Chapter 13 Dividends and buy-backs

1. Corporate Financial Strategy4th edition Dr Ruth Bender Chapter 13Dividends and buy-backs

2. Dividends and buy-backs: contents • Learning objectives • Dividend strategy and the life cycle model • Some factors that might affect dividend policy • Signalling effect of a change in dividends • Reasons for companies to buy back their own shares • Lintner: target dividend pay-out ratio

3. Learning objectives • Set out the main arguments in favour of and against companies paying dividends. • Identify different types of dividend policy. • Explain why companies might prefer to undertake periodic share purchases rather than pay dividends. • Understand why different types of investor might have a preference for either dividends or buyouts.

4. Dividend strategy and the life cycle model

5. Some factors that might affect dividend policy • Tax regime • To avoid agency issues of holding too much spare cash • Signalling mechanism to the market

6. Signalling effect of a change in dividends

7. Reasons for companies to buy back their own shares • To increase eps • To increase management’s percentage holding • More flexible than paying a dividend • To buy out weaker shareholders • To give shareholder a choice of how they get their return • To offset eps dilution from share option exercise • To improve management’s business focus by gearing up • To reduce the cost of capital Apply to buy-backs but not dividends Apply to buy-backs and to dividends

8. Lintner: target dividend pay-out ratio Research by Lintner indicated that companies have a target dividend pay-out ratio, but that they never actually pay that full amount. He suggested that companies determine their annual dividend based on the following formula: DIV1 – DIV0 = a × {(r × eps1) – DIV0} DIV0is the dividend paid last year DIV1 is the dividend to be paid this year eps1 is the earnings per share this year r is the target dividend pay-out ratio a is an adjustment factor.