Corporate Payout Policy: Overview

Payout Policy: Topic Overview

• Examines how corporations distribute cash to shareholders
• Looks at the information conveyed through dividends and share repurchases
• Addresses the debate over dividends versus repurchases
• Explores the circumstances making dividends valueable
• Explores arguments for dividends decreasing value
• Discusses payout policy in relation to a firm's life cycle

Dividend Payout Facts (2011-2020)

• Conducted on nonfinancial firms.
• Firms paying dividends and repurchasing shares: 24.1%
• Firms paying dividends but not repurchasing shares: 23.7%
• Firms repurchasing shares but not paying dividends: 12.0%
• Firms not paying dividends or repurchasing shares: 40.1%

Dividend Payments

• Declaration Date: The date when a company announces its intention to pay a dividend
• Ex-Dividend Date: Determines who is eligible for the dividend payment
  • Stockholders prior to this date receive the dividend
• Record Date: Determines which shareholders receive the dividend
  • Those registered on this date receive the dividend
• Payment Date: The date dividend checks are mailed out to shareholders
• Cash Dividend: Payment of cash from a firm to its stockholders
• Stock Dividend: Distribution of additional shares to a company's stockholders
• Stock Splits: When a company issues additional shares to its stockholders
• Stock Repurchase: When a company distributes cash to its stockholders via repurchasing shares

Stock Dividends vs Stock Splits

• A stock dividend is like a stock split, giving stockholders new shares per share they already own
• A two-for-one stock split means investors get one extra share for every two shares owned
• Example: a two-for-one split is like a 100% stock dividend
• Stock dividends don't change assets, profit, or total value, instead share price drops as share count goes up

Example: ABC Corporation

• ABC Corporation stock sells for $30/share when a 10% stock dividend is declared
• Owners of 100 shares of ABC Corporation, get shares valued at $3 each
• This equates to an extra $3 X 100 Shares = $300 cash or shares
• After the dividend, the holder will have $300 and 10 shares of ABC stock

Stock Dividend Example: Amoeba Products

• Amoeba Products has 2 million shares priced at $15 each
• The company announces a 50% stock dividend
• Outstanding shares after dividend: 2 million + (2 million x 0.50) = 3 million shares
• Price per share after the stock dividend: the firm was 2 mil x $15 per share, or $30 mil = $30 mil/3 mil shares = $10 per share

Interpreting Payout Information

• Dividend increases signal management's confidence in future cash flow and earnings
• Dividend cuts signal a lack of confidence and is bad news for investors

Stock Repurchase Methods

• Open-market repurchase is the most common
• Tender offer: A company offer to buy shares at a certain price, holders decide whether or not to sell
• Auction (Dutch auction): shareholders provide a price range on which they would consider selling stock
• Direct negotiation (Greenmail): a firm buys back stock from a specific investor, this is often at a premium to avoid a hostile takeover

Dividend Decision Survey (2005) Findings

• 93.8%: Firms try to avoid reducing dividends
• 89.6%: Firms try to maintain a smooth dividend stream
• 88.2%: Firms monitor the current dividend level
• 77.9%: Firms dislike changes that must be reversed
• 66.7%: Firms considers the change in dividend
• 65.4%: Firms prefer raising new capital than reducing dividends
• 42.8%: Firms report external capital costs less than dividend cuts

Stock Repurchase/Share Repurchase vs Dividends

• Share repurchase defined as the firms distribution of cash to stockholders by repurchasing shares of their own stock

Example 1: Original Balance Sheet

• Original Balance Sheet
  • Assets: Cash ($150,000), Other Assets ($950,000), Value of Firm ($1,100,000)
  • Liabilities & Equity: Debt ($0), Equity ($1,100,000), Value of Firm ($1,100,000)
• Shares outstanding = 100,000
• Share price = $1,100,000/100,000 = $11

Example 2: Cash Dividend of $1 per Share

• Balance sheet after cash dividend
  • Assets: Cash ($50,00), Other Assets ($950,000), Value of Firm ($1,000,000)
  • Liabilities & Equity: Debt ($0), Equity ($1,000,000), Value of Firm ($1,000,000)
• Shares outstanding = 100,000
• Share price = $1,000,000/100,000 = $10

Example 3: $100,000 Stock Repurchase Program

• Post $100,000 stock repurchase program balance sheet
  • Assets: Cash ($50,00), Other Assets ($950,000), Value of Firm ($1,000,000)
  • Liabilities & Equity: Debt ($0), Equity ($1,000,000), Value of Firm ($1,000,000)
• Shares outstanding = 90,909
• Share price= $1,000,000/90,909 = $11

Dividend Irrelevance for Shareholder's Wealth

• In the case of no dividend total shareholder wealth = $11
• Cash dividend decreases the share price from $11 to $10, total shareholder wealth is is $10+ $1= $11
• Share purchase: an investor who doesn't participate holds the share unchanged ($11 total wealth)
• Investor selling earns cash; total shareholder wealth = $11

The Dividend Decision

• Top level executive dividend policies:
• Managers dislike changing dividends, preferring to reduce it
• Managers smooth dividends instead of increasing it
• Dividend changes track earnings over the long term
• Focus more on changes instead of amount
• Key Factors in a firm's dividend strategies:
  • Target payout ratios
  • Repurchase decisions
  • Information given by dividends and repurchases

Dividend Policy

• Dividend policy has no impact on the value of the firm because investments are not impacted
• In an efficient market, investment and borrowing remain unchanged, so dividend policy is irrelevant

Rational Demiconductor Example

• Rational Demiconductor declares a dividend of $1,000 with no extra cash and needing $1,000 for investments
• It issues new shares, and uses M&M Theory to show the firm's value doesn't change.
• Record date balance sheet: Cash (1,000); Asset value (9,000); Total value (10,000 + New project 2,000); # of shares (1,000); Price per share ($12)
• Payment date balance sheet: Cash (0); Asset value (9,000); Total value (9,000); New project (2,000); # of shares (1,000); Price per share ($11)
• Post-Payment balance sheet: Cash (1,000); Asset value (9,000); Total value (10,000); New project (2,000); # of shares (1,091); Price per share ($11)
• Assume stockholders use proceeds from dividend payment to purchase stock issue with cash

Dividends Can Increase Value Because of Market Imperfections

• There are natural investors who like high-payout stocks
• High-dividend stocks are attractive to investors
• This client base can increase stock price
• Free-cash-flow problem: Managers avoid excess cash on hand and are pressured to invest wisely
• Larger cash payouts force investment

Using Dividends as Signals

• Higher dividends imply solid cash flow and strong earnings
• Dividend cuts imply the opposite
• A confident company's managemnt increases dividends

Tax Consequences on Dividends

• In a tax environment capital gains are lower than tax on dividends
• Total cash flow will be higher if profits are held
• This means both the firm and shareholders benefit

Payout Policy and Life Cycle

• The firm's financial plans are a residual effect
• The longer an orginization exists, the more it changes the payout
• Younger firms will have profits based on investment opportunities, which helps shareholders reduce short term taxation
• Mature firms: Pay out more Positive-NPV and worry about free cash issues
• Older firms offer greater payout