1. Dividend Policy Professor XXXXX Course Name / Number

2. 2 Dividend Fundamentals Announcement date The day the firm announces the dividend, dividend record, and payment dates Date of record All persons recorded as stockholders on this date receive the declared dividend. Relevant dates for dividend payments Ex dividend date The persons that buy the stock before ex dividend date will receive the current dividend. Several business days before date of record

3. 3 Maximum Amount a Firm Can Pay in Cash Dividends Where legal capital defined as par value of common stock, maximum payout is $340,000 (Paid-in capital + RE). In states where legal capital includes all paid-in capital, maximum payout is $140,000 (only Retained Earnings).

4. 4 Types of Dividends Types of dividend policies –Constant payout ratio policy –Constant nominal payments (standard worldwide) –Low regular and extra dividend Stock repurchases –Buying shares on the market –Tender Offer to Shareholders –Private Negotiation (Green Mail) Stock dividends and stock splits –Stock dividend: payment of a dividend in the form of stock –Stock splits affect firm’s shares similarly to stock dividends. Cash dividends –Regular Cash Dividend –Special Cash Dividend –National differences in payment methods

5. 5 Patterns In Dividend Policies Worldwide Pronounced industry patterns –The same worldwide –Profitable firms in mature industries tend to pay out much larger fractions of their earnings. Distinct national patterns –Companies in common law countries have higher payouts than those from civil law countries. –US companies are now near global average. Within industries, dividend payout tends to be directly related to asset intensity and the presence of regulation. Almost all firms maintain constant nominal dividend payments per share for long periods of time.

6. 6 Dividend Payment Measures: A Comparison 2.02%37.42% Common law median 25.11% Dividend to earnings (Payout ratio), % 0.83% Civil law median Dividends to sales, % Source: Rafael laPorta, Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert W. Vishny, “Agency Problems and Dividend Policies around the World”

7. 7 The Fraction of All Publicly Traded U.S. Firms Paying Cash Dividends 100 80 60 40 20 0 1926 1936 1946 1956 1966 1976 1986 1996 Percent Frame A Year Source: Eugene F. Fama and Kenneth R. French, “Disappearing Dividends: Changing Firm Characteristics or Lower Propensity to Pay?” Journal of Applied Corporate Finance 14 (Spring 2001), pp. 67-79

8. 8 Aggregate Dividend Payout Ratio for U.S. Corporate Sector % Source: Statistical Abstract of United States, U.S department of Commerce, various issues (1972-2001)

9. 9 Dividend Payout Ratios For Selected U.S. Industries Source: Standard & Poors Industry Reports, various issues (2001)

10. 10 Patterns Observed In Dividend Policies Worldwide The stock market reacts positively to dividend increases and negatively to decreases or cuts. It is unclear how dividends affect the required return on a firm's common stock. Taxes influence dividend payouts, but the net effect is ambiguous. –Firms paid dividends before and after income tax. –Empirical evidence shows that tax increases lead to higher payouts, rather than lower.

11. 11 Models Of Dividend Payments Several competing theories are advanced to explain observed patterns in dividend policies. The Agency Cost / Contracting Model The Signaling Model Mainstream favorite: the agency cost/contracting model The signaling model of dividends: firms pay dividends to “burn money,” separate from weaker rivals

12. 12 The Agency Cost / Contracting Model Of Dividend Payments Dividends exist to overcome agency problems between managers and shareholders. Managers “commit” to paying out free cash flow as dividends. Based on ownership structure: private and closely held firms rarely pay dividends; big public firms have high payouts. Based on investment opportunity set: mature firms have high payout; high-growth firms have low payouts.

13. 13 Dividend Policy Irrelevance In A World Without Market Imperfections Miller & Modigliani (1961) showed dividend policy cannot impact firm value in a world without market frictions. Miller & Modigliani showed this the same way that they proved that capital structure was irrelevant. Value is determined solely by investment policy and profitability of the firm’s assets. Investors can sell shares to mimic the dividend policy.

14. 14 Dividend Policy Irrelevance In A World Without Market Imperfections An example.... Adams Construction and Feldon Home Builders Two identical companies, except their dividend policy. Both have 4 millions shares outstanding. Both companies have assets worth $40 million. Expected net cash inflow is $6 million next year. Adams Construction Feldon Home Builders Return on investment15% Price per share$10 Both firms anticipate an investment opportunity next year that will require $6 million. How will the two firms finance this opportunity?

15. 15 Adams Construction Pays out 100% of next year’s cash inflows as dividends. Earns and distributes $1.50/share Will raise $6 million in a new equity offering to finance the new investment opportunity 600,000 shares at $10 each Today Tomorrow Assets worth $40 million 4 million shares $10 per share Assets worth $46million 4.6 million shares $10 per share Adams Construction original shareholders earn 15% return in the form of dividend.

16. 16 Feldon Home Builders Retains next year’s $6 million cash inflows; invest $6 million in the new investment opportunity Today Tomorrow Assets worth $40 million 4 million shares $10 per share Assets worth $46million 4 million shares $11.5 per share Shareholders earn required return of 15% in the form of stock price increase. Firm value for both firms is the same, regardless of the dividend payout policy!

17. 17 Real-World Influences On Dividends Personal taxes on dividends –Should discourage payments –Empirical evidence is ambiguous. –Dividends paid before 1936 (no taxes) and after 1936 (dividends taxed) –Some evidence of positive relation between payout and t PS Security issuance costs –Should discourage payments. –If costly to issue new stocks and bonds, firm should retain cash. Investor trading costs –This factor argues in favor of dividends. –Cost of selling shares for income has fallen steadily.

18. 18 Real-World Influences On Dividends Dividends might be a “residual” after funding investments. But dividends are most stable of all CF series. Dividends may convey information in markets with info asymmetries. –But what specific information? Isn’t there a cheaper way to signal? –Latest empirical evidence: dividends signal the past, not the future.

19. 19 How Do Corporations Set Dividend Payments? Managers believe investors value steady dividend payments. Managers seem to have target payout ratio, but only over time. –Will allow payout to vary in the short term to keep $ dividends the same. –Will only raise $ dividend if permanent earnings increase. –Will only cut $ dividend if firm facing financial disaster. Managerial reluctance to change nominal dividend payment gives rise to partial adjustment model.

20. We can explain inter-industry differences in dividend payout. We know that ownership matters greatly and roughly how. We are convinced that dividends exist because of flaws in human ability to communicate and commit, not flaws in how markets work. Dividends convey information. Initiations and increases convey good news, decreases convey catastrophic news. Common law countries have higher payouts than civil law. What Do We Know About Dividends?

21. Exactly how do taxes impact dividends? Exactly what information is conveyed by dividends? Most puzzling: why has fraction of firms paying dividends declined in the US, but not elsewhere? What Don’t We Know About Dividends?