2015, Study Session # 11, Reading # 38

DIVIDENDS & SHARE REPURCHASE

EY
ATCF
CFO
DRPs

=
=
=
=

Earning Yield
After Tax Cost of Financing
Chief Financial Officer
Dividend Reinvestment
Plans

BVPS = Book Value per Share

EPS = Earnings per Share
MP = Market Price

1. INTRODUCTION
Dividend payout to shareholders based upon numbers of shares owned.

Board of directors declare dividend (sometime with consent of shareholders).

Companys payout = cash dividends + value of shares repurchased

Payout policy set of rules guiding payout.

Payment of dividends is usually discretionary.

Under some jurisdictions dividends are double taxed

Dividend payout ratio = cash dividends (on common share) / NI.

2. DIVIDENDS: FORMS

Cash Dividends

2.1 Regular Cash Dividends

2.2 Extra or Special

(Irregular) Dividends

2.1.1 Dividends
Reinvestment Plans (DRPs)

Other Forms

2.3 Liquidating Dividends

2.4 Stock Dividends

2.1 Regular Cash Dividends

Different markets pay dividends at different frequencies.

US & Canada quarterly

Europe & Japan semi-annually

Asian markets annually

Management can use dividend announcement to
shareholders confidence.

An
in regular dividend can
share price.

2.1.1 Dividends Reinvestment Plans (DRPs)

Open-Market DRP

Company purchases shares
in open market of the
dividend amount &
allocate to plan
participants.

New-Issue DRP

Blend of both types

Called Scrip dividend

scheme in UK.

Company creates (issue)
new shares.

DRP automatic reinvestment plan offered by some companies.

Can be helpful for small shareholders as a means to increase no. of shares (long term).
New-issue DRPs save floatation cost.
Participating shareholders may not have to bear additional transaction cost.
Potential disadvantage extra record keeping for tax purpose.
If share price for re-invested dividend
 than the original purchase price then original dividend reinvesting will
 avg. cost basis.

Cash dividends are fully taxed even when re-invested in the same year.

Such plans are useful in tax-deferred accounts e.g. retirement accounts.

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2.5 Stock Splits

2015, Study Session # 11, Reading # 38

2.2 Extra Dividend

Extra, special, irregular dividend paid by a company that does not pay dividends regularly.
It can be an additional (one time) payment with regular dividend.
Companies in cyclical industries may use this in strong cycles.
Companies could have stated polices for extra dividends.
Suspension Company stops paying any cash dividends.

2.3 Liquidating

It is paid when a company:

Goes out of business and net assets (adjusted for liabilities) are distributed to
shareholders.

Sells a portion of business & distributes its proceeds.

Pays dividends in excess of accumulated retained earnings (impairing stated capital).

2.4 Stock Dividends

Non-cash form of dividend also called bonus issue of shares.

Company distributes additional shares usually 2-10% of outstanding shares.
Total wealth (market value) remains same.
Cost per share is reduced.
 In share price is offset by
in no. of shares outstanding.
Generally not taxable.
Proportionate ownership & value of each shareholders ownership position remain same.
From companys perspective
shares broaden shareholder base so advantageous and

probability of more individuals owning stock.
Stock dividend can keep stock in optimal range ($20 to $80 in US).
It has no economic impact on the company.
Cash dividend can affect capital structure:

Reduce assets and equity.

Liquidity ratios can.

Financial leverage ratios can
.
Stock dividends have no such effects.

2.5 Stock Splits

Similar to stock dividend in economic impact.
Apart from usually 2 for 1 or 3 for 1, unusual split like 5 for 4 etc. can occur.
Companies can announce stock split any time.
Typically it is considered a positive sign for future
in stock price.
Reverse stock splits
share price,  no. of shares outstanding but no
impact on market value of shareholders equity.

Reverse stock splits are done to
price of stock to a marketable range.

Reverse stock splits are done by companies coming out of financial distress.

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2015, Study Session # 11, Reading # 38

3. DIVIDENDS: PAYMENT CHRONOLOGY

3.1 Declaration Date

Corporation issue
statement declaring
specific dividend

Dividend could be of any
type.

On declaration date
companies also announce
holder-of-record and
payment date.

3.2 Ex-Dividend Date

3.3 Holder-of-Record Date

First date when share

trades without(ex)dividend.

Time b/w ex-date & holder
-of- record date is linked to
trade settlement cycle of
the exchange on which
shares are listed.

Investors owing share
till/on ex-date receive
dividend.

Determined by securities
exchange.

Also called owner-of record

date, date of book closure,
shareholder of record date,
record date, and date of
record.

Typically two days after exdividend date.

Determined by corporation

Owner of stock in companys
records will be deemed to
have ownership of shares for
receiving upcoming dividend.

3.4 Payment Date

Also known as payable
date.

Date when actually
payment is transferred.

It can occur on weekend
and holiday

3.5 Interval between Key Dates in the Dividend Payment Chronology

Usually time b/w ex-date & record date is fixed to 2 days.

Other dates vary company to company.

Most companies follow a fairly set routine.

4. SHARE REPURCHASES

4.1 Share Repurchase Methods

4.2 Financial Statement Effects of Repurchases

A. Buy in the open market

4.2.1 Changes in Earnings per Share

B. Buy back a fixed number

of shares at a fixed price

4.2.2 Changes in Book Value per Share

4.3 Valuation Equivalence of Cash Dividends

& Share Repurchases: The Baseline

C. Dutch Auction
D. Repurchase by direct
negotiation

4. SHARE REPURCHASES

Share repurchases (buyback) a transaction in which company buys back its own shares.
Uses corporate cash.
An alternative to cash dividends
Repurchases shares are classified as treasury shares or stock.
Not considered for voting, dividends or calculating EPS.
In many markets it is becoming increasingly common.
After amount of repurchase is authorized, companies may or may not follow.
Unlike cash dividends, buybacks are not done proportionally to ownership percentage.
Common method outside US & Canada is open market repurchase.
Not all methods are permissible according to laws.

Reasons why companies opt for buybacks

Support share price (most frequently cited in the U.S. by chief financial officers)
Flexibility in distributing cash to shareholders.
To absorb
in shares outstanding resulting from stock options.
Tax efficiency in some cases where tax on cash dividends exceeds tax on capital gains.

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2015, Study Session # 11, Reading # 38

A. Buy in the open market
Most common method.
Company buys back its shares in open market.
Maximum flexibility for the company.
No legal obligation to honor the program.
For 1) liquidity 2) acquisition 3) capital expenditures, company may not follow through
with an announcement program.

In US open market transactions shareholders approval not required.

It Europe open market transactions approval is required.

A cost effective method if competently timed to minimize price impact and to exploit
perceived undervaluation.

B. Buy back a fixed number of shares at a fixed price

A fixed price tender offer to repurchase a specific
number of shares at fixed price.

Typically its a premium price.
C. Dutch Auction

A tender offer to existing shareholders but
company stipulates a range of acceptable prices.

A minimum price is uncovered.

Company pays the price to all qualified bids.

Can be accomplished in a short term period.

D. Repurchase by direct negotiation

In some markets company negotiate to buy back shares.
A major shareholder is involved.
Price is often premium to market.
May be done to keep block of shares after overhanging the market.
Greenmail premium purchase of accumulated shares from a hostile
investor to prevent takeover.

Large investors may negotiate at discount to generate liquidity when in a
weak position.

4.2 Financial Statement Effects of Repurchases

Both balance sheet & income statements are affected.

Assets  and equity  refinanced by cash
leverage.

Leverage magnified when repurchase is financed with debt.

4.2.1 Changes in Earnings per Share

 No. of shares outstanding can
EPS (assuming NI remains
constant).

Generally share repurchases may
, or no effect on EPS.

Effects depend upon repurchase financed internally or externally and
their cost.

For internal financing,
EPS if funds are free (idle).

For external financing,
EPS earning yield > after tax cost of
financing for repurchase.

EPS is unchanged earning yield = after tax cost of financing.

EPS  earning yield < after tax cost of financing for repurchase.

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2015, Study Session # 11, Reading # 38

4.2.2 Changes in Book Value per Share

If MP > BVPS BVPS  after repurchase.

If MP < BVPS BVPS
after repurchase.

4.3 Valuation Equivalence of Cash Dividends

& Share Repurchases: The Baseline

If tax treatment is similar, both share repurchase and
cash dividends are equivalent.

If shares repurchased at premium from one
shareholder the remaining shareholders wealth is
reduced.

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