Chapter 17
Dividends and Payout Policy
PhD, Phan Hong Mai
School of Banking and Finance
National Economics University
[email protected] 12-1
Chapter Outline
17.1 Cash Dividends
17.2 Does Dividend Policy Matter?
17.3 Stock Dividends and Stock Splits
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Dividends
Any direct payment by the corporation to the
shareholders may be considered a dividend
or a part of dividend policy.
Dividends usually come in two different
forms: cash dividends and stock dividends.
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17.1 Cash Dividends
Four basic type of cash dividends:
Regular cash dividend: cash
payments made directly to stockholders,
usually each quarter. reduces
Extra cash dividend: indication that corporate
cash
the “extra” amount may not be repeated
and
in the future. retained
Special cash dividend: similar to extra earnings
dividend, but definitely will not be
repeated.
Liquidating dividend: some or all of reduces
capital
the business has been sold. 17-4
17.1 Cash Dividends
The
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17.1 Cash Dividends
Dividend Payment
Declaration Date: The date on which the board of
directors passes a resolution to pay a dividend.
Date of Record: The date by which a holder must be
on record to be designated to receive a dividend.
Ex-dividend Date: The date two business days
before the date of record. If you buy on this date
or after, the previous owner will get the dividend.
Date of Payment: The date on which the dividend
checks are mailed.
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17.1 Cash Dividends
Dividend Payment
On January 15, the board of directors passes a
resolution to pay a dividend of $1 per share on
February 16 to all holders of record as of January 30.
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17.1 Cash Dividends
Dividend Payment
Price Behavior around the Ex-Dividend Date
for a $1 Cash Dividend
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17.2 Does Dividend Policy Matter?
Dividend policy is the decision to pay
dividends versus retaining funds to reinvest in
the firm and pay them out later.
Dividend policy, therefore, is the time pattern of
dividend payout.
Dividend question: “Should the firm pay out a
large percentage of its earnings now or a small
(or even zero) percentage?
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17.2 Does Dividend Policy Matter?
Dividends matter: the value of the stock is based
on the present value of expected future dividends.
So higher dividends will make a firm more
valuable, all else equal. The firm can improve
dividends by increasing productivity, tax savings,
product marketing, or cash flow…
Dividend policy MAY NOT matter: in theory, if
the firm pay out a small (or even zero) percentage
and reinvests capital now, it will grow and can pay
higher dividends in the future.
-> in the simple world, choosing one dividend
policy will not impact the stock price.
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17.2 Does Dividend Policy Matter?
Suppose a firm has considered two dividend
policies: (1) Pay out dividends of $10,000 per
year for each of the next two years or (2) Pay
$9,000 this year, reinvest the other $1,000
into the firm and then pay $11,120 next year.
If investors require a 12% return, does
dividend policy matter to the market value of
the firm?
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17.2 Does Dividend Policy Matter?
Real-World factors favoring a HIGH dividend
payout
Desire for current income: Individuals that need
current income (for immediate consumption). Some
groups (trust funds and endowment funds) that are
prohibited from spending principal.
Uncertainty resolution: no guarantee that the
higher future dividends will materialize.
Taxes: although dividends taxed at the personal rate,
there are some investors who do not receive
unfavorable tax treatment from holding high–dividend
yield.
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17.2 Does Dividend Policy Matter?
Real-World factors favoring a LOW dividend
payout
Taxes: Individuals in upper income tax brackets
might prefer lower dividend payouts, given the
immediate tax liability, in favor of higher capital gains
with the deferred tax liability.
Flotation costs: low payouts can decrease the
amount of capital that needs to be raised, thereby
lowering flotation costs.
Dividend restrictions: in some cases, debt
contracts might limit the percentage of income that
can be paid out as dividends. 17-13
17.2 Does Dividend Policy Matter?
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17.3 Stock Dividends and Stock Splits
Stock dividend: A payment made by a firm to its
owners in the form of stock.
The effect of a stock dividend is to increase the
number of shares that each owner holds, so each
share is simply worth less.
-> diluting the value of each share outstanding.
A stock dividend is commonly expressed as a
percentage; for example, a 20 percent stock
dividend means that a shareholder receives one new
share for every five currently owned.
20%= 20 vs 100 = 1 vs 5
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17.3 Stock Dividends and Stock Splits
Stock split: An increase in a firm’s shares
outstanding without any change in owners’
equity.
A split is expressed as a ratio instead of a
percentage. When a split is declared, each share
is split up to create additional shares. For
example, in a three-for-one (3-1) stock split,
each old share is split into three new shares.
-> A Stock split increases the number of shares
outstanding and also reduce the value per share.
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17.3 Stock Dividends and Stock Splits
Stock dividend:
Number of new shares = Number of old shares x (1
+ percent stock dividend)
Price of a new share = Price of an old share / (1 +
+ percent stock dividend)
Stock split: Left / Right
Stock split ratio = New / Old (three-for-one -> ratio = 3/1)
Number of new shares = Number of old shares x
Stock split ratio
Price of a new share = Price of an old share / Stock
split ratio
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Summary and Conclusions
Dividends are paid in cash, and cash is something
that everybody likes. In theory, dividend policy is
irrelevant.
Desire for current income, Uncertainty resolution
and Taxes are real-world considerations that favor
a high dividend payout.
Individual shareholder income taxes and new issue
flotation costs are real-world considerations that
favor a low dividend payout.
Stock dividend and Stock split all increase the
number of shares outstanding and reduce the
value per share. 12-18
HOMEWORKS
Concepts review: 1, 3, 5, 6, 9
Question and Problems: 1, 2, 3, 4
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