CHAPTER 17: PAYOUT POLICY
Chapter 17 Learning Objectives
Describe how dividends are paid out and how corporations decide how much to pay. 2.
Explain how stock repurchases are used to distribute cash to investors. 3.
Explain why dividend increases and repurchases are good news for investors and why dividend cuts are bad news. 4.
Explain why payout policy would not affect shareholder value in perfect and efficient financial markets. 5.
Show how market imperfections, especially the different tax treatment of dividends and capital gains, can affect payout policy.
Firms can pay cash to shareholders in two major ways; cash dividends and share repurchases. This chapter analyzes both options and provides the student with insight into a firm’s payout policy decisions.
Chapter 17 Outline
Methods of Paying Shareholders
The Dividend Discount Model
“Smooth” Dividend Policy
The Payout Controversy
Dividend Policy is Irrelevant to Firm Value
Dividend Policy Adds Value
Dividend Policy Reduces Value
How Corporations Pay Cash to Shareholders
Corporations can pay shareholders by paying a dividend or by repurchasing shares.
Cash Dividend – Payment of cash by the firm to its shareholders. Stock repurchase – Firm buys back stock from its shareholders.
Cash Dividend – Payment of cash by the firm to its shareholders. •
Regular Dividend – A dividend that is expected to be paid consistently into the future. •
Special Dividend – A dividend that is not likely to be repeated. Stock Dividend/Split – Distributions of additional shares to a firm’s stockholders.
Stock Dividends: Example
Imagine a corporation currently has 10 million shares outstanding selling at $60 per share and declares a three-for-two stock split.
After the split, how many shares will be outstanding?
After the split, what will be the new share price?
Dividend Policy: Key Dates
Union Pacific Quarterly Dividend Key Dates
What would you expect to happen to the price of a share of stock on the day it goes ex-dividend?
Shares of large firms trade constantly, so corporations must specify a particular day’s roster of shareholders who qualify to receive any announced dividend. •
Declaration Date – The date on which the corporation announces a dividend payment. •
Ex-dividend Date – Without dividend. Buyer of a stock after the ex-dividend date does not receive the most recently declared dividend. •
Record Date – Shareholders registered on this date will be the ones to receive the most recently declared dividend. •
Payment Date – The date the dividend payment is actually sent to shareholders.
Imagine a firm has 100,000 shares outstanding, worth $1 million in total. If the firm issues a $1-per-share cash dividend, how is shareholder wealth affected? Before Dividend:
After the cash dividend, the market value of the firm falls to $900,000 and shareholders gain $100,000 in cash. Stock Repurchases
Four ways to implement:
Stock Repurchase – Firm buys back stock from its shareholders. •
Open market repurchase: Occurs when the firm purchases stock in the secondary market, just like any other investor. •
Tender offer: Firm offers to buy back a stated number of shares at a fixed price. •
Auction: Firm states a range of prices at which it is prepared to repurchase. •
Direct negotiation: Firm may negotiate repurchase of a block of shares from a major shareholder.
Stock Repurchase: Example
Imagine a firm has 100,000 shares outstanding, worth $1 million in total. If the firm buys back 10,000 shares at $10 each, how is shareholder wealth affected? Before Dividend:
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