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Dividend Policy: Theory and Practice

Dividend Policy: Theory and Practice. Why do corporations pay dividends? Does paying dividends Ý S/H wealth?. Mechanics of dividend payment. Decl. date Ex-div. Record Pmt. 3/4/03 4/17 (Th.) 4/21 (M) 5/9

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Dividend Policy: Theory and Practice

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  1. Dividend Policy: Theory and Practice Why do corporations pay dividends? Does paying dividends Ý S/H wealth?

  2. Mechanics of dividend payment Decl. date Ex-div. Record Pmt. 3/4/03 4/17 (Th.) 4/21 (M) 5/9 • Last day you can buy stock and get dividend: 4/16/02 • S.P. ¯ by the $ amount of dividend on the ex-dividend date (theoretically) Chhachhi/BA 519/Ch. 18

  3. Miller-Modigliani (MM)’s Dividend Irrelevance Theorem • Ass.: taxes=transaction costs=0 and • Firm’s investment policy is unaffected by dividend policy • Firmvalue (0 div.) = Firmvalue (­ div.) HOW? • S/Hs receive returns in 2 forms: • Dividends & Stock Price appreciation (CGs) • ­ dividends, ¯ the CG and vice-versa • Overall S/H’s returns are identical • Indifferent to dividend policy

  4. Homemade Dividends • S/Hs through their actions can alter the corporate dividend policy to suit their needs • thus, corporation can’t do anything for the S/Hs that they can’t do for themselves Chhachhi/BA 519/Ch. 18

  5. If Taxes & Trans. costs ¹ 0, What should be firm’s div. policy? • Tdiv. > Tcapital gains • Investors are not indifferent to level of dividends • prefer smaller or no dividends at all • Firm with a # of +NPV projects • not enough $ to fund the projects & to pay dividends • paying dividends Þ will have to raise funds in the market-- stock/bond issue • investors have to pay taxes and firm has to pay issuance costs. lose-lose proposition

  6. Dividend Policy in the Real World-- Continued • Managers with excess cash • Should pay dividends; Otherwise they would be tempted to spend the extra money on negative NPV projects • e.g., “bad” acquisitions • Dividends serve as signal about firm’s future performance • Clientele Effect Chhachhi/BA 519/Ch. 18

  7. Repurchases • Repurchases can be used as a substitute (for dividends) mechanism for distributing cash • Taxes make repurchases more attractive • H.W. 2, 5, 7, 20 Chhachhi/BA 519/Ch. 18

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