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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

Dividend Policy: Theory and Practice

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

mechanics of dividend payment
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

miller modigliani mm s dividend irrelevance theorem
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
homemade dividends
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

if taxes trans costs 0 what should be firm s div policy
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
dividend policy in the real world continued
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

repurchases
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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