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Dividend Policy

Dividend Policy. 05/29/2008 Ch. 10. What is a dividend?. Return of Cash to the Owners Forms Periodic Cash Dividend - $0.50 per share each quarter (an example) Share repurchase – Company buys back shares any shareholders can sell back a portion of their ownership

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Dividend Policy

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  1. Dividend Policy 05/29/2008 Ch. 10

  2. What is a dividend? • Return of Cash to the Owners • Forms • Periodic Cash Dividend - $0.50 per share each quarter (an example) • Share repurchase – Company buys back shares any shareholders can sell back a portion of their ownership • Liquidating Dividend (Liquidating Event) – Sell all your shares and terminated ownership (can sell ownership to another person or to the company) • What is not a dividend • Stock split – just exchanging a $20 for two $10s • Stock dividend – just a small stock split

  3. Chapter 10 Question • Are Dividends Good or Bad? • Three Answers • Dividend Policy is Irrelevant • “Cash Dividends” are good • “Cash Dividends” are bad • We will explore the basis of each answer • First, the mechanics of a cash dividend • Timing, Amount, Which Owner and so on…

  4. Mechanics of a Cash Dividend • Board (Management) chooses to return cash to the shareholders • Board declares amount per share • Date of record (the day that the current shareholder will be determined for the dividend) • Payment date (day the cash is “mailed’) • There is continuous buying and selling of shares so the price of the stock will reflect who will receive the cash dividend • Market determines the ex-date of the stock • Buying stock before ex-date means stock trades with the dividend • Buying stock after the ex-date the stock trades without the dividend

  5. Cash Dividend Example • On February 1, 2008 Pepsi Management declares a $0.375 per share to be paid to record holders as of February 15, 2008 to be paid on March 6, 2008 (timeline diagram…page 447) • The price of Pepsi is $68.63 on February 1st • The ex-date is February 12th, that is, any shares that trade before Feb. 12th will be with dividend • Anyone who buys the shares on or before 2-12-2008 will have their name on the official records at Pepsi before the close of business on February 15th • The date of record is February 15th • Pepsi will “prepare the list” of shareholders as of the close of business on this date • Checks will be mailed to the record holders on March 6, 2008. • Should you always wait to sell after 2-12-2008?

  6. Cash Dividend Example – Cont. • When to sell or buy the shares of Pepsi • Price at close on February 12th -- $71.96 • Price at close on February 13th -- $71.63 • Price change on ex-date is $0.33 • Selling Date is irrelevant (Revenue is always with div) • Seller gets Price (which includes dividend) before 2-12 • Seller gets Price without dividend but will receive dividend • Buying Date is irrelevant (Cost is always w/o div) • Buyer never gets the dividend… • Pays dividend to seller before 2-12, but gets dividend from Pepsi, after 2-12 just pays for stock

  7. Some More Dividend Terms • Dividend Yield – Dividend / Price • Dividend Payout – Dividends / Net Income • Retention Ratio – 1 minus Dividend Payout • This is the percent of the Net Income “reinvested” in the company for the owners • DRIPS – Dividend Reinvestment Programs • Rather than receive a cash dividend, the dividends are “rolled” back to the company and the owner receives additional stock • Target Dividend Payout Ratio – anticipated annually distribution percent • Sticky Dividends – reluctance to lower dividends

  8. Dividend Policy is Irrelevant • Note, dividends are not irrelevant but rather the way they are paid is irrelevant • Shareholders can undo any dividend policy and make it their own desired policy • In a world of no taxes…no transaction costs • Old Ms. Hubbard owns 10,000 shares at $10.00 per share • Wants dividend for this period of $10,000 • Company will pay either $0 or $1 or $2

  9. Undoing the Dividend Policy • With $0 dividend policy • Ms. Hubbard sells 1,000 shares – gets $10,000 for selling and now has 9,000 at $10 for “paper wealth of $90,000 • With $1/share dividend policy • Ms. Hubbard gets dividend check of $10,000 • Price of shares fall by cash dividend to $9 • “Paper Wealth” $9 x 10,000 = $90,000 • With $2/share dividend policy • Ms. Hubbard will receive $20,000 dividend check • Ms. Hubbard uses $10,000 to buy additional shares now at $8 per share ($10,000 / $8 = 1,250 shares) • “Paper Wealth” is 11,250 x $8 = $90,000 • Ms. Hubbard always has $10,000 cash and $90,000 paper

  10. Dividends Are Bad • Adding Taxes to the mix • Dividends are taxed as ordinary income • Selling shares – only gain is taxed and this is at the capital gains tax rate • Shareholders want to avoid taxes • Back to Ms. Hubbard • Dividend policy is $0, $1 or $2 • Tax rate is 25% ordinary income, 15% capital gains, and original price of stock is $10

  11. After-Tax Cash Flow of Dividends • At $0 – • Sells 1,000 shares and pays no taxes • Receives $10,000 after tax • At $1 – • Receives check of $10,000 but pays tax of $2,500, must sell 250 shares to get to $10,000 cash • At $2 – • Receives check of $20,000 but pays tax of $5,000 • Only has $5,000 for buying stocks, gets only 500 more shares • Ms. Hubbard prefers no cash dividends…

  12. Dividends are Bad • There are many different tax rates • Corporations in some countries get tax relief on dividends paid • Individuals in some countries get “tax relief” • Shareholders get credit for taxes paid by corporation • Some countries have lower rates on dividends • Individuals can pick timing of receipt with no dividend policy (take dividends when income is lower and thus lower taxes) • Some funds pay no taxes • Foundations • Pension Funds • Mutual Funds

  13. Dividends are Good • Bird in the Hand – give it to shareholders now before the company goes bankrupt • Company has more cash than investment opportunities – give excess to shareholders • Shareholder like dividends – Widows and Orphans story where they are relying on dividends • Disciplines Managers – reduce the amount of cash in the company and managers must validate new borrowing with capital markets

  14. Different Policies • Policies attract certain types of clienteles • High-Yield policies attract shareholders that like dividends • Low-Yield policies attract shareholders that want less distributions in the form of cash dividends • Signally Theory • Dividends are costly to imitate so they signal optimistic outlook for future dividends

  15. Problems to Review • All but 3 and 4 • Problem #1 – Marginal Tax Rate of Investors (PriceB – PriceA)/Dividend = (1 – tORD)/(1 – tCAP) ($50 - $46.50) / $5 = (1 – tORD)/(1 – 0.40) -tORD = ($3.50 / $5) x 0.60 -1 = -0.58 or 58% • Problem #2 – Arbitrage all stocks where the stock price falls by less than the cash dividend Proof – NE Gas Buy stock before ex-date, sell after ex-date What is your cash flow, $48 + $4 - $50 = $2

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