Dividend Policy and Firm value

Dividend Decisions
Session No. 2

1 Manish Parmar
 Key Concepts and Skills
 Understand dividend types and how they

are paid

 Understand the issues surrounding

dividend policy decisions

 Understand why share repurchases are an

alternative to dividends

 Understand the difference between cash

and stock dividends

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 Chapter Outline: Ross
18.1 Different Types of Dividends
18.2 Standard Method of Cash Dividend
Payment
18.3 The Benchmark Case: An Illustration of
the Irrelevance of Dividend Policy
18.4 Repurchase of Stock
18.5 Personal Taxes and Dividends
18.6 Real-World Factors Favoring a High
Dividend Policy
18.7 The Clientele Effect: A Resolution of
Real-World Factors?
18.8 What We Know and Do Not Know about
Dividend Policy
3 18.9 Stock Dividends and Stock Splits
 Dividend payments can be made in
either of the following ways:- (18.1)
Cash Dividend - Payment of cash by the firm to its
shareholders. (Normally companies pay regular
dividends and sometimes it pays special dividend)
 Public companies often pay quarterly.

 Sometimes firms will pay an extra cash dividend,

i.e. Special Dividend.

 The extreme case would be a liquidating

dividend.
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 Dividend payments can be made
in either of the following ways:-
Stock Dividend - Distribution of additional shares to
a firm’s Shareholders. (Bonus shares)

Stock Splits – The par value per share is reduced

and the number of shares is increased
proportionately. In both the above cases:-

 No cash leaves the firm

 The firm increases the number of shares

outstanding
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TABLE 1 Effect of Bonus Shares and Share Splits
(I) Equity portion before the bonus issue:
Equity share capital (30,000 share of Rs 100 each) Rs 30,00,000
Share premium (@ Rs 25 per share) 7,50,000
Retained earnings 62,50,000
Total equity 1,00,00,000
(II) Equity portion after the bonus issue (1 : 2 ratio):
Equity share capital (45,000 shares of Rs 100 each) 45,00,000
Share premium (45,000 shares × Rs 25) 11,25,000
Retained earnings (Rs 62,50,000 – 15,000 shares × Rs 125) 43,75,000
Total equity 1,00,00,000
(III) Equity portion after the share splits (10 : 1 ratio):
Equity share capital (3,00,000 shares of Rs 10 each) 30,00,000
Share premium 7,50,000
Retained earnings 62,50,000
Total equity 1,00,00,000
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 18.2 Standard Method of Cash
Dividend
Cash Dividend - Payment of cash by the firm
to its shareholders.

Ex-Dividend Date - Date that determines

whether a stockholder is entitled to a dividend
payment; anyone holding stock immediately
before this date is entitled to a dividend.

Record Date – Date on which company

determines existing shareholders.

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 Procedure for Cash Dividend
25 Oct. 1 Nov. 2 Nov. 4 Nov. 7 Dec.
…

Declaration Cum- Ex- Record Payment

Date dividend dividend Date Date
Date Date

Declaration Date: The Board of Directors declares a payment

of dividends.
Cum-Dividend Date: Buyer of stock still receives the dividend.
Ex-Dividend Date: Seller of the stock retains the dividend.
Record Date: The corporation prepares a list of all individuals
believed to be stockholders as of 4 November.
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 Price Behavior
 In a perfect world, the stock price will fall by
the amount of the dividend on the ex-
dividend date.
-t … -2 -1 0 +1 +2 …

$P

$P - div
The price drops Ex-
by the amount of dividend
the cash Date
dividend. Taxes complicate things a bit. Empirically, the
price drop is less than the dividend and occurs
on of the ex- dividend date.
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