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Questions and Answers
What is the primary purpose of a company's payout policy?
What is the primary purpose of a company's payout policy?
- To influence the stock price.
- To determine how to distribute cash to shareholders. (correct)
- To minimize the company's tax liabilities.
- To maximize the company's short-term profits.
Which of the following payout methods involves a company distributing additional shares to its stockholders?
Which of the following payout methods involves a company distributing additional shares to its stockholders?
- Stock repurchase
- Stock split (correct)
- Cash repurchase
- Cash dividend
What is the significance of the 'ex-dividend date'?
What is the significance of the 'ex-dividend date'?
- It is the date determining eligibility for a dividend payment. (correct)
- It is the date shareholders must register to receive the dividend.
- It is the date dividend checks are mailed to shareholders.
- It is the date on which the firm announces its intention to pay a dividend.
How does a dividend increase tend to affect investors' perception of a company?
How does a dividend increase tend to affect investors' perception of a company?
Which stock repurchase method involves a company buying back shares directly from a specific investor, often at a premium?
Which stock repurchase method involves a company buying back shares directly from a specific investor, often at a premium?
What is a key concern for managers when deciding on dividend policy?
What is a key concern for managers when deciding on dividend policy?
According to the dividend irrelevance theory, in a perfect market, what impact does dividend policy have on the value of the firm?
According to the dividend irrelevance theory, in a perfect market, what impact does dividend policy have on the value of the firm?
How might the agency cost of idle cash influence a company's decision to pay dividends?
How might the agency cost of idle cash influence a company's decision to pay dividends?
In a tax environment where dividends are taxed more heavily than capital gains, how should taxpaying investors view a company that shifts its payout policy from dividends to stock repurchases?
In a tax environment where dividends are taxed more heavily than capital gains, how should taxpaying investors view a company that shifts its payout policy from dividends to stock repurchases?
What is characteristic of young growth firms regarding payout policy?
What is characteristic of young growth firms regarding payout policy?
A company has 2 million shares outstanding at a price of $15 per share. If the company declares a 50% stock dividend, how many shares will be outstanding after the dividend is paid?
A company has 2 million shares outstanding at a price of $15 per share. If the company declares a 50% stock dividend, how many shares will be outstanding after the dividend is paid?
Following the stock dividend in the previous question, what would be the new price per share if the firm's total value remains the same ($30 million)?
Following the stock dividend in the previous question, what would be the new price per share if the firm's total value remains the same ($30 million)?
ABC Corporation is selling for $30 per share. If you own 100 shares and a 10% stock dividend is declared, what will you receive?
ABC Corporation is selling for $30 per share. If you own 100 shares and a 10% stock dividend is declared, what will you receive?
A firm has assets of $1,100,000 and 100,000 shares outstanding, making the price per share $11. If the firm distributes a cash dividend of $1 per share, what would be the new price per share?
A firm has assets of $1,100,000 and 100,000 shares outstanding, making the price per share $11. If the firm distributes a cash dividend of $1 per share, what would be the new price per share?
Continuing from the previous question, if the firm instead used $100,000 to repurchase its own stock, approximately how many shares would be outstanding if the repurchase occurred at the original price of $11 per share?
Continuing from the previous question, if the firm instead used $100,000 to repurchase its own stock, approximately how many shares would be outstanding if the repurchase occurred at the original price of $11 per share?
How are stock dividends similar to stock splits?
How are stock dividends similar to stock splits?
Why is it that a two-for-one stock split is equivalent with a 100% stock dividend?
Why is it that a two-for-one stock split is equivalent with a 100% stock dividend?
In terms of dividends, what conveys lack of confidence and is regarded as bad news?
In terms of dividends, what conveys lack of confidence and is regarded as bad news?
Company A offers to buy shares at a fixed price, and the shareholders decided whether to sell. Which type of stock repurchase method is this?
Company A offers to buy shares at a fixed price, and the shareholders decided whether to sell. Which type of stock repurchase method is this?
Which of the following statements best reflects the attitude of senior executives towards dividend policy?
Which of the following statements best reflects the attitude of senior executives towards dividend policy?
A company is trying to determine whether to issue dividend checks or not and are deciding based on the current dividend level. This best illustrates what factor?
A company is trying to determine whether to issue dividend checks or not and are deciding based on the current dividend level. This best illustrates what factor?
According to dividend policy irrelevance in efficient capital market, which of the following statements is true?
According to dividend policy irrelevance in efficient capital market, which of the following statements is true?
What is the consequence when companies can convert dividends into capital gains?
What is the consequence when companies can convert dividends into capital gains?
Young growth firms are known for their
Young growth firms are known for their
True or False: Shareholders get dividend payments on the ex-dividend date.
True or False: Shareholders get dividend payments on the ex-dividend date.
What's the effect of companies retaining cash?
What's the effect of companies retaining cash?
The managers of a corporation with plenty of cash on hand but few valuable investment opportunities is affected by?
The managers of a corporation with plenty of cash on hand but few valuable investment opportunities is affected by?
Investors that don't participate in share purchase will:
Investors that don't participate in share purchase will:
Rather than reducing dividend, what do companies do?
Rather than reducing dividend, what do companies do?
If after increasing dividends, a company does not have the cashflow to support the dividends, this:
If after increasing dividends, a company does not have the cashflow to support the dividends, this:
If investors do not need dividends to convert shares to cash, then investors typically will:
If investors do not need dividends to convert shares to cash, then investors typically will:
A firm repurchases shares from a specific investor, usually at a premium to prevent a hostile takeover. This best describes what?
A firm repurchases shares from a specific investor, usually at a premium to prevent a hostile takeover. This best describes what?
Flashcards
Cash Dividend
Cash Dividend
Payment of cash by the firm to its shareholders.
Ex-Dividend Date
Ex-Dividend Date
Date determining stockholder eligibility for a dividend payment.
Record Date
Record Date
The person who owns stock on this date receives the dividend.
Stock Dividend
Stock Dividend
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Stock Splits
Stock Splits
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Stock Repurchase
Stock Repurchase
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Information content of dividends
Information content of dividends
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Open-market repurchase
Open-market repurchase
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Tender offer
Tender offer
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Auction (Dutch auction)
Auction (Dutch auction)
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Direct negotiation (Greenmail)
Direct negotiation (Greenmail)
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Dividend Smoothing
Dividend Smoothing
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Young growth firms: lower payout
Young growth firms: lower payout
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Firms increase payout because they run out of growth ideas.
Firms increase payout because they run out of growth ideas.
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Study Notes
Payout Policy
- Payout policy involves how corporations distribute cash to their shareholders
Learning Objectives
- Corporations can payout cash through dividends or stock repurchases
- Dividends and repurchases communicate information
- Dividend versus repurchase is a controversial payout policy
- Dividends potentially increase value
- Dividends also potentially reduce value
- Payout policy is linked to the firm's life cycle
Facts about payouts
- Payout practices for nonfinancial firms from 2011-2020
- 24.1% paid dividends and repurchased stock
- 23.7% repurchased stock but did not pay dividends
- 12.0% paid dividends but did not repurchase stock
- 40.1% did neither
- U.S. data from 1985-2020 indicates that repurchases have become increasingly common
Dividend Payments
- Several key dates related to dividend payments
- Declaration date: the firm announces intent to pay a dividend
- Ex-dividend date: shares start being traded without the dividend attached
- Record date: shareholders registered on this date will receive the dividend
- Payment date: dividend checks are mailed to shareholders
- A cash dividend is a payment of cash by the firm to its shareholders
- The ex-dividend date determines who is eligible for a dividend
- The record date determines who receives the dividend
- A stock dividend involves distributing additional shares to a firm's stockholders
- Stock splits involve issuing additional shares to firm's stockholders
- A stock repurchase involves distributing cash to stockholders by repurchasing shares
Stock Dividend and Stock Split
- Stock dividends are similar to stock splits
- Stockholders are given a fixed number of new shares for each one held
- A two-for-one stock split means each investor gets one additional share for every two shares held
- This is equivalent to a 100% stock dividend
- Stock dividends do not change firm assets, profit, or total value
- Share price per diluted share decreases from stock dividends
- Example: ABC Corporation stock is at $30/share & declares a 10% dividend
- If 100 ABC shares are owned, then 10 shares valued at $3 each are received
- This equals 3X100holdingsfor3 X 100 holdings for 3X100holdingsfor300
- An example is shown of how to calculate outstanding shares after a stock dividend
- A firm has 2 million shares at $15/share & declares 50% dividend
- 2 million X 0.50 = 1 million
- 1 million + 2 million = 3 million shares outstanding after payment
- The new price per share will total value of the firm was 2 mil X 15or15 or 15or30 mil & does not change
- Therefore, price per share is 30million/3millionsharesor30 million/3 million shares or 30million/3millionsharesor10/share
Payout Information
- Dividends communicate information
- Increases in dividends convey managers' confidence in future cash flow and earnings
- Dividend cuts imply a lack of confidence & are therefore bad news
Methods of Stock Repurchases
- Stock Repurchases:
- Open-market repurchase – The most common one
- Tender offer – Offer to buy shares at a fixed price
- Auction (Dutch auction) – Variation of the tender offer
- Direct negotiation (Greenmail) - Company buys back shares from specific investor at premium
Dividend Decision Survey
- Survey data indicates that firms try to avoid reducing dividends at near 94%
- A smooth dividend stream is maintained at close to 90%
- 88.2% of firms look at the current dividend level
- 77.9% are reluctant to make a change that may have to be reversed
- 66.7% firms consider the change in dividend
- 65.4% would rather raise new funds than reduce dividends
- External capital is lower than that of a dividend cut 42.8% of the time
Stock Reurchases: Examples
- An original balance sheet example is provided, where Price per share is $11
- After a cash dividend of 1pershareispaid,anewshareprice=1 per share is paid, a new share price = 1pershareispaid,anewshareprice=10
- After 100,000stockrepurchase,ashareprice=100,000 stock repurchase, a share price = 100,000stockrepurchase,ashareprice=11
Dividend Irrelevance
- Total wealth of shareholders that hold one share = $11 where no dividend is given
- If they are given via cash dividend, the price per share decreases from 11to11 to 11to10
- This is compensated by the $1 per share dividend
- Total wealth of the shareholder = 10+10 + 10+1
- In the case of share purchase, non-participating investors will hold the share unchanged with a total wealth of $11
- In the case of share purchase, participating investors will now hold cash from selling share with total wealth of $11
The Dividend Decision
- Senior executive dividend policy features
- The determination or existence of Dividends
- Avoid reversals on changes
- Dividends are “smoothed” over time
- Dividends follows shifts in long-run and sustainable earnings
- Focus more on absolute levels
- Target payout ratios
- Repurchase decisions
- Information content of dividends and repurchases
Dividend Policy Irrelevance
- Investors don't need dividends to convert shares to cash
- Firms can pay higher premium prices without higher dividends
- The dividend will have no value on the firm's value, with efficient capital markets
- Investment borrowing policy
- Example of Rational Demiconductor needing 1000forinvestmentsanddeclaring1000 for investments and declaring 1000forinvestmentsanddeclaring1,000 dividend
- Record Date for Cash = 1,000
- Payment date for cash = $0
- Post-Payment Date, new shares are issued
Dividends Increase Value
- Market imperfections, but natural clienteles exist for dividend stocks
- High-dividend clienteles exist with plenty of options to choose
- Increased stock price for dividend payers
- Idle Cash Agency Cost
- Management has plenty of hands on cash, investment is costly
- Dividend increases send good news on earnings
- Dividend cuts send bad news
- High payouts can signal dividend's confidence and fortunes for the manager
Dividends Decrease Value
- Tax consequences for companies converting dividends into capital gains
- Payments taxed heavily in some cases compared to low taxing capital
- Taxpayers favor lower taxing firms
Payout Policy and the Life Cycle of the Firm
- Payout is residual depending on investment and financial situations
- Payouts change with firm life cycles
- Young firms have lower payouts due to profit opportunities
- Cash avoids costs to minimize bills
- Investors are not worried over compensation tied to stocks
Payouts increase as firms mature
- Projects become scarce
- Investors worry about the market
- Firms age, more and more calls for payout
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