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Chapter 14 Stock Splits, Dividends, and Dividend Policy

Chapter 14 Stock Splits, Dividends, and Dividend Policy. Cash Dividends Dividend Policy Selecting a Dividend Policy Stock Splits and Stock Dividends Reasons for Stock Splits Reverse Splits Specialized Dividend Plans. Cash Dividends. Payments to owners of the company

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Chapter 14 Stock Splits, Dividends, and Dividend Policy

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  1. Chapter 14Stock Splits, Dividends, and Dividend Policy • Cash Dividends • Dividend Policy • Selecting a Dividend Policy • Stock Splits and Stock Dividends • Reasons for Stock Splits • Reverse Splits • Specialized Dividend Plans

  2. Cash Dividends • Payments to owners of the company • Distribution is taxed (currently) • Decision to pay cash dividend by Board of Directors • Stipulates • Amount • Date of Record • Date of Payment • Some important issues when buying and selling stock • Settlement Date • Street Name, Beneficiary Owner, and Owner of Record

  3. Cash Dividend • Example, Pepsi Dividend of Feb. 2004 • Amount of dividend announced on Feb 5th • Stock trades with dividend until Feb 25th • Record date set on Feb 27th • Actual Payment on Mar 10th • If you buy stock before Feb 25th you receive the cash dividend • If you buy stock after Feb 25th original owner receives dividend • Price of stock falls on morning of Feb 26th by size of the dividend

  4. Cash Dividends • Not all cash dividends are “regular” • Typically very predictable in time • Typically very predictable in amount • Extra or special dividends • One time payments not scheduled to be repeated in near future • Reward to owners during good performance • Stock Dividends – just paper no real value • Liquidating Dividends – final payment to owners

  5. Dividend Policy • Choice on size of dividends, large yields versus small (zero) yields • Dividend Clientele • Widows and Orphans want large dividends – they rely on the dividend income • Tax avoiders – they want small or no dividends and take “profits” in capital gains at time of sale • Does it matter? Dividend Irrelevance Theory • Can undo any dividend policy to match needs • Works in world of no taxes • Complications in world of taxes • Alternative for company, keep money and reinvest in company

  6. Dividend Policy • Reasons for Low-Payout Policy • Tax avoidance or postponement • Higher potential future returns • Firm avoids need for additional outside funds • Reasons for High-Payout Policy • Distribution of profits with low transaction costs • Convenience of direct deposit • Cash today versus uncertainty tomorrow

  7. Selecting a Dividend Policy • From perspective of Firm • Payment should be maintainable in future with some variation in earnings • Payment should not be reduced (bad news signal) • Payment cannot include legal capital • Payment cannot violate bond covenants • From perspective of owner – dividend policy irrelevant? Individual select companies with current dividend policies that meet their need

  8. Stock Splits and Stock Dividends • Paper Transactions of no value to owner • Trading a $20 bill for 2 $10 bills • Stock dividends are small stock splits • Follows trading patterns of cash dividends • Declaration date (size of split announced) • Date of record set by Board of Directors • Payment date set when new shares will be mailed • Buying after ex-date, new shares go to old shareholders so new owner gets “due bill”

  9. Reasons for Stock Splits • Value comes from… • Preferred Trading Range – stocks trade better in $20 to $40 range • Signaling Hypothesis – strong past performance will continue • Increased Liquidity – more available shares and thus lower costs to transact (jury still out on this reason) • Economic debate remains on value of split

  10. Reverse Splits • Reduces number of outstanding shares • Like trade 2 $10 for a $20 • No apparent value • Perceived value • Stock price moves back into preferred trading range • Can avoid potential delisting of stock from ex-change • Potential reduction in liquidity?

  11. Specialized Dividend Plans • Stock Repurchases • “Selective” cash dividend, owner decides if he/she wants dividend by selling stock • Must be for a business reason not just to avoid taxes • Not all plans are completed • 35% never start • 35% only partially completed • Stock repurchased • Treasury Stock – for future reissue • Treasury stock has no voting rights and cannot receive dividends (cash dividends) • DRIPs – Dividend Reinvestment Plans

  12. Problems • Problem 5 – Dividend Pattern • Problem 7 – Creating Your Own Dividend Policy • Problem 13 – Stock Split • Problem 17 – Stock Repurchase Plan

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