Dividend Policy
Professor XXXXX
Course Name / Number
Dividend Fundamentals
Relevant dates for dividend payments
Announcement
date
The day the firm announces the dividend,
dividend record, and payment dates
Date of record
All persons recorded as stockholders on this
date receive the declared dividend.
Ex dividend
date
2
The persons that buy the stock before ex
dividend date will receive the current dividend.
Several business days before date of record
Maximum Amount a Firm Can
Pay in Cash Dividends
Where legal capital defined as par value of common stock,
maximum payout is $340,000 (Paid-in capital + RE).
Alpha Corporation’s Stockholders’ Equity
Common stock at par
$100,000
Additional paid-in capital
200,000
Retained earnings
140,000
Total stockholders’ equity
$440,000
In states where legal capital includes all paid-in capital,
maximum payout is $140,000 (only Retained Earnings).
3
Types of Dividends
Cash
dividends
– Regular Cash Dividend
– Special Cash Dividend
– National differences in payment methods
Types of
dividend
policies
– Constant payout ratio policy
– Constant nominal payments (standard
worldwide)
– Low regular and extra dividend
Stock
dividends
and stock
splits
4
Stock
repurchases
– Stock dividend: payment of a dividend
in the form of stock
– Stock splits affect firm’s shares similarly
to stock dividends.
– Buying shares on the market
– Tender Offer to Shareholders
– Private Negotiation (Green Mail)
Patterns In Dividend Policies
Worldwide
Distinct
national
patterns
Pronounced
industry
patterns
– Companies in common law countries have
higher payouts than those from civil law
countries.
– US companies are now near global
average.
– The same worldwide
– Profitable firms in mature industries tend
to pay out much larger fractions of their
earnings.
Within industries, dividend payout tends to be directly
related to asset intensity and the presence of regulation.
5
Almost all firms maintain constant nominal dividend
payments per share for long periods of time.
Aggregate Dividend Payout Ratio
for U.S. Corporate Sector
%
90
80
70
60
50
40
30
20
10
0
70
8
72
74
76
78
80
82
84
86
88
90
92
94
96
98
2000
Source: Statistical Abstract of United States, U.S department of Commerce, various issues (1972-2001)
Dividend Payout Ratios For
Selected U.S. Industries
Payout
Ratio Industry
Industry
Biotechnology
Airlines
0%
0
Household non-durables
Industrial metals
41%
46
Computer software
2
Pharmaceuticals
47
Semiconductors
7
Banking
47
Computer hardware
14
Basic chemicals
48
Commcl Transportation
15
Foods & non-alcohol bev
51
Prop & cas Insurance
20
Autos & auto parts
42
Aerospace & defense
28
Electric utilities
65
Paper & forest products
28
Alcohol bev & tobacco
70
Telecommunications
39
Oil & gas product & mktg
75
41
9
Payout
Ratio
Source: Standard & Poors Industry Reports, various issues (2001)
Patterns Observed In Dividend
Policies Worldwide
The stock market reacts positively to dividend increases
and negatively to decreases or cuts.
Taxes influence dividend payouts, but the net effect is
ambiguous.
– Firms paid dividends before and after income tax.
– Empirical evidence shows that tax increases lead to
higher payouts, rather than lower.
It is unclear how dividends affect the required return on a
firm's common stock.
10
Models Of Dividend Payments
Several competing theories are advanced to explain
observed patterns in dividend policies.
The Agency Cost /
Contracting Model
The Signaling Model
Mainstream favorite: the agency cost/contracting
model
The signaling model of dividends: firms pay dividends to
“burn money,” separate from weaker rivals
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The Agency Cost / Contracting
Model Of Dividend Payments
Dividends exist to overcome agency problems between
managers and shareholders.
Managers “commit” to paying out free cash flow as
dividends.
Based on ownership structure: private and closely held
firms rarely pay dividends; big public firms have high
payouts.
Based on investment opportunity set: mature firms
have high payout; high-growth firms have low payouts.
12
Dividend Policy Irrelevance In A
World Without Market Imperfections
Miller & Modigliani (1961) showed dividend policy cannot
impact firm value in a world without market frictions.
Miller & Modigliani showed this the same way that they
proved that capital structure was irrelevant.
Value is determined solely by investment policy and
profitability of the firm’s assets.
Investors can sell shares to mimic the dividend policy.
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Dividend Policy Irrelevance In A
World Without Market Imperfections
An example....
Adams
Construction
and Feldon
Home Builders
Two identical companies, except their dividend
policy. Both have 4 millions shares outstanding.
Both companies have assets worth $40 million.
Expected net cash inflow is $6 million next year.
Adams
Construction
Feldon Home
Builders
Return on investment
15%
15%
Price per share
$10
$10
Both firms anticipate an investment opportunity next year that will
require $6 million. How will the two firms finance this opportunity?
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Adams Construction
Pays out 100% of next year’s cash inflows as dividends.
Earns and distributes $1.50/share
Will raise $6 million in a new equity offering to finance the
new investment opportunity
600,000 shares at $10 each
Today
Assets worth $40 million
4 million shares
$10 per share
15
Tomorrow
Assets worth $46million
4.6 million shares
$10 per share
Adams Construction original shareholders earn 15% return in the form
of dividend.
Feldon Home Builders
Retains next year’s $6 million cash inflows; invest $6
million in the new investment opportunity
Today
Assets worth $40 million
4 million shares
$10 per share
Tomorrow
Assets worth $46million
4 million shares
$11.5 per share
Shareholders earn required return of 15% in the form of
stock price increase.
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Firm value for both firms is the same, regardless of the dividend payout
policy!
Real-World Influences On
Dividends
Personal
taxes on
dividends
– Should discourage payments
– Empirical evidence is ambiguous.
– Dividends paid before 1936 (no taxes) and
after 1936 (dividends taxed)
– Some evidence of positive relation between
payout and tPS
Security
issuance
costs
– Should discourage payments.
– If costly to issue new stocks and bonds, firm
should retain cash.
Investor
trading costs
17
– This factor argues in favor of dividends.
– Cost of selling shares for income has fallen
steadily.
Real-World Influences On
Dividends
Dividends might be a “residual” after funding
investments.
But dividends are most stable of all CF series.
Dividends may convey information in markets with
info asymmetries.
– But what specific information? Isn’t there a cheaper
way to signal?
– Latest empirical evidence: dividends signal the past,
not the future.
18
How Do Corporations Set
Dividend Payments?
Managers believe investors value steady dividend
payments.
Managers seem to have target payout ratio, but only
over time.
– Will allow payout to vary in the short term to keep $ dividends
the same.
– Will only raise $ dividend if permanent earnings increase.
– Will only cut $ dividend if firm facing financial disaster.
19
Managerial reluctance to change nominal dividend payment gives rise
to partial adjustment model.
What Do We Know About Dividends?
We can explain inter-industry differences in dividend payout.
We know that ownership matters greatly and roughly how.
We are convinced that dividends exist because of flaws in
human ability to communicate and commit, not flaws in
how markets work.
Dividends convey information. Initiations and increases
convey good news, decreases convey catastrophic news.
Common law countries have higher payouts than civil law.
What Don’t We Know About
Dividends?
Exactly how do taxes impact dividends?
Exactly what information is conveyed by dividends?
Most puzzling: why has fraction of firms paying
dividends declined in the US, but not elsewhere?