Dividend Policy
1
Cash dividends: ordinary,
extraordinary.
Types of
dividends
Stock dividend: increases
number of shares,
reduces share price.
2
Stable: Fixed dividend amount
(or increase) over time.
Types of policies
Constant: Based on a target
payout ratio (contingent on
earnings)
Residual: Div paid only after
funding needs are covered.
3
Dividend events
• Declaration Date: Date in which management
(BofD) declares the Dividend.
• Date of Record: Date (set by firm) on which
investors must own shares to receive the
declared dividend.
• Ex-Dividend Date: Date set by NASD (one bus.
day before Date of Record) in which a stock
becomes ex-dividend.
• Ex-dividend stock: no longer provides holder
with right to receive recently declared div.
(price drops)
• Payment Date: the date that the “check” is
actually mailed to investors
4
Dividend events
Ex-dividend
date
Declaration
date
2-3 weeks
Board
announces
dividend
Holder-ofrecord date
1 Bus day
Stock must
be bought
before this
date to
receive
dividend
Company
closes books
and records
owners of
stock
Payment
date
2-3 weeks
Dividend is
paid
Price drops
today by
about the
dividend
amount
5
Ex-dividend
date
Declaration
date
2-3 weeks
Board
announces
dividend
Holder-ofrecord date
Payment
date
2-3 weeks
Dividend is
paid
“ST. PAUL, Minn., Nov. 7, 2023 /PRNewswire/ -- The 3M Board of Directors (NYSE:MMM)
today declared a dividend on the company's common stock of $1.50 per share for the
fourth quarter of 2023. The dividend is payable Dec. 12, 2023, to shareholders of record at
the close of business on Nov. 17, 2023.
3M has paid dividends to its shareholders without interruption for more than 100 years.”
The ex-dividend date is Nov. 16, 2023.
6
Closing Prices: Arlington Asset Investment Corp
(AI)
$28.00
$27.90
$27.80
Ex-dividend day
Dividend: 0.88
$27.70
$27.60
$27.50
$27.40
$27.30
$27.20
$27.10
17-Jun
18-Jun
19-Jun
20-Jun
21-Jun
22-Jun
23-Jun
24-Jun
25-Jun
26-Jun
27-Jun
28-Jun
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Metrics related to dividend
payments
• Dividend yield:
Rdiv= Divide annual dividend
payment per share by price per
share. The remaining return
required by equity holders is thus
a function of capital gains
• Dividend Payout = Dividends/NI
8
Some dividend facts (1)
• Firms tend to have long term
dividend payout targets
• Maintaining dividend level is
on par with investment
decisions
9
Some dividend facts (2)
• Managers are not receptive to
changes in dividend policy.
• They only increase dividends
when they believe they can
sustain payments.
• They only decrease payout
when forced to.
• => Changes in dividend payments
do follow changes in earnings, but
in a lagged fashion.
10
Some dividend facts (3)
• A change in dividend policy affects
share prices.
• Dividend payments are a function of the
firm’s life-cycle:
• Firms with high growth and investment
opportunities have low or null payout
ratios
• Mature firms with stable earnings and
fewer investment opportunities have
higher payout ratios
• Dividend policy is related to industry
11
Because markets are not
perfect:
• Information asymmetry: dividend
policy may be relevant, and thus affect
share price, if a change in policy
provides a signal of firm quality (i.e., an
optimistic/pessimistic view of future
CFs).
• Transaction costs: dividend payments
are costly and therefore a valid signal.
In addition, s/h incur costs when forced
to undo any undesired dividend policy
made by the firm(clientele effect).
Thus, dividend policy does matter to
them.
12
Because markets are not
perfect:
• Flotation costs: S/h will not be indifferent to
the source of financing. If investment
opportunities must be financed by issuing
securities (because portion of available
funds are committed to Div.), the flotation
costs are paid by s/h.
• Taxes: differences in tax treatment of
dividends versus capital gains generates
clientele effect.
• Agency costs: excessive cash availability
may prove “too tempting” for management.
A commitment to a set dividend policy
exerts greater control of the manner in
which managers use the firm’s cash.
13
The alternative:
Share Repurchase
• Firm buys own shares in
the mkt, sellers receive
cash
• Once purchased, firm can
retire shares or keep them
in stock
14
Some facts about share repurchases
• Funded with residual cash flow after
investment spending
• Provide greater flexibility than dividends
• Provide greater benefit in countries with
greater tax differences in treating dividends
versus capital gains
• Less common in countries with weak
corporate governance, since a repurchase
can occur to provide s/h with extra cash
payment
15
DIVIDEND
REPURCHASE
• Cash for s/h (but may generate a
tax disadvantage)
• Cash for s/h (tax advantage?)
• Allows capital structure changes.
• Allows capital structure changes
(no commitment)
• Signals positive earnings
expectations
• Signals undervaluation
• Reduces excess liquidity (agency
costs)
• Reduces excess liquidity (agency
cost)
• Control considerations*
16
Dividend policy must
be subordinate to:
• Investment decision:
• Dividend policy should not
prevent the firm from taking on
good investment projects
• Financing decision:
• Dividend policy should not force
the firm to deviate from its
optimal capital structure. Also,
issuing equity has high flotation
costs (2-10%, but can reach as
high as 20% for small stock
issues).
17
In practice, choice
depends on firm type:
• Business risk (EBIT volatility)
• Types of assets (intangibles, like R&D)
• Stage in life cycle of firm
• Market imperfections:
• Agency costs (Management vs. s/h)
• Flotation costs
• Transaction costs
• Government regulation
18
Steps in determining
dividend policy
1.
Determine FCF available to common
shareholders:
FCFE = FCF - (Interest*(1-t)) + Debt
OR FCFE=NI + DEP-CAPEX- INV in WC + Change in debt
…and compare this to dividends received (dividends + share
repurchases) :
•
If DIV = FCFE, firm is using full payment capacity.
•
If DIV < FCFE, firm is paying less than able to. Thus, it is
accumulating cash or investing in financial assets.
•
If DIV > FCFE, firm pays more than it can. It must be
getting the cash from cash or asset issuance (for
example, issuing stock).
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2.
Assess quality of investment projects and
dividend policy:
A)
B)
Firm has good projects and Div>FCFE: Firm is
losing value. It is generating a deficit of cash that
forces it to issue equity or debt, and perhaps
“pass” on some good projects. Reduce div.
payout and invest more.
Firm has good projects and Div<FCFE. Firm is
accumulating cash. This may be justified (agency
costs aside) if funds are to be used in future
+NPV projects. Adequate policy.
C) Firm does not have enough good projects and
DIV>FCFE. Any bad project should be eliminated,
thus increasing FCFE to sustain dividend
payments. If this is not enough, then reduce div.
payout.
D) Firm does not have enough good projects and
DIV<FCFE. Loses value. Accumulates cash,but will
be pressured to adopt higher Payout instead of
investing in bad projects. Should have higher
Payout.
3. Relationship between dividend
and financing policy:
Remember that payments to s/h
reduce equity => increase
leverage.
• If firm has low leverage, if
need be, it could pay more
div than its available FCFE.
• If firm has high leverage, it
should pay less div than its
available FCFE
21
Why then, do firms
pay dividends?
•Clientele effects
•Signaling
•Agency
•Regulation
22