Intro to Financial Management
Dividend Policy
Review
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Homework
Income stream risks
Business risks
Operating risk
– Break-even analysis
– Operating leverage
• Capital structure
– Leverage
– Coverage ratio
– Match maturity of financing with ‘maturity’ of asset
Dividend Policy
• Dividend payout ratio
= dividend per share / earnings per share
• Tradeoff between
• Dividends and future growth
• Dividends and external financing
Dividend Policy and Stock Price
• Three views
1. No effect
2. High dividend will increase the stock price
Reason – less risk to investor
3. Low dividend will increase the stock price
Reason – investors can defer taxes
Dividend Payment Theories
• Residual Dividend Theory
– Pay dividend only if no more investments to make with the cash
• Clientele Effect
– Those who want dividends, will invest in dividend paying stocks
– Those that don’t, won’t
• Information Effect
– Dividend payout changes can signal information from the firm
• Agency Costs
– Costs, such as reduced stock price, due to agency conflict
– Dividends may reduce these costs
• Expectations Theory
– Market reacts as reality changes relative to their expectations
Dividends in Practice
• Legal restrictions
– E.g. must have assets > liabilities
• Liquidity constraints
– May not have the cash
• Earnings predictability
– Future years may not have as good cash flows
• Maintaining Ownership Control
– May retain earnings so do not have to issue new stock
Dividend Policies
1. Constant dividend payout ratio
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Percent of earning paid is constant
Dollar amount will not be
2. Stable dollar dividend
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Relatively stable (constant) payout
Will change only when management thinks appropriate
3. Small regular dividend plus year-end extra
4. One-time dividend payout
Stock Dividend and Stock Splits
• Stock dividend
– Distribution of shares proportionate to current holding
• Stock split
– Exchange current shares for new, more shares
• Same effect, different accounting
• Why?
– Optimal trading range, perhaps
– Signal information, perhaps
Stock Repurchases
• When firm buys back its stock from the market
• Why?
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Reduces shares on the market
Increases EPS, ROE
Increases leverage
Reduces costs of small (e.g. fractional) shareholders
Result, higher stock price
• What should a firm do with excess cash?
Give dividends or repurchase shares?
– Want long-term gain or cash now?
– Theoretically, owners should not care
– Note that Apple is doing both