1. Payout Policy

2. Topics Covered Information in Dividends and Stock Repurchases
Facts About Payout
Information in Dividends and Stock Repurchases
Dividends or Repurchases? The Payout Controversy
The Rightists
Taxes and the Radical Left
Payout Policy and the Life Cycle of the Firm 2 2 2 2 3 2

3. Payout Policies
Cash Dividend
vs.
Stock Repurchase

4. Dividend & Stock Repurchases
U.S. Data

5. How Firms Pay Dividends
Stock Dividend - Distribution of additional shares to a firm’s stockholders
Stock Splits - Issue of additional shares to firm’s stockholders
Cash Dividend - Payment of cash by the firm to its shareholders
Regular
Special 8

6. Dividend Terms Record Date Declaration Date Payment Date
Ex-Dividend Date

7. Dividend Payments Dec.15, 2014 Feb. 4, 2015 Feb. 6, 2015 Mar. 3, 2015
Pfizer
declares regular
quarterly dividend
of $.28 per share.
Dividend will be paid
to shareholders
registered
on this date.
Shares start to
trade ex dividend.
Dividend checks
are mailed
to shareholders.
Declaration date
Ex-dividend date
Record
date
Payment
date

8. How Firms Repurchase Stock
Stock Repurchase - Firm buys back stock from its shareholders
Stock Repurchase (4 methods)
1. Buy shares on the market
2. Tender offer to shareholders
3. Dutch auction
4. Private negotiation (Green Mail) 5

9. The Information Content of Dividends
Senior Executive Dividend Policy Features
(How Dividends are Determined)
Managers are reluctant to make dividend changes that might have to be reversed
Managers “smooth” dividends and hate to cut them. Dividends changes follow shifts in long-run, sustainable levels of earnings.
Managers focus more on dividend changes than on absolute levels 18

10. The Information Content of Dividends
Dividends and stock repurchase decisions contain information
The information contained in the decisions varies
Asymmetric information may be conveyed
Dividend increases could mean overpriced stock or increased future profits
The signal varies based on prior information about the company

11. Dividend Decision Survey (2004)
The Payout Decision
Dividend Decision Survey (2004)

12. Dividend Policy is Irrelevant
Miller and Modigliani
Since investors do not need dividends to convert shares to cash they will not pay higher prices for firms with higher dividend payouts. In other words, dividend policy will have no impact on the value of the firm. 19

13. Dividend Policy is Irrelevant
Example - Shareholder Value Rational Demiconductor Record Pmt Stock $11 $10 Cash 0 $1 Total Value $11 $11 25

14. Dividends or Repurchases?
Rational Demiconductor balance sheet example.

15. Stock Repurchases and DCF Models of Share Price
Calculate Market Capitalization
Done by forecasting and discounting free cash flow paid to shareholders
To calculate share price, divide market capitalization by number of outstanding shares
Calculate Value of Dividends Per Share
Account for increased dividend growth rate per share
Caused by declining number of shares as shares are repurchased

16. Dividend Policy } { Before Dividend After Dividend New stockholders
Each share worth this before … }
… and worth this after
Total value of firm {
Old stockholders
Total number of shares
Total number of shares
Example of 1/3rd of worth paid as dividend and raising money via new shares

17. Dividend Policy Dividend financed by stock issue
No dividend, no stock issue
New stockholders
New stockholders
Shares
Cash
Firm
Cash
Shares
Cash
Old stockholders
Old stockholders

18. Dividend Theories Leftists (M&M) - Dividend does not effect value
Rightists - Dividends increase value
Middle of the roaders - Leftist theory with some reality thrown in
Residual Dividend Policy

19. Dividends Increase Value
Market Imperfections and Clientele Effect There are natural clients for high-payout stocks, but it does not follow that any particular firm can benefit by increasing its dividends. The high dividend clientele already have plenty of high dividend stock to choose from. These clients increase the price of the stock through their demand for a dividend paying stock.

20. Dividends Increase Value
Dividends as Signals Dividend increases send good news about cash flows and earnings. Dividend cuts send bad news. Because a high dividend payout policy will be costly to firms that do not have the cash flow to support it, dividend increases signal a company’s good fortune and its manager’s confidence in future cash flows.

21. Dividends Decrease Value
Tax Consequences Companies can convert dividends into capital gains by shifting their dividend policies. If dividends are taxed more heavily than capital gains, taxpaying investors should welcome such a move and value the firm more favorably. In such a tax environment, the total cash flow retained by the firm and/or held by shareholders will be higher than if dividends are paid.

22. Taxes and the Radical Left
Since capital gains are taxed at a lower rate than dividend income, companies should pay the lowest dividend possible
Dividend policy should adjust to changes in the tax code

23. Taxes and the Radical Left29

24. Empirical Evidence on Dividends and Taxes
In recent years, the case for low dividends has been weakened
Top tax rates on dividends: 15%
Top tax rates on capital gains: 15%
One advantage to investors:
Capital gains taxes are deferrable
One advantage to corporations:
Corporations pay corporate income tax on only 30% of any dividends received from investments in other corporations.

25. Taxes and Dividend Policy
In the U.S., shareholders are taxed twice (figures in dollars)

26. Alternative Tax Systems
Under imputed tax systems, such as that in Australia, shareholders receive a tax credit for the corporate tax the firm pays (figures in Australian dollars)

27. Payout Policy and the Life Cycle of the Firm
Residual Dividend Policy r
MRI = IRR
12%
COC
Qty., $

28. Payout Policy and the Life Cycle of the Firm
Questions for the Financial Manager
Is the company generating positive free cash flow after making all investments with positive NPVs and is the positive free cash flow likely to continue?
Is the firm’s debt ratio prudent?
Are the company’s holdings of cash a sufficient cushion for unexpected setbacks and a sufficient war chest for unexpected opportunities?

29. Dividends Increase Value
Apple stock price increased, despite paying no dividend. It sent a signal of growth. 27