investors with different objectives 2. They might not all receive unfavorable tax treatment from holding high-dividend yield, rather than low-dividend yield securities
Why might "large" institutions favor high dividend yields?
1. Institutions like pension and trust funds are a lot of the time set up to manage money on behalf of others 2. Institutions like univ. endowment funds and trust funds are usually prohibited from spending any "principal"
What are the areas of the "to pay or to reinvest" debate related to dividend policy?
1. Kinds of dividends and how they are paid 2. Shown not to matter 3. Strategies firms might employ to implement a dividend policy - includes share repurchases an alternative to dividends
Which of the 3 philosophical positions is the correct one?
1. Look at stock prices 2. Stock prices rise when current dividend is unexpectedly increased & vice-versa 3. Behavior is consistent with the 3rd position
Are there any other ways to express the amount of a dividend payment?
1. Percentage of the market price (dividend yield) 2. Percentage of net income or earnings per share ( dividend payout )
Why does a share repurchase cause EPS to increase?
1. Reduces the number of outstanding shares 2. no effect on total earnings 3. EPS rises
What are some basic types of cash dividends?
1. Regular cash dividends 2. Extra dividends 3. Special dividends 4. Liquidating dividends
3 observations about the parameters of dividend policy
1. Research and economic logic suggest that a firms particular dividend policy "doesn't matter" 2. Similar to the capital structure question 3.
What factors favor a "low dividend" payout?
1. Taxes 2. Expected returns are personal taxes 3. Floatation costs
Real world factors favoring a low payout
1. Taxes 2. Flotation costs 3. Dividend restrictions
Why should companies pay "high dividends"?
1. The discounted value of near dividends is higher than the present value of distant dividends 2. Two companies with the same earning power and position in industry, the one paying the larger dividend will almost always sell at a higher price
2 real-world problems with stock repurchases?
1. Verifiability - will firm really repurchase like any other investor in 2nd market? 2. Might force managers to make a neg. NPV inv. if management "insiders" believe stock is overvalued in market
Ex-dividend date
2 business days before the date-of-record, establishing those names entitled to a dividend
Why is the phrase "thought" to be stockholders important?
A firms records might not show recent sales of stock so the dividend payment could get credited to the wrong person
Plow back ratio
Addition to retained earnings / net income
Why has the number of firms that actually pay dividends gone down? why?
Amount of dividends paid is enormous Reasons: 1. Many more small firms, pay smaller dividends on smaller profits 2. For flexibility, share repurchases have replaced cash distr.
Stock repurchase
Another way to pay out a firms earnings to its owners Provides more preferable tax treatment than dividends
Clientele effect
Argument states that different groups of investors desire different levels of dividends
Why are dividends not irrelevant?
Bc if the dividend payment is raised the value of the stock will rise as well
Why is determining the "after-tax value" complicated?
Bc of the different tax rate and tax rules that apply for different buyers
Who makes the decision to pay a dividend?
Board of directors of the corporation
Investors are able to transform any firms into a different policy by...
Buying or selling shares of stock on their own
Dividend payout ratio
Cash dividends / net income
why might some non-individual investors prefer high-dividend payout?
Corp. investors get tax-breaks on dividends paid out
Date of record
Date by which a holder must be "on record" in order to be designated to get a dividend
Date of payment
Date that dividend checks are mailed
Current policy
Dividends set equal to cash flow
Why do stock prices react favorably when a dividend payment goes up?
Expectations of future dividends are revised upwards not bc the firm has increased its current payout
If the PV pf expected future dividends falls what happens to the stock price?
Falls
Dividends are irrelevant True or false
False
Open market purchases
Firm not revealed as buyer and purchases like any other investor in the secondary market
How do investors price a security?
Forecasting and discounting future dividends
An unexpected increase in dividend tends to signal _______ ?
Good news
What is the usual way of expressing the cash dividend payment?
In terms of dollars per share
Alternative policy
Initial dividend > cash flow
What 3 things can stock splits and stock dividends do?
Leave, increase, and decrease the value of the firm
How do share dividends effect other outstanding shares?
Make them worth less
Tender offer
Makes offer above current market price so has to offer a reward to the current shareholders willing to sell
Extra cash dividend
Management is indicating that the "extra" may or may not be repeated in the future
Cash dividends
Most common type of dividend ( usually 4x a year)
Why isn't reward of stock dividend a "true" dividend?
Not in cash
What effect does the payout of a stock dividend have?
Number of shares each stockholder holds increases
Current policy formula
P(0)= [D1/(1+R)^1] + [D2/(1+R)^2] D= dividend per share R = required return
Some of the best known members of the "tax-exempt investment"
Pension, endowment and trust funds
1 - dividend payout ratio
Plow back ratio
The value of the stock equals _______ of future dividends?
Present value
If dividend payment raises what will value of stock do?
Raise
What does it mean the EPS increases?
Reflects the change in the number of shares outstanding
_______ have an incentive to pursue low or zero-payout stocks and _______ have an incentive to pursue high-payout stocks
Rich people Corporations
Stock split
Same as stock dividend but this is a ratio When declared, it's split up to create more shares
Why would a $1 dividend today be worth more than that same $1 in a bank account by a corporation?
Shareholder can sell some of the stock and actually convert that $1 worth into cash much quicker than the company would ever do it for the shareholder Liquidity is worth a premium to you
In a share repurchase a shareholder pays taxes ONLY if...
Shareholder chooses to sell and has capital gain on the sale
What is the "re-fined" dividend policy question?
Should a firm pay a large, small, or zero percentage of earnings now?
What is the accurate dividend policy question?
Should pay out cash now or invest the cash and pay it out later
What is the 2 part "dividend policy" question?
Should the firm pay out money to its shareholders? Should the firm take that money and invest it for its shareholders?
Liquidating dividend
Some or all of the business had been liquidated
Why might a firm face restrictions on its ability to pay dividends
State law may prohibit a corporation from paying dividends if the dividend amount exceeds the firms retained earnings
Small stock dividends
Stock dividends that are less than 20-25%
What happens to the value of the stock overnight?
Stock worth about $1 less on Friday morning so the price will decline by approx. this amount from Thursday's close to Friday's opening
What are some reasons for a low payout?
Tax benefits and flotation costs
Why do repurchases benefit the firm?
Tax considerations
Homemade dividends
The [tailor-made] dividend policy created by the individual investors who [basically] undo official corporate dividend policy by reinvesting dividends or selling shares of stock
Declaration date
The date the board passes to pay dividend
What does the term dividend policy let you know about the dividend?
The time pattern of dividend payout
Companies cut dividends only with great reluctance True or False
True
Dividend policy is irrelevant
True
Special dividend
Truly unusual or one-time event and won't be repeated
No matter what pattern of dividend payout a firm chooses _________ will always be the same
Value of the stock
Targeted repurchase
When company feels like they need to buyback its own stock from another corporation, at a premium, to avoid takeover
If there are no imperfections is the cash dividend and share repurchase the same thing?
YES
Ex-dividend date
a. Buy on this date or after and the previous owner will get the dividend b. Ex dividend date convention indicates who is entitled to the dividend c. Dividend has "value"
What other factors favor a high dividend payout policy?
a. Desire for current income b. Resolution of uncertainty
Why is the key word "about" so important when talking about the value of stock?
a. Dividends are taxed as income to the individual b. The actual price might drop and be closer to some measure of the dividends "after-tax value"
Date of record
a. Firm prepares a list of people thought to be stockholders b. Shareholders are also known as the holders of record
Large stock dividends
dividend Greater than 25%
Dissatisfied stockholders can modify any firms dividend policy to suit themselves True or false
true