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Dividend Policy: Theory and Practice. Why do corporations pay dividends? Does paying dividends Ý S/H wealth?. Mechanics of dividend payment. Decl. date Ex-div. Record Pmt. 3/4/03 4/17 (Th.) 4/21 (M) 5/9

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Dividend Policy: Theory and Practice

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Dividend policy theory and practice l.jpg

Dividend Policy: Theory and Practice

Why do corporations pay dividends? Does paying dividends Ý S/H wealth?


Mechanics of dividend payment l.jpg

Mechanics of dividend payment

Decl. date Ex-div. Record Pmt.

3/4/03 4/17 (Th.) 4/21 (M) 5/9

  • Last day you can buy stock and get dividend:4/16/02

  • S.P. ¯ by the $ amount of dividend on the ex-dividend date (theoretically)

Chhachhi/BA 519/Ch. 18


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Miller-Modigliani (MM)’s Dividend Irrelevance Theorem

  • Ass.: taxes=transaction costs=0 and

  • Firm’s investment policy is unaffected by dividend policy

  • Firmvalue (0 div.) = Firmvalue (­ div.) HOW?

    • S/Hs receive returns in 2 forms:

      • Dividends & Stock Price appreciation (CGs)

    • ­ dividends, ¯ the CG and vice-versa

    • Overall S/H’s returns are identical

      • Indifferent to dividend policy


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Homemade Dividends

  • S/Hs through their actions can alter the corporate dividend policy to suit their needs

    • thus, corporation can’t do anything for the S/Hs that they can’t do for themselves

Chhachhi/BA 519/Ch. 18


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If Taxes & Trans. costs ¹ 0, What should be firm’s div. policy?

  • Tdiv. > Tcapital gains

  • Investors are not indifferent to level of dividends

    • prefer smaller or no dividends at all

  • Firm with a # of +NPV projects

    • not enough $ to fund the projects & to pay dividends

      • paying dividends Þ will have to raise funds in the market-- stock/bond issue

      • investors have to pay taxes and firm has to pay issuance costs.lose-lose proposition


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Dividend Policy in the Real World-- Continued

  • Managers with excess cash

    • Should pay dividends; Otherwise they would be tempted to spend the extra money on negative NPV projects

      • e.g., “bad” acquisitions

  • Dividends serve as signal about firm’s future performance

  • Clientele Effect

Chhachhi/BA 519/Ch. 18


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Repurchases

  • Repurchases can be used as a substitute (for dividends) mechanism for distributing cash

  • Taxes make repurchases more attractive

  • H.W. 2, 5, 7, 20

Chhachhi/BA 519/Ch. 18


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