Chapter 15
Dividend Policy
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© 2007 Thomson South-Western
Dividend Policy
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A firm’s dividend policy refers to the choices its
managers make about distributing cash to
shareholders.
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whether to pay shareholders a regular (recurring) cash
dividend
how large the cash dividend should be
how frequently it should be paid
The dividend payout ratio, calculated by dividing the
cash dividend per share by its earnings per share,
indicates the percentage of each dollar earned that
firms distribute to the owners.
The dividend yield, which equals a stock’s dividend
divided by its price, measures the rate of return
represented by the dividend payment.
Dividend Trends: Share
Repurchase Programs
Companies announcing share repurchase
programs state they will buy back some of
their own shares, usually through openmarket purchases.
 Share repurchases give managers an
alternative method to distribute cash to
shareholders.
 The annual value of share repurchases in the
United States sometimes exceeds that of
dividends, and investors clearly welcome
repurchase announcements.
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Dividend Trends: Decline in
Payment of Dividends
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Decline in the fraction of U.S. companies
paying dividends
had a lower propensity to pay
dividends in 1999 than before.
 Companies
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Recent research documents a clear rebound in
the number of companies paying dividends
 Provides
somewhat less clear-cut evidence of an
increase in average dividend payout ratios
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Increasing concentration of corporate profits
and dividends among a few large companies
Cash Dividend Payment
Procedures
In the U.S., as in most countries, shareholders
have no legal right to receive dividends.
 Instead, a firm’s board of directors decides
what dividends the firm will pay.
 Most U.S. firms that pay dividends do so once
every quarter.
 Corporations in other industrialized countries
generally pay dividends annually or
semiannually.
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Relevant Dividend Dates
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Shareholders of record are entitled to the
dividend.
Because it takes time to make bookkeeping
entries after stocks trade, investors who buy
stock on the record date will miss the
dividend payment.
To receive the dividend, an investor must
own the stock before the ex-dividend date,
usually two business days prior to the date
of record.
Firms distribute dividends on the payment
date, which usually comes a few weeks after
the record date.
Relevant Dividend Dates
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External Factors Affecting
Dividend Policy
Most U.S. states prohibit corporations from
paying out as dividends any portion of their
“legal capital,” which the law defines as the
par value of common stock.
 Some states define legal capital to include the
common stock’s par value and any additional
paid-in capital.
 States establish these capital-impairment
restrictions to provide a sufficient equity base
to protect creditors’ claims.
 Laws do not prohibit a firm from paying more
in dividends than its current earnings.
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Calculating the Maximum Amount a Firm
Can Pay in Cash Dividends - Example
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Types of Dividend Policies
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Constant payout ratio policy
 pays
a set fraction of its earnings to shareholders
each period
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Constant nominal payment policy
 firm
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pays the same dividend each period
Low-regular-and-extra policy
 pays
a low regular dividend, supplemented by an
additional cash payment at irregular intervals
 extra
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dividend or special dividend
Other Forms of Dividends
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Stock dividends
 additional
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shares of stock rather than cash
Stock splits
 its
share price declines because the number of
outstanding shares increases.
 reverse stock splits replacing a certain number of
outstanding shares with just one new share
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Share repurchases
 variety
of motivations influence firms’ share
repurchases.
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Market Value of Share Repurchases by
U.S. Corporations, 1972–2001
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Methods to Repurchase Shares
 Open-market
share repurchase: firms
buy back their shares in the open
market.
 Tender offer, or self-tender: firms offer
to buy back a certain number of shares
at a premium above the current market
price.
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Payout Policies Worldwide
 Payout
policies show distinct national
patterns.
 Payout policies show pronounced
industry patterns, and these are the
same worldwide.
 Asset-rich, regulated, and slow-growing
companies tend to have high dividend
payout ratios.
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Payout Policies Worldwide
Firms maintain constant nominal dividend
payments per share for significant periods of
time.
 Whereas the number (and fraction) of publicly
traded companies that pay dividends has been
declining since roughly the 1970s, the
aggregate payout ratio of the U.S corporate
sector has been increasing.
 Investors react positively to dividend (and
share repurchase) initiations and increases
but react negatively to dividend decreases or
eliminations.
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Aggregate Payout Ratio (Dividends and
Share Repurchases) for the U.S.
Corporate Sector, 1972–2001
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Payout Policies Worldwide
Taxes influence payout policies, but taxes
neither cause nor prevent companies from
initiating dividend payments or share
repurchases.
 In spite of intensive research, it is unclear
exactly how dividend payments affect the
required return on a firm’s common stock.
 Changes in transactions costs or in the
technical efficiency of capital markets seem to
have little effect on dividend payments.
 Ownership matters.
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Agency Cost Model Of Dividends
 Agency
cost /contracting model of
dividends (or simply, the agency cost
model)
 Assumes
that firms begin paying to
overcome the agency problems resulting
from a separation of corporate ownership
and control
 Privately-held
 Public
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firms
firms
Signaling Model
 The
signaling model of dividends
assumes that managers use dividends to
convey positive information to poorly
informed shareholders
 Like the agency cost model, the
signaling model predicts that stock
prices should rise (fall) in response to
dividend increases (cuts)
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Catering Theory
 Catering
theory of dividends predicts
that corporate managers cater to
investor preferences by
 paying
dividends when investors assign a
premium to dividend-paying stocks
 not paying when investors assign a
discount to dividend payers.
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Dividend Irrelevance In A World
With Perfect Capital Markets
 As
long as the firm accepts all positiveNPV investment projects and has
costless access to capital markets, it can
pay any level of dividends it desires.
 If a firm pays out its earnings as a
dividend, it must issue new shares to
raise the cash required to finance its
ongoing investments.
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Real-world Influences on
Dividend Policy
 Dividends
do not exist to overcome
changing technical problems with
markets and tax regimes;
 Dividends exist to overcome unchanging
human problems with trust,
communication, and commitment.
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Real-world Influences on
Dividend Policy
When the personal tax rate on dividends
exceeds the tax rate on capital gains, we have
a clear-cut prediction: Firms should not pay
dividends.
 Wealth tax: tax on stock appreciation is levied
every period, regardless of whether investors
sell their shares
 Most countries dictate that investors pay
capital gains taxes only when they realize
their gains by selling shares.
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Imputation Tax System
Gives individual investors an “imputed” tax
credit along with the dividends they receive
from companies.
 Investors can then claim the corporate income
tax paid by the firm as a credit against their
personal tax liability.
 Ex-dividend-day study: examines whether
(and how) differing capital gains and dividend
income tax rates impact the average change
in a firm’s stock price on its ex-dividend day.
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