Cash Dividend Payment Procedures

Cash Dividend Payment Procedures

• Shareholders do not have a legal entitlement to dividends; the board of directors decides dividend payments.
• Most US firms distribute dividends quarterly.
• Annual dividend adjustments are common practice.

Dividend Smoothing

• Companies tend to smooth dividends over time, as earnings are more volatile than dividends.
• Dividend decreases can negatively impact investor confidence.

Relevant Dividend Dates

• Shareholders of record are entitled to receive dividends.
• Investors purchasing stock on the record date will not receive the dividend.
• To receive the dividend, the stock must be owned before the ex-dividend date, typically two business days before the record date.
• Dividends are distributed on the payment date, a few weeks after the record date.

Dividend Payout Ratio & Dividend Yield

• The payout ratio is computed by dividing the cash dividend per share by the earnings per share, indicating the percentage of profits distributed to owners.
• The yield is calculated by dividing the stock's dividend by its price, measuring the rate of return from dividend payments.

Stock Dividends, Stock Splits, Reverse Splits

• Stock dividends involve issuing additional shares instead of cash.
• A 2-for-1 split doubles the number of shares, leaving market capitalization unchanged.
• Stock splits increase the number of shares while decreasing their value.
• A 1-for-2 reverse split increases the value per share.
• Reverse splits may address a low stock price or concerns about delisting.

Share Repurchases

• Companies repurchase their own shares usually through open-market purchases.
• Share repurchases offer an alternative method for distributing cash to shareholders.
• Share repurchase value in the US can exceed dividends, welcomed by investors.
• Methods include open-market share repurchase, tender offers, and Dutch auction repurchases.

Dividend Policy

• Dividend policy includes long-run target payout ratios.
• Dividend changes follow shifts in long-run sustainable earnings, not short-term fluctuations.
• Companies avoid increasing dividends if future cuts could be necessary.
• Emphasis is placed on dividend changes rather than absolute levels.

Miller-Modigliani Theorem

• In perfect capital markets, payout policy does not affect a firm's value.
• Firms can pay any dividend level if they accept positive NPV projects and have access to capital markets.
• If payout policy affects firm value, it is due to market imperfections.

Tax Policy Concerning Dividends

• Dividends are taxed at an individual’s long-term capital gain tax rate.
• Income from repurchases is taxed only upon the investor selling shares back to the company.
• This dynamic encourages a shift from dividends toward repurchases.

Agency Costs

• Dividend payments can mitigate agency problems arising from the separation of ownership and control.
• Investors value firms that don't hoard excessive cash more highly.
• Dividend payers are typically older, larger firms with more cash and fewer growth opportunities, with dispersed stock ownership.
• Dividend payers have greater average market values and slower growth, and are older than non-payers.

Signaling Cost Models of Dividends

• Dividends convey positive information to poorly informed shareholders.
• Stock prices may rise or fall in response to dividend increases or cuts.

Borrowing in a Foreign Currency to Hedge Foreign Exchange Risk

• Subsidiaries of MNCs often finance operations in the currency of their product invoicing.
• Foreign currency loans can create a "natural hedge" against currency fluctuations.
• This strategy is suited for subsidiaries in countries with low interest rates.
• It reduces exposure to rate movements by using cash inflows to cover debt outflows.

Currency Swaps for Hedging

• A currency swap involves exchanging currencies at intervals, aligning cash outflows with revenue in the same currency.
• Currency swaps function as a series of forward contracts.

Simulation Analysis to Determine the Best Currency for Borrowing

• Simulation inputs include initial investment needs, spot rates, interest rates, expected revenue, operating expenses, and forecast future spot rates.

Debt Maturity Decision and Yield Curve

• Yield curve shapes vary across countries.
• Upward-sloping curves may reflect compensation for illiquidity associated with long-term debt.
• The decision involves balancing loan maturity with interest rates and potential refinancing needs.

Fixed vs Floating Rate Debt Decisions

• MNCs seeking long-term maturities but avoiding fixed rates might consider floating rate bonds.
• Forecasting rates helps determine expected interest payments for floating rate loans.
• Floating rates are now commonly tied to SOFR.

Hedging Interest Payments with Interest Rate Swaps

• Interest rate swaps hedge the risk of rising rates for MNCs with floating rate debt.
• Financial institutions act as dealers offering these swaps.

Types of Interest Rate Swaps

• In a plain vanilla interest rate swap, one party makes fixed-rate payments in exchange for floating-rate payments, based on a notional value.
• Accretion swap - Notional value increases over time.
• Amortizing swap - Notional value decreases over time.
• Basis (floating-for-floating) swap - Exchanges two floating rate payments.
• Callable swap - The fixed-rate payer can terminate the swap, typically when interest rates fall.
• Forward swap - Payments start at a future date.
• Puttable swap - The floating-rate payer can terminate the swap, usually if interest rates rise.
• Zero-coupon swap - Fixed-rate payments are postponed until maturity.

Swaption

• A swaption grants the owner the right, but not the obligation, to enter a swap.

Canadian Pacific Case: Contingent Value Right Structure

• The CVR compensated Norfolk Southern shareholders if the Surface Transportation Board (STB) rejected the merger.
• It provided downside protection through payments contingent on regulatory outcomes.

Drawbacks of Canadian Pacific’s Offer

• Regulatory uncertainty about STB approval due to antitrust concerns.
• Management's skepticism regarding CP’s Precision Scheduled Railroading operating model.
• Valuation concerns that the offer undervalued NS’s long-term standalone potential.
• Cultural and integration risks between two large railroads with different management cultures.

Advantages of Canadian Pacific’s Offer

• Premium over market value with a cash and stock mix.
• Experienced leadership with CEO Hunter Harrison’s track record.
• Projected synergies of approximately $3 billion.
• Enhanced transcontinental network service and efficiency.

How Canadian Pacific Planned to Cut Norfolk Southern’s Costs

• Implementation of Precision Scheduled Railroading (PSR).
• Asset rationalization to reduce excess resources.
• Labor efficiency improvements via automation and process optimization.
• Fuel and maintenance savings through efficient train operations.

Publicly Traded Bonds

• Public bonds must be registered with the SEC.
• Investment banks typically assist in their issuance.
• Most public bonds are fixed-rate offerings.

Privately Held Bonds

• Loans are private debt agreements with financial institutions.
• Private placements are unregistered issues sold directly to accredited investors.

Regular vs Shelf Registration

Regular Registration

• A traditional SEC registration process under the Securities Act of 1933.
• Securities must be sold soon after registration.
• Used for single, immediate offerings.
• Less flexible, requiring detailed disclosures and SEC approval.

Shelf Registration (Rule 415)

• Allows issuers to register a large amount of securities up front for later sale.
• Securities can be issued over time (up to three years).
• Common for well-known seasoned issuers (WKSIs).
• Highly flexible, allowing timing based on market conditions.
• Reduces administrative burden and improves market responsiveness.

Factors that Determine the Cost of Long-Term Debt

• Loan maturity - Yield curves typically slope upwards, due to greater exposure to the risk of default.
• Loan Size - Considers the trade-off between administrative costs per dollar and increased risk exposure.
• Borrower risk - Higher default risk leads to higher interest rates.
• Basic cost of money - Prevailing rates on low-risk instruments influence other loan rates.

Bond Indentures

• Bond contract provisions specify payment details, covenants, security, and sinking fund requirements.

Call Features

• Call features allow issuers to repurchase bonds before maturity at a call price.
• Call price is often par value plus one year of interest (call premium).
• Issuers can retire issues early when interest rates fall.
• Bondholders are compensated via higher interest rates.

Advantages and Disadvantages of Leasing

Advantages

• Effective depreciation of land.
• Sale-leaseback enhances firm liquidity.
• Provides 100% financing.
• Lower claims against the firm in bankruptcy (3 years' payments).
• Reduced risk of asset obsolescence.
• Avoids restrictive covenants of long-term loan agreements.

Disadvantages

• Leases do not have stated interest costs. Effective cost may be higher than if the firm borrow money to purchase.
• Lessee does not receive salvage value.
• Modifications or improvements may require approval.
• Lease payments continue even if assets become obsolete.

Convertible Bonds

• Allow bondholders to convert each bond into a stated number of common stock shares.

Internal vs External Short-Term (ST) Financing

Internal

• Check other subsidiaries cash flow positions to determine whether any internal funds are available.
• Direct one subsidiary to loan to another.
• Increase markups on supplies sold to subsidiaries.
• An MNC should have an internal system that consistently monitors the amount of short term financing by all subsidiaries – allows parent company to limit debt financing by subsidiaries.

External

• Short-term notes or unused debt securities.
• Commercial paper.
• Bank loans maintain a relationship with banks.

Access to Funding During the Credit Crisis

• During crises, MNCs experienced limited access to short-term funding.
• Financial institutions favored treasury securities (flight to quality).
• Corporate debt interest rates increased.

Borrowing a Developing Country’s Currency

• Developing countries tend to have higher inflation and low level of saving, causing interest rates to be relatively high.

Effective Financing Rate, Including Exchange Rates

• Actual financing rates depend on the interest rate and currency value fluctuations over the loan term.

Forward Premium and Interest Rate Parity

• If interest rate parity exists, the currency will exhibit a forward premium that offsets the differential between its interest rate and the home interest rate.
• Covered interest arbitrage financing with low-interest-rate currency yields an effective rate equal to the home interest rate.

Exchange Rate Forecasts with a Probability Distribution

• Combine exchange rate forecasts and foreign interest rates to predict the effective financing rate.
• Use probability distributions instead of relying on a single point estimate (such as sensitivity analysis).
• Compare the distribution to the home currency's known financing rate.

Financing with a Portfolio of Currencies

• Financing with a portfolio of currencies may result in a larger variance
• With diversification of currencies, lower financing costs are possible but currencies must not be highly correlated.
• Estimating variance becomes complex as more currencies are added.

Key Formulas

• Dividend Payout Ratio = dividend per share/earnings per share
• Dividend Yield = Dividend per share/price per share