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Dividend Policies: Key Concepts and Implications

Explore dividend policy theories, implications, and strategies such as signaling theory, clientele effect, and stock repurchase. Learn about the impact of taxes, payment methods, and stock splits.

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Dividend Policies: Key Concepts and Implications

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  1. Dividend policy • Relevance? • Payment of dividends • Tax implications • Dividend policies • Stock dividends and stock splits Dividend Policy

  2. Pay me now or pay me later? • Theory: dividend policy is not relevant • Firm will have finite amount of earnings to distribute over its “lifetime” • If distribute now, leaves less for future • PV of dividends doesn’t change • Assumes firm selects projects with positive NPVs • Therefore, dividend policy doesn’t impact firm value Dividend Policy

  3. Signaling theory • Raising dividends is a favorable sign • Few companies would do this if can’t sustain new dividend • A “surprise” increase will increase price of stock • Dividends increased from $1.30 to $1.40; market anticipated $1.45 Dividend Policy

  4. Signaling theory • High dividend yield (D / P) • Mature company? • Dividend yield averages 2% • In the 1970s, over 5% • Foreign companies higher • Or is it risk of dividend cut? Dividend Policy

  5. Signaling theory • Cutting dividends is generally greeted with big drop in price of stock • February 2011: Barnes and Noble eliminates dividend to preserve cash • BUSE has EPS of -$5.41 in 2009. Can it pay dividends in that year? • Borrow to maintain dividend? Dividend Policy

  6. Clientele effect • Investors who need income: dividends are great • Utilities, banks • Investors who want growth: no dividends • Technology stocks Dividend Policy

  7. Payment of dividends • In U.S., quarterly dividends • Foreign companies, often twice per year • McDonalds: changed to annual dividends • Will others follow this change? • Company must have • Retained earnings • Cash • Permission of debt holders (covenants) Dividend Policy

  8. Dividend dates • Declaration date • Ex-dividend date • Own stock at end of this day, get dividend • What happens to stock price next day? • Payment date Dividend Policy

  9. Tax Implications • Dividends • Income taxed at corporate level • Dividends taxed to recipient • Second taxation of this income • Now taxed at capital gains tax rate Dividend Policy

  10. Tax implications • Retain earnings • Reinvest in positive NPV projects • Required return: at least as high as shareholders could earn • Apple had over $50 billion in cash in 2011 and still paid no dividends • Increase wealth of firm, stock price • No tax on increase in stock price until it is sold Dividend Policy

  11. Alternative dividend policies • Residual • Constant payout • Stable dividend Dividend Policy

  12. Residual • Fund all positive NPV projects • Distribute remaining earnings • Dividends fluctuate • Not as highly valued? • Implications under signaling theory Dividend Policy

  13. Constant payout ratio • Payout constant percent of earnings • Foreign companies • U.S: 22% payout ratio • Taiwan: 69% payout ratio • Again, dividends fluctuate Dividend Policy

  14. Stable dividend • Maintain stable annual dividends • Only increase if can sustain • Borrow to maintain for short-term Dividend Policy

  15. Stock repurchase • March 2012: Apple (with $100 billion in cash): • announces initial dividend of $2.65 per quarter (1.8% yield) • Authorizes $10 billion in stock repurchase • Treasury stock • Open market versus auction • If investor wants cash, can sell stock • If not, generally price of stock should increase • Supply and demand • Earnings per share impact Dividend Policy

  16. Stock Splits • 2 for 1 stock split • Mechanics: • Own 100 shares at $80 per share before split • Own 200 shares at $40 per share after split??? Dividend Policy

  17. Stock Splits • Why? • Maintain price range for stock • Remember stocks trade in 100 share lots • Small investors • Institutional investors • Reverse split • Signal?? • Indication of future prospects Dividend Policy

  18. Stock dividends • Distribute stock instead of cash • Steak-N-Shake: 20% stock dividend each year • Keep stock in tighter trading range Dividend Policy

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