Irwin/McGraw-HillChapter16FundamentalsofCorporateFinanceThirdEditionDividendPolicyBrealeyMyersMarcusslidesbyMatthewWillIrwin/McGraw-HillTheMcGraw-HillCompanies,Inc.,2001TopicsCoveredHowDividendsarePaidHowDoCompaniesDecideonDividendPaymentsWhyDividendPolicyShouldNotMatterWhyDividendsMayIncreaseFirmValueWhyDividendsMayReduceFirmValueDividendPaymentsRecordDate-Personwhoownsstockonthisdatereceivedthedividend.Ex-DividendDate-Datethatdetermineswhetherastockholderisentitledtoadividendpayment;anyoneholdingstockbeforethisdateisentitledtoadividend.CashDividend-Paymentofcashbythefirmtoitsshareholders.DividendPaymentsStockRepurchase-Firmbuysbackstockfromitsshareholders.StockDividend-Distributionofadditionalsharestoafirm’sstockholders.StockSplits-Issueofadditionalsharestofirm’sstockholders.DividendPaymentsJul28Aug10Aug11Aug13Sept10DeclarationWith-Ex-dividendRecordPaymentdatedividenddatedatedatedateSharepricefallsStockDividendExample-AmoebaProductshas2millionsharescurrentlyoutstandingatapriceof$15pershare.Thecompanydeclaresa50%stockdividend.Howmanyshareswillbeoutstandingafterthedividendispaid?Answer2milx.50=1mil+2mil=3milsharesStockDividendExample-cont-Afterthestockdividendwhatisthenewpricepershareandwhatisthenewvalueofthefirm?AnswerThevalueofthefirmwas2milx$15pershare,or$30mil.Afterthedividendthevaluewillremainthesame.Pricepershare=$30mil/3milsh=$10persh.StockRepurchaseExample-CashdividendversussharerepurchaseStockRepurchaseExample-CashdividendversussharerepurchaseStockRepurchaseExample-CashdividendversussharerepurchaseTheDividendDecision1.Firmshavelongertermtargetdividendpayoutratios.2.Managersfocusmoreondividendchangesthanonabsolutelevels.3.Dividendschangesfollowshiftsinlong-run,sustainablelevelsofearningsratherthanshort-runchangesinearnings.4.Managersarereluctanttomakedividendchangesthatmighthavetobereversed.Lintner’s“StylizedFacts”(HowDividendsareDetermined)DividendPolicyisIrrelevantExample-AssumeABCCo.hasnoextracash,butdeclaresa$1,000dividend.Theyalsorequire$1,000forcurrentinvestmentneeds.UsingM&MTheory,andgiventhefollowingbalancesheetinformation,showhowthevalueofthefirmisnotalteredwhennewsharesareissuedtopayforthedividend.RecordDatePmtDatePostPmtCash1,00001,000(40sh@$25)AssetValue5,0005,0005,000TotalValue6,0005,0006,000#ofShares200200240price/share$30$25$25NEWSHARESAREISSUEDDividendPolicyisIrrelevantExample-continued-ShareholderValueRecordPmtPostStock6,0005,0006,000Cash01,0000TotalValue6,0006,0006,000Stock=240sh@$25=6,000Assumestockholderspurchasethenewissuewiththecashdividendproceeds.DividendsIncreaseValueMarketImperfectionsandClienteleEffectTherearenaturalclientsforhigh-payoutstocks,butitdoesnotfollowthatanyparticularfirmcanbenefitbyincreasingitsdividends.Thehighdividendclientelealreadyhaveplentyofhighdividendstocktochoosefrom.Theseclientsincreasethepriceofthestockthroughtheirdemandforadividendpayingstock.DividendsIncreaseValueDividendsasSignalsDividendincreasessendgoodnewsaboutcashflowsandearnings.Dividendcutssendbadnews.Becauseahighdividendpayoutpolicywillbecostlytofirmsthatdonothavethecashflowtosupportit,dividendincreasessignalacompany’sgoodfortuneanditsmanager’sconfidenceinfuturecashflows.DividendsDecreaseValueTaxConsequencesCompaniescanconvertdividendsintocapitalgainsbyshiftingtheirdividendpolicies.Ifdividendsaretaxedmoreheavilythancapitalgains,taxpayinginvestorsshouldwelcomesuchamoveandvaluethefirmmorefavorably.Insuchataxenvironment,thetotalcashflowretainedbythefirmand/orheldbyshareholderswillbehigherthanifdividendsarepaid.DividendsDecreaseValue
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