power point for dividend policy

8/19/2019 power point for dividend policy

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Chapter 13

Dividend Policy


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Copyright © 2006 Pearson Addison- 13-2

Learning oals

1. !nderstand cash dividend pay"entproced#res$ the ta% treat"ent o&dividends$ and the role o& dividendreinvest"ent plans.

2. Descri'e the resid#al theory o& dividendsand the (ey arg#"ents )ith regard to

dividend irrelevance and relevance.3. Disc#ss the (ey &actors involved in

esta'lishing a dividend policy.


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Learning oals *cont.+

,. evie) and eval#ate the three 'asictypes o& dividend policies.

. /val#ate stoc( dividends &ro"acco#nting$ shareholder$ and co"panypoints o& vie).

6. /%plain stoc( splits and stoc(rep#rchases and the &ir"s "otivation &or#nderta(ing each o& the".


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Copyright © 2006 Pearson Addison- 13-,

Dividend #nda"entals

• A dividend is a redistri'#tion &ro" earnings.

• ost co"panies "aintain a dividend policy )here'ythey pay a regular dividend on a #arterly 'asis.

• 4o"e co"panies pay an extra dividend to re)ardshareholders i& theyve had a partic#larly good year.any co"panies pay dividends according to a presetpayout ratio$ )hich "eas#res the proportion o&

dividends to earnings.

• any co"panies have paid reg#lar dividends &or over ah#ndred years.


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Dividend #nda"entals *cont.+

• Dividend growth tends to lag 'ehind earningsgro)th &or "ost corporations *see ne%t slide+.

• 4ince dividend policy is one o& the &actors thatdrives an investors decision to p#rchase astoc($ "ost co"panies announce their dividendpolicy and telegraph any e%pected changes inpolicy to the p#'lic.

• 5here&ore$ it can 'e seen that "any co"panies#se their dividend policy to provide information not other)ise availa'le to investors.


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In the financial press. Transactions in the stock on

the ex dividend date are indicated by an “x” next to

the volume of transactions.

In general, stock prices fall by an amount equal to

the quarterly dividend on the ex dividend date.

Dividend #nda"entalsCash Dividend Pay"ent Proced#res

• ate of !ecord 5he date on )hich investors "#st o)nshares in order to receive the dividend pay"ent.

• "x ividend ate o#r days prior to the date o& record.

5he day on )hich a stoc( trades e% dividend *e%cl#siveo& dividends+.


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Dividend #nda"entals CashDividend Pay"ent Proced#res *cont.+

• ate of !ecord 5he date on )hich investors "#sto)n shares in order to receive the dividendpay"ent.

• "x ividend ate o#r days prior to the date o&record. 5he day on )hich a stoc( trades e%dividend *e%cl#sive o& dividends+.

• istribution ate 5he day on )hich a dividend is

paid *pay"ent date+ to stoc(holders. 8t is #s#allyt)o or "ore )ee(s 'e&ore stoc(holders )ho o)nedshares on the date o& record receive theirdividends.



/%a"ple/%a"ple

At the #arterly dividend "eeting on :#ne 10th$ the #dol&

Co"pany 'oard o& directors declared an ;0.90 cashdividend &or holders o& record on riday$ :#ly 2nd. 5he &ir"

had 100$000 shares o& stoc( o#tstanding. 5he pay"ent

*distri'#tion+ date )as onday$ A#g#st 2nd.


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When the dividend )as anno#nced 'y the directors$

;90$000 o& the retained earnings *;.90>share % 100$000

shares+ )as trans&erred to the dividends paya'le acco#nt.

As a res#lt$ the (ey acco#nts changed as &ollo)s

#ash $%&&,&&& ividends 'ayable $ )&,&&&

!etained "arnings *%&,&&&




#dol& Co"panys stoc( 'egan selling e% dividend 2

'#siness days prior to the date o& record$ )hich )as

Wednesday$ :#ne 30th. 5his date )as &o#nd 'y s#'tracting

2 days &ro" the :#ly 2nd date o& record. P#rchasers o&

#dol&s stoc( on 5#esday$ :#ne 2=th or earlier received the

rights to the dividends? those )ho p#rchased the stoc( on or

a&ter :#ne 30th

did not. Ass#"ing a sta'le "ar(et$ #dol&sstoc( price )as e%pected to drop 'y a'o#t ;0.90 per share

)hen it 'egan selling e% dividend on :#ne 30th.



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5he net e&&ect o& the dividend pay"ent is a red#ction o&the &ir"s assets *thro#gh a red#ction in cash+ and

e#ity *thro#gh a red#ction in retained earnings+ 'y a

total o& ;90$000 *the dividend pay"ent+.

#ash $(%&,&&& ividends 'ayable $ &

!etained "arnings *%&,&&&

@n A#g#st 2nd$ the &ir" "ailed dividend chec(s to

shareholders o& record as o& :#ly 20th. 5his prod#ced

the &ollo)ing 'alances in the (ey acco#nts o& the &ir".



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Dividend #nda"entals5a% 5reat"ent o& Dividends

• 5he +obs and rowth Tax !elief!econciliation -ct of %&& signi&icantly changedthe ta% treat"ent o& corporate dividends 'y

dropping the ta% rate to the rate applica'le oncapital gains$ )hich has a "a%i"#" rate o& 1.

• 8""ediately a&ter passage o& the Act$ "any &ir"seither initiated or increased dividends paid to

their shareholders and this red#ction in thedegree o& do#'le ta%ation o& dividends ise%pected to contin#e.


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Dividend einvest"ent Plans

• Dividend einvest"ent Plans *D8P4+ ena'lestoc(holders to #se dividends received on the &ir"sstoc( to ac#ire additional sharesBeven &ractional

sharesBat little or no transaction cost.• With D8P4$ plan participants typically can ac#ire

shares at a'o#t percent 'elo) the prevailing"ar(et prices.

• ro" its point o& vie)$ the &ir" can iss#e ne) shares toparticipants "ore econo"ically$ avoiding the #nderpricing and &lotation costs that )o#ld acco"pany thep#'lic sale o& ne) shares.


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/tep (0 etermine the optimal level of capital

expenditures which is given by the point of intersection

of the investment opportunities schedule 1I2/3 and

weighted marginal cost of capital schedule 145##3.

5he elevance o& Dividend Policy5he esid#al 5heory o& Dividends

• 5he residual theory o& dividends s#ggests that dividendpay"ents sho#ld 'e vie)ed as resid#alBthe a"o#nt le&tover a&ter all accepta'le invest"ent opport#nities have'een #nderta(en.

• !sing this approach$ the &ir" )o#ld treat the dividenddecision in three steps as &ollo)s


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/tep %0 6sing the optimal capital structure proportions,

estimate the total amount of equity financing needed to

support the expenditures estimated in /tep (.

/tep 0 7ecause the cost of retained earnings is less

than new equity, use retained earnings to meet the equity

requirement in /tep %. If inadequate, sell new stock. If

there is an excess of retained earnings, distribute the

surplus amount8the residual8as dividends.

5he elevance o& Dividend Policy5he esid#al 5heory o& Dividends *cont.+


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• 8n s#"$ this theory s#ggests that no cashdividend is paid as long as the &ir"se#ity need is in e%cess o& the a"o#nt o&retained earnings.

• #rther"ore$ it s#ggests that the re#iredret#rn de"anded 'y stoc(holders is not

in&l#enced 'y the &ir"s dividend policyBapre"ise that in t#rn s#ggests thatdividend policy is irrelevant.



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@ver'roo( 8nd#stries$ a "an#&act#rer o& canoes and other

s"all )atercra&t$ has availa'le &ro" the c#rrent periods

operations ;1.9 "illion that can 'e retained or paid o#t in

dividends. 5he &ir"s opti"al capital str#ct#re is 30 de't

and 70 e#ity. ig#re 13.2 depicts the &ir"s WCC

sched#le along )ith three invest"ent opport#nity

sched#les *8@4s+. or each 8@4$ the level o& total ne)

&inancing or invest"ent deter"ined 'y the point o&

intersection o& the 8@4 and the WCC has 'een noted.



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Copyright © 2006 Pearson Addison- 13-1=



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5a'le 13.1 sho)s that i& 8@41 e%ists$ the &ir" )ill pay o#t

;70$000 in dividends 'eca#se only ;1$00$000 o& the

;1$900$000 o& availa'le earnings is needed. 5he ta'le alsosho)s the dividend payo#ts associated )ith 8@42 and

8@43. Depending on )hich 8@4 e%ists$ the &ir"s dividend

)o#ld in e&&ect 'e the resid#al$ i& any$ re"aining a&ter all

accepta'le invest"ents have 'een &inanced.



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5he elevance o& Dividend Policy Arg#"ents &or Dividend 8rrelevance

• erton iller and ranco odigliani *+developed a theory that sho)s that in perfectfinancial "ar(ets *certainty$ no ta%es$ no

transactions costs or other "ar(eti"per&ections+$ the val#e o& a &ir" is #na&&ected'y the distri'#tion o& dividends.

• 5hey arg#e that val#e is driven only 'y the

t#re earnings and ris( o& its invest"ents.

• etaining earnings or paying the" in dividendsdoes not a&&ect this val#e.


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5he elevance o& Dividend Policy Arg#"ents &or Dividend 8rrelevance *cont.+

• 4o"e st#dies s#ggested that large dividendchanges a&&ect stoc( price 'ehavior.

• arg#ed$ ho)ever$ that these e&&ects are the

res#lt o& the in&or"ation conveyed 'y thesedividend changes$ not to the dividend itsel&.

• #rther"ore$ arg#e &or the e%istence o& aclientele e&&ect.

• 8nvestors pre&erring dividends )ill p#rchase highdividend stoc(s$ )hile those pre&erring capitalgains )ill p#rchase lo) dividend paying stoc(s.


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(. The firm9s value is determined solely by the earning power

and risk of its asset investments.

%. If dividends do affect value, they do so because of the

information content, which signals management9s futureexpectations.

. - clientele effect exists that causes shareholders to receive

the level of dividends they expect.

5he elevance o& Dividend Policy Arg#"ents &or Dividend 8rrelevance *cont.+

• 8n s#""ary$ and other dividend irrelevanceproponents arg#e thatBall else 'eing e#alBaninvestors re#ired ret#rn$ and there&ore the val#e o& the

&ir"$ is #na&&ected 'y dividend policy 'eca#se


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• Contrary to dividend irrelevance proponents$ ordonand :intner s#ggested stoc(holders pre&er c#rrentdividends ant that a positive relationship e%ists 'et)een

dividends and "ar(et val#e.• #nda"ental to this theory is the bird;in;the;hand

arg#"ent )hich s#ggests that investors are generallyris(-averse and attach less ris( to current as opposed

to t#re dividends or capital gains.•


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actors A&&ecting Dividend PolicyLegal Constraints

• ost state sec#rities reg#lations prevent &ir"s &ro"paying o#t dividends &ro" any portion o& the co"panyslegal capital )hich is "eas#red 'y the par val#e o&

co""on stoc(Bor par val#e pl#s paid-in-capital.• Dividends are also so"eti"es li"ited to the s#" o& the

&ir"s "ost recent and past retained earningsBaltho#ghpay"ents in e%cess o& c#rrent earnings is #s#ally

per"itted.• ost states also prohi'it dividends )hen &ir"s have

overd#e lia'ilities$ is legally insolvent$ or 'an(r#pt.


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actors A&&ecting Dividend PolicyLegal Constraints *cont.+

• /ven the 84 has r#led in the area o& dividend policy.

• 4peci&ically$ the I!/ prohibits &ir"s &ro" ac#iringearnings to red#ce stoc(holders ta%es.

• 8 the 84 can deter"ine that a &ir" has acc#"#lated ane%cess o& earnings to allo) o)ners to delay payingordinary inco"e ta%es *on dividends+$ it "ay levy anexcess earnings accumulation tax on any retained

earnings a'ove ;20$000 &or "ost '#sinesses.

• 8t sho#ld 'e noted$ ho)ever$ that this r#ling isseldo" applied.


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actors A&&ecting Dividend PolicyContract#al Constraints

• 8n "any cases$ co"panies are constrained inthe e%tent to )hich they can pay dividends 'yrestrictive provisions in loan agree"ents and

bond indentures.• enerally$ these constraints prohi'it the pay"ent

o& cash dividends #ntil a certain level o& earningsare achieved or to a certain dollar a"o#nt or

percentage o& earnings.

• Any violation o& these constraints generallytrigger the de"and &or i""ediate pay"ent.


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actors A&&ecting Dividend Policy8nternal Constraints

• A co"panys a'ility to pay dividends is #s#allyconstrained 'y the amount of available cash rather than the level o& retained earnings against

)hich to charge the".

• Altho#gh it is possi'le to 'orro) to paydividends$ lenders are #s#ally rel#ctant to grant

the" 'eca#se #sing the nds &or this p#rposeprod#ces not operating 'ene&its that help torepay the".


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actors A&&ecting Dividend Policyro)th Prospects

• Ee)er$ rapidly-gro)ing &ir"s generally pay littleor no dividends.

•


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actors A&&ecting Dividend Policy@)ner Considerations

• 5he &ir" "#st esta'lish a policy that has a&avora'le e&&ect on the )ealth o& the "aFority o& itso)ners.

• 8& a &ir" has a large percentage o& )ealthyshareholders$ it "ay decide to pay o#t a lo)erpercentage o& its earnings to allo) the" to delaythe pay"ent o& ta%es #ntil they sell the stoc(.

•


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actors A&&ecting Dividend Policy@)ner Considerations *cont.+

• A second consideration is the owner9sinvestment opportunities.

• A &ir" sho#ld not retain nds &or invest"ent proFects

yielding lo)er ret#rns that the o)ners co#ld o'tain &ro"e%ternal invest"ents o& e#al ris(.

• A &inal consideration is the potential dilutionof ownership.

• 8& a &ir" pays o#t a high percentage o& earnings$ ne)e#ity capital )ill have to 'e raised )ith co""on stoc(.


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actors A&&ecting Dividend Policyar(et Considerations

• Perhaps the "ost i"portant aspect o& dividend policy isthat the &ir" "aintain a level o& predictability.

• 4toc(holders that pre&er dividend-paying stoc(s pre&er a

contin#o#s strea" o& &i%ed or increasing dividends.

• 4hareholders also vie) the &ir"s dividend pay"ent as asignal o& the &ir"s t#re prospects.

•

i%ed or increasing dividends are o&ten considered apositive signal$ )hile erratic dividend pay"ents arevie)ed as negative signals.


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5ypes o& Dividend PoliciesConstant-Payo#t-atio Policy

• With a constant;payout;ratio dividend policy$the &ir" esta'lishes that a speci&ic percentage o&earnings is paid to shareholders each period.

• A "aFor shortco"ing o& this approach is that i&the &ir"s earnings drop or are volatile$ so too)ill 'e the dividend pay"ents.

• As "entioned earlier$ investors vie) volatiledividends as negative and ris(yB)hich canlead to lo)er share prices.


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Peachtree 8nd#stries$ a "iner o& potassi#"$ has a

policy o& paying o#t ,0 o& earnings in cash

dividends. 8n the periods )hen a loss occ#rs$ the

&ir"s policy is to pay no cash dividends.

5ypes o& Dividend PoliciesConstant-Payo#t-atio Policy *cont.+


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5ypes o& Dividend Policieseg#lar Dividend Policy

• A regular dividend policy is 'ased on thepay"ent o& a &i%ed-dollar dividend eachperiod.

• 8t provides stoc(holders )ith positivein&or"ation indicating that the &ir" is doing)ell and it "ini"iGes #ncertainty.

• enerally$ &ir"s #sing this policy )illincrease the reg#lar dividend onceearnings are proven to 'e relia'le.


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5he dividend policy o& Wood)ard La'oratories$ a prod#cer

o& a pop#lar arti&icial s)eetener$ is to pay ann#al dividends

o& ;1.00 per share #ntil per-share earnings e%ceeded ;,.00

&or three consec#tive years. At that point$ the ann#al

dividend is raised to ;1.0 per share$ and a ne) earnings

platea# is esta'lished. 5he &ir" does not anticipate

decreasing its dividend #nless its li#idity is in Feopardy.

Data &or Wood)ards earnings$ dividends$ and average

stoc( prices &or the past 12 years &ollo).

5ypes o& Dividend Policieseg#lar Dividend Policy *cont.+


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5ypes o& Dividend Policieseg#lar Dividend Policy *cont.+


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5ypes o& Dividend PoliciesLo)-eg#lar-and-/%tra Dividend Policy

• !sing this policy$ &ir"s pay a low regulardividend$ s#pple"ented 'y additional dividends)hen earnings can s#pport it.

• When earnings are higher than nor"al$ the &ir")ill pay this additional dividend$ o&ten called anextra dividend$ )itho#t the o'ligation to"aintain it d#ring s#'se#ent periods.

• 5his type o& policy is o&ten #sed 'y &ir"s )hosesales and earnings are s#scepti'le to s)ings inthe '#siness cycle.


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@ther or"s o& Dividends4toc( Dividends

• A stock dividend is paid in stoc( rather than in cash.

• any investors 'elieve that stoc( dividends increase theval#e o& their holdings.

• 8n &act$ &ro" a "ar(et val#e standpoint$ stoc( dividendsnction "#ch li(e stoc( splits. 5he investor ends #po)ning "ore shares$ '#t the val#e o& their sharesis less.

• ro" a 'oo( val#e standpoint$ nds are trans&erred&ro" retained earnings to co""on stoc( and additionalpaid-in-capital.


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5he c#rrent stoc(holders e#ity on the 'alance sheet

o& arrison Corporation$ a distri'#tor o& pre&a'ricated

ca'inets$ is as sho)n in the &ollo)ing acco#nts.

@ther or"s o& Dividends4toc( Dividends *cont+

• Acco#nting Aspects


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8& arrison declares a 10 stoc( dividend and the

c#rrent "ar(et price o& the stoc( is ;1>share$ ;10$000o& retained earnings *10 % 100$000 shares %

;1>share+ )ill 'e capitaliGed.

5he ;10$000 )ill 'e distri'#ted 'et)een the co""onstoc( *par+ acco#nt and paid-in-capital in e%cess o& par

acco#nt 'ased on the par val#e o& the co""on stoc(.

5he res#lting 'alances are as &ollo)s


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• 5he 4hareholders Hie)point

– ro" a shareholder9s perspective$ stoc( dividendsres#lt in a dil#tion o& shares o)ned.

– or e%a"ple$ ass#"e a stoc(holder o)ned 100 sharesat ;20>share *;2$000 total+ 'e&ore astoc( dividend.

– 8& the &ir" declares a 10 stoc( dividend$ the

shareholder )ill have 110 shares o& stoc(. Io)ever$the total val#e o& her shares )ill still 'e ;2$000.

– 5here&ore$ the val#e o& her share "#st have &allen to;19.19>share *;2$000>110+.


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• 5he Co"panys Hie)point

– Disadvantages o& stoc( dividends incl#de• 5he cost o& iss#ing the ne) shares

• 5a%es and listing &ees on the ne) shares

• @ther recording costs

– Advantages o& stoc( dividends incl#de

• 5he co"pany conserves needed cash• 4ignaling e&&ect to the shareholders that the &ir" is

retaining cash 'eca#se o& l#crative invest"entopport#nities


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Delphi Co"pany$ a &orest prod#cts concern$ had200$000 shares o& ;2-par val#e co""on stoc(

o#tstanding and declares a 2-&or-1 split. 5he total

'e&ore and a&ter split i"pact on stoc(holders e#ity is

@ther or"s o& Dividends4toc( 4plits

• A stock split is a recapitaliGation that a&&ects then#"'er o& shares o#tstanding$ par val#e$earnings per share$ and "ar(et price.

• 5he rationale &or a stoc( split is that it lo)ers theprice o& the stoc( and "a(es it "ore attractiveto individ#al investors


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@ther or"s o& Dividends4toc( 4plits *cont.+


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!esearch on both stock splits and stock dividends

generally supports the theory that they do not affect

the value of shares.

They are often used, however, to send a signal to

investors that good things are going to happen.

@ther or"s o& Dividends4toc( 4plits *cont.+

• A reverse stock split red#ces the n#"'er o& shareso#tstanding and raises stoc( priceBthe opposite o& astoc( split.

• 5he rationale &or a reverse stoc( split is to addrespecta'ility to the stoc( and convey the "eaning thatit isnt a F#n( stoc(.


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@ther or"s o& Dividends4toc( ep#rchases

• A stock repurchase is the p#rchasing andretiring o& stoc( 'y theiss#ing corporation.

• A rep#rchase is a partial liquidation sinceit decreases the n#"'er o&

shares o#tstanding.• 8t "ay also 'e tho#ght o& as an alternative

to cash dividends.


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@ther or"s o& Dividends4toc( ep#rchases *cont.+

• Alternative reasons &or stoc( rep#rchases

– 5o #se the shares &or another p#rpose

– 5o alter the &ir"s capital str#ct#re

– 5o increase /P4 and @/ res#lting in ahigher "ar(et price

– 5o red#ce the chance o& a hostile ta(eover


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@ther or"s o& Dividends 4toc(ep#rchases Hie)ed as a Cash Dividend

• 5he rep#rchase o& stoc( res#lts in a type o&reverse dilution.

• 5he net e&&ect o& the rep#rchase is si"ilar to thepay"ent o& a cash dividend.

• Io)ever$ i& the &ir" pays the dividend$ theo)ner )o#ld have to pay ta% on the inco"e.

• 5he gain on the increase in share price as ares#lt o& the rep#rchase$ ho)ever$ )o#ld not 'eta%ed #ntil sold.

power point for dividend policy

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