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Dividend Policy by Team Name. Learning Objectives. Understand different dividends policies Understand how these policies can affect shareholder investment decisions Application of dividend policies

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dividend policy by team name
Dividend Policy

by Team Name

learning objectives
Learning Objectives
  • Understand different dividends policies
  • Understand how these policies can affect shareholder investment decisions
  • Application of dividend policies
  • Be able to assess the impact that dividend policies can have on existing and potential investors in an organisation.
dividend policy
Dividend Policy
  • Modigliani and Miller: Dividends are irrelevant.
what is dividend
What is Dividend?
  • Cash distribution of earnings. Any direct payment by the corporation to the shareholders.
  • Usually paid periodically
  • Different expressions of dividends led to tree concepts
      • Dividend per share ($)
      • Dividend yield (%)
      • Dividend Payout (%)
types of dividends
Types of Dividends
  • Liquidating
  • Extra cash
  • Stock Dividend. (None true Dividend)
  • Stock Split
  • Note from the real world:
    • USA Accounting Standards and IFRS (International Financial Reporting Standards),
dividend payment chronology
Dividend Payment Chronology

Jan 28





Feb 16



Jan 15



Jan 30

Record Day

example of the irrelevance of dividend policy
  • The price of the stock is independent of the dividend policy. (in a perfect word)
  • Case: Bristol is an all-equity firm, that will be dissolved in 1 year from time 0. Bristol will receive cash flow of 10,000 at time 0 and 1 and do not have any other NPV project. The rate of return is 10% and the number of outstanding shares is 1,000
    • Now consider two scenarios with different dividend policy.
example of the irrelevance of dividend policy scenario b

Total Dividend $

Total Dividend $


New StockH

Original StockH





Year 1

Year 1

Year 0

Year 0



example of the irrelevance of dividend policy share price scenario a
  • Remember the point we are making is that the price of the stock is independent from the dividend policy we choose.
  • Value of the firm:
  • The price of each of the stock
  • Or
  • Price of the stock after dividend is paid is 19.09-10=9.09

= 19,090.1


= 19.09



= 19.09

example of the irrelevance of dividend policy share price scenario b
  • Applying equation 3 to the corresponding cash flows at year 0. Remember the graph two slides before.
  • Modigliani and Miller: Dividends are irrelevant.
  • BONUS: How we calculate the price at which the new equity will be issued.
    • And the number of shares issued is


= 19.09

irrelevance of dividend policy home made dividends
  • We will learn how stock holders can compensate for any of the two dividend policies.
  • Home made dividends.
irrelevance of dividend policy home made dividends1

B)Co. sells equity to gave more cash to pay more first. StockH can invest the extra $1 with a 10% for 1 year to obtain in year 1 a dividend of $10


A)Co. pays dividends immediately

Year 0


C)Co. buys equity to pay more in year 1. Stock H may sell one share $1 in yr 0 to have a dividend of $10

$ 9




Year 1

take a breath lets review
Take a breathLets review
  • Dividends: Concept, way to express them, and types
  • Dividends Payment Chronology
  • M&M´s. “Dividends are irrelevant”
  • We test M&M´s
    • Value of the firm
    • Price of the stock
    • Impact and methodology of buying and selling equity
  • Bonus 1: The share price will rise if the dividend raises any given year while keeping it steady in the future.
  • Bonus 2: Dividends and Capital Expenditure (investments).
share repurchases real life considerations and factors
Share RepurchasesReal life considerations and factors.
  • Historically Different trends in USA and Europe
  • Alternative to cash dividends. We will see in the next slide.
  • Mechanisms for Share Repurchases
    • Open Market
    • Tender offer
    • Targeted Repurchase
dividends v repurchases conceptual considerations
Dividends v RepurchasesConceptual considerations
  • A co. has a cash excess of $300,000, is considering dividend payment of $3 to each SH (100,000). After the dividend is paid earnings will be $450,000 per year or $4.50 per SH. PRICE EARNING RATIO IS 6 for comparable ind. The share price after dividend is paid is $27.
  • Now they have decided to repurchase 10,000 shares at $30 by a tender offer. The new earnings per share is $5 ($450,000/90,000). The price of the share after repurchase is $30 (6x$5).
dividends v repurchases real world considerations
Dividends v RepurchasesReal world Considerations
  • Flexibility. Company Commitment.
  • Executive Compensation: CEO´s would prefer repurchase.
  • Offset of dilution: The exercise of share options has a dilution effect
  • Undervaluation: Co. buy they own equity because is their best investment. Specially when the stock price is temporally depressed.
  • Taxes. Repurchases offer a tax advantage


personal taxes and dividends firms with out sufficient cash
Personal Taxes and Dividends.Firms with out sufficient Cash

2) Dividend



Not to issue new equity to pay dividends in firms with out sufficient cash.

1)Co. emits $100 in new equity to pay as dividends..

3) Government $25

(25% income dividend taxes)

4) Entrepreneur


personal taxes and dividends firms with sufficient cash
Personal Taxes and Dividends.Firms with sufficient Cash
  • We will test the previous recommendation for a case in which the Co. has extra cash and has chosen all +NPV projects. Some options instead of paying dividends are:
    • Select additional capital budgeting projects. Pet projects
    • Acquire other companies. Good for whom?
    • Purchase financial assets. Depends on the rate of personal and co. taxes.
personal taxes and dividends firms with sufficient cash example
Personal Taxes and Dividends.Firms with sufficient Cash, Example
  • Your Co. has extra CF of $1,000 board of directors wants you to assess the best option for the SHs between a dividend payout immediately and investing in Treasury Bills with a r=10% for 5yr and after that pay the dividend.
  • Investors: Dividend tax 15%, personal tax 28%
  • Company: Corporate tax 30%
  • Option A: You decide to pay the dividend, discounting the dividend tax, SHs will receive today $1,000*(1-0.15)=$850.

If invested in securities SHs will have in 5y 850*(1.072)^5= $1,203.35.

Note that the effective interest rate is 10-(1-0.28)=7.2%

  • Option B: Invest in securities $1,000*(1.07)^5= $1,402.55. The net dividend will be $1,402.55*(0.15)= $1,192.17
personal taxes and dividends firms with sufficient cash1
Personal Taxes and Dividends.Firms with sufficient Cash
  • Stock Repurchase: Considering current tax law, SH´s normally will prefer Repurchases.
  • Assume you will receive $100 dividend payment, in your country the tax is 15% so tax is $15.

Now assume you sell equity of $100 and that the initial cost of your equity was $60, the profit before taxes is $40, because in most countries the tax applies only in the profit in this case the tax will be $6 ($40x.15)

take a breath and review
Take a Breath and review
  • Dividends v Repurchases conceptual consideration

Repurchase or Dividends are irrelevant

  • A glimpse in Dividends and buybacks trends in USA and Europe and the mechanisms for repurchase.
  • Dividends v Repurchases real considerations.
      • Low Cash. Not to issue equity to pay Dividends
      • High, steady cash. Repurchase is the strongest case over other options due to the tax advantage (Capital Budgeting, Acquisitions, Financial Assets)
  • Other real factors affecting Dividends v Repurchases (Flexibility, Executive Compensation, Offset dilution, Undervaluation and taxes.)
  • Bonus: The price of the stock is the Earnings per Share times Price Earning Ratio.
high dividend policy real world factors
HIGH DIVIDEND POLICY Real world factors:
  • Desire for current income: Costs involve in the transaction of selling stocks
  • Behavioral Finance: Self control.
  • “Agency costs”: Paying dividends equal to the surplus of cash flow. (It is not a true argument in favor of Dividends.)
  • Information Content of Dividends: The share price usually increases when dividends payout is announced and decreases when a cut in dividends is announced.
high dividend policy bonus
  • Why a rise in dividends rises the price of the stock?

Cash Flow (CF)=Capital Expenditures(CE)+Dividends(D)

Note: if the firm is not buying back or selling new equity).

  • Suppose you are and investor doing the cash flow forecast for CO. A. CO. A announces current D for $50M and market believes CE for $80M. CF=$130M.

Option 1 Co. announces D for $70M market may assume CF remains $130M this is a capital ex of $60M. Option 2 the market expects unchanged CE $80M implying a CF= $150M (80M+70M)

the clientele effect
The Clientele Effect
  • A firm can increase it price of stock if an unsatisfied clientele exists. Once payouts are conform to the desire of the shareholders no single firm can affect its market value by changing from high dividend to low dividend policy.
  • Further more, this Effect suggested that according to the level of tax scheme clientele falls in 3 different payout categories.
the catering theory of dividends
The Catering Theory of Dividends.
  • Malcom Baker and Jeffrey Wurgler.
  • There are times that Co. could be mispriced or when there are changes in the demand of dividend equities (clientele effect)
  • If the dividend increases the price of the stock does not necessarily has to increase.
  • If the demand for dividend paying shares is low then it is not likely that an announcement of paying dividends will lead to a higher price of the stock
  • Managers are able to rationally respond to this time variation in the investors demand by modifying their dividends policy.
take another breath lets resume what we know
Take another breath. Lets resumeWhat we know
  • Dividends has a tax disadvantage.
  • The total amount of real dividends (cash dividends and sales repurchases) have increased significantly.
  • Bonus: Peterson and Ang found that dividends for a representative year where paid to indiiduals with high taxes.
  • Bonus: Eije and Megginson: % of European co. paying dividends has fallen and have been replace for buybacks. Skinner and DeAngelo: Smalls firms have move away from dividends and bigger co. have increase them.
corporations smooth dividends
Corporations Smooth Dividends
  • John Lintner in 1956: Dividends to earning ratio target is long term and set low if the sum of +NPV projects is relatively high to the cash available.
  • Only part of any change in earnings is likely to be permanent. Dividend changes appear after a period of time t needed to assess earning changes.
smooth dividends application
Smooth Dividends application
  • CGI targeted a payout ratio of .030. Last year EPS of $10 cash dividend and dividend payout of $3 per share.. Earnings has jumped to $20 this yr. Managers do not believe all this change is permanent they do not plan to increase the dividends all the way to $6 (EPS x Payout Ratio= $20x0.30). Their speed of adjustment coefficient is s=.5 so = 0.5($6-$3)=$1.5
  • Note: the speed coefficient s is a number between 0 and 1. If s= 0 there is not change in dividends Do=D1. If s=1 the actual change in dividend is equal to the target change in dividend.
dividends pros cons
Dividends Pros Cons
  • Appeal to investors (transaction cost from selling equity)
  • Behavioral Finance. Good for self control
  • Dividends increase may be a good signal for future cash flow
  • D. can be use to boost the management performance
  • Taxes
  • Reduces internal sources of financing. Leading to forgive +NPV projects or to external debt.
  • Cuts will affect adversely the share price.
survey evidence
Survey Evidence
  • Recent large survey to Financial executives about dividend policy.
  • To privilege steady dividend policy, and try to avoid any dividends cuts.
  • There is a concern about future earnings levels when forecasting dividends and making decision.
  • They do not believe that individual taxes paid by the share holders is very important.
stocks dividends and stocks splits
Stocks Dividends and Stocks Splits.
  • Stock Dividend: Dividend paid out in shares (specie).
  • A 20% stock dividend equals 1 new stock for every 5 stocks you own.
  • Stock Split, is basically a Stock dividend expressed as ratio.
  • 3:1 Stock split means that for each current stock you will get 3 new shares.
  • Different accounting Standards.
  • Stocks dividends or Stock Splits do not affect the wealth of the SH or the value of the firm
stock dividends do not affect the sh s or the v of the firm example
Stock Dividends do not affect the SH´s or the V of the Firm. Example
  • Company with a total market value of $660,000 and 10,000 shares. With 10% stock dividend share are 11,000 with a value of $60 each.
  • Consider a SH with 100 shares worth $66 before the stock dividend, he would have 110 after the stock dividend worth $60 the total value of the equity in both cases is $6,600
  • Consider a 2-1 stock split, after the split there are 20,000 shares outstanding with a value of 660,000/20,000= $33. The number of shares doubles and the price halves.
  • However this is a perfect world!!!
reverse splits real factors to consider
Reverse Splits. Real Factors to consider
  • The effect is that the value of each stock increases. A 1:5 reverse split for each 5 old shares you get one but the value of that one is 5 times the original value.
    • Transaction Costs: Might be less to share holders
    • Liquidity and Marketability: Popular trading range
    • Shares below certain value are not consider respectable.
    • Stock Exchange minimum stock price.