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Dividend policy

Dividend policy. Relevance? Payment of dividends Tax implications Dividend policies Stock dividends and stock splits. Pay me now or pay me later?. Theory: dividend policy is not relevant Firm will have finite amount of earnings to distribute over its “lifetime”

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Dividend policy

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  1. Dividend policy • Relevance? • Payment of dividends • Tax implications • Dividend policies • Stock dividends and stock splits Dividend Policy

  2. Pay me now or pay me later? • Theory: dividend policy is not relevant • Firm will have finite amount of earnings to distribute over its “lifetime” • If distribute now, leaves less for future • PV of dividends doesn’t change • Assumes firm selects projects with positive NPVs • Therefore, dividend policy doesn’t impact firm value Dividend Policy

  3. Signaling theory • Raising dividends is a favorable sign • Few companies would do this if can’t sustain new dividend • A “surprise” increase will increase price of stock • Dividends increased from $1.30 to $1.40; market anticipated $1.45 Dividend Policy

  4. Signaling theory • High dividend yield (D / P) • Mature company? • Dividend yield averages 2% • In the 1970s, over 5% • Foreign companies higher • Or is it risk of dividend cut? Dividend Policy

  5. Signaling theory • Cutting dividends is generally greeted with big drop in price of stock • February 2011: Barnes and Noble eliminates dividend to preserve cash • BUSE has EPS of -$5.41 in 2009. Can it pay dividends in that year? • Borrow to maintain dividend? Dividend Policy

  6. Clientele effect • Investors who need income: dividends are great • Utilities, banks • Investors who want growth: no dividends • Technology stocks Dividend Policy

  7. Payment of dividends • In U.S., quarterly dividends • Foreign companies, often twice per year • McDonalds: changed to annual dividends • Will others follow this change? • Company must have • Retained earnings • Cash • Permission of debt holders (covenants) Dividend Policy

  8. Dividend dates • Declaration date • Ex-dividend date • Own stock at end of this day, get dividend • What happens to stock price next day? • Payment date Dividend Policy

  9. Tax Implications • Dividends • Income taxed at corporate level • Dividends taxed to recipient • Second taxation of this income • Now taxed at capital gains tax rate Dividend Policy

  10. Tax implications • Retain earnings • Reinvest in positive NPV projects • Required return: at least as high as shareholders could earn • Apple had over $50 billion in cash in 2011 and still paid no dividends • Increase wealth of firm, stock price • No tax on increase in stock price until it is sold Dividend Policy

  11. Alternative dividend policies • Residual • Constant payout • Stable dividend Dividend Policy

  12. Residual • Fund all positive NPV projects • Distribute remaining earnings • Dividends fluctuate • Not as highly valued? • Implications under signaling theory Dividend Policy

  13. Constant payout ratio • Payout constant percent of earnings • Foreign companies • U.S: 22% payout ratio • Taiwan: 69% payout ratio • Again, dividends fluctuate Dividend Policy

  14. Stable dividend • Maintain stable annual dividends • Only increase if can sustain • Borrow to maintain for short-term Dividend Policy

  15. Stock repurchase • March 2012: Apple (with $100 billion in cash): • announces initial dividend of $2.65 per quarter (1.8% yield) • Authorizes $10 billion in stock repurchase • Treasury stock • Open market versus auction • If investor wants cash, can sell stock • If not, generally price of stock should increase • Supply and demand • Earnings per share impact Dividend Policy

  16. Stock Splits • 2 for 1 stock split • Mechanics: • Own 100 shares at $80 per share before split • Own 200 shares at $40 per share after split??? Dividend Policy

  17. Stock Splits • Why? • Maintain price range for stock • Remember stocks trade in 100 share lots • Small investors • Institutional investors • Reverse split • Signal?? • Indication of future prospects Dividend Policy

  18. Stock dividends • Distribute stock instead of cash • Steak-N-Shake: 20% stock dividend each year • Keep stock in tighter trading range Dividend Policy

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