Chapter 19

Dividends and Other Payouts

McGraw-Hill"Irwin

Copyright 2010 by the McGraw-Hill Companies, Inc. All rights reser e!.

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
19.1 ifferent !ypes of "ayouts 19.# Standard $ethod of Cash ividend "ay%ent 19.& !he 'ench%ark Case( )n *llustration of the *rrelevance of ividend "olicy 19.+ ,epurchase of Stock 19.- "ersonal !a.es/ ividends/ and Stock ,epurchases 19.0 ,eal-1orld 2actors 2avoring a 3igh ividend "olicy 19.4 !he Clientele 5ffect( ) ,esolution of ,eal-1orld 2actors6 19.7 1hat 1e Know and o 8ot Know about ividend "olicy 19.9 "utting *t )ll !ogether 19.19 Stock ividends and Stock Splits
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19.1 ifferent !ypes of "ayouts

$any co%panies pay a regular cash dividend.

"ublic co%panies often pay :uarterly. So%eti%es fir%s will pay an e.tra cash dividend. !he e.tre%e case would be a li:uidating dividend. 8o cash leaves the fir%. !he fir% increases the nu%ber of shares outstanding. 1rigley;s <u% sends a bo. of chewing gu%.

Co%panies will often declare stock dividends.

So%e co%panies declare a dividend in kind.

Other co%panies use stock buybacks.

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19.# Standard $ethod of Cash ividend

Cash Dividend - "ay%ent of cash by the fir% to its shareholders. Ex-Dividend Date - ate that deter%ines whether a stockholder is entitled to a dividend pay%ent> anyone holding stock i%%ediately before this date is entitled to a dividend. Record Date = ate on which co%pany deter%ines e.isting shareholders.
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"rocedure for Cash ividend

#- Oct. 1 8ov. # 8ov. - 8ov. 4 ec.

eclaration ate 5.Cu%dividend dividend ate ate ,ecord ate "ay%ent ate

Declaration Date( !he 'oard of irectors declares a pay%ent of dividends. Cum-Dividend Date( 'uyer of stock still receives the dividend. Ex-Dividend Date( Seller of the stock retains the dividend. Record Date( !he corporation prepares a list of all individuals believed to be stockholders as of - 8ove%ber.
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"rice 'ehavior

*n a perfect world/ the stock price will fall by the a%ount of the dividend on the e.-dividend date. @ -t @ -# -1 9 A1 A# ?P
?P - div !he price drops 5.by the a%ount of dividend ate the cash Taxes complicate things a bit. Empirically, the dividend. price drop is less than the dividend and occurs within the first few minutes of the ex-date.
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19.& !he *rrelevance of ividend "olicy

) co%pelling case can be %ade that dividend policy is irrelevant. Since investors do not need dividends to convert shares to cash> they will not pay higher prices for fir%s with higher dividends. *n other words/ dividend policy will have no i%pact on the value of the fir% because investors can create whatever inco%e strea% they prefer by using ho%e%ade dividends.
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3o%e%ade ividends

'ianchi *nc. is a ?+# stock about to pay a ?# cash dividend. 'ob *nvestor owns 79 shares and prefers a ?& dividend. 'ob;s ho%e%ade dividend strategy(

Sell # shares e.-dividend

ho%e%ade dividends ?& ?109 ividend Cash fro% dividend Cash fro% selling stock ?79 ?#+9 !otal Cash ?#+9 Balue of Stock 3oldings ?+9 C 47 D ?9 ?&/1#9
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ividend "olicy *s *rrelevant

*n the above e.a%ple/ 'ob *nvestor began with a total wealth of ?&/&09(

)fter a ?& dividend/ his total wealth is still ?&/&09(

)fter a ?# dividend and sale of # e.-dividend shares/ his total wealth is still ?&/&09(

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ividends and *nvest%ent "olicy

2ir%s should never forgo positive 8"B proEects to increase a dividend For to pay a dividend for the first ti%eG. ,ecall that one of the assu%ptions underlying the dividend-irrelevance argu%ent is( H!he invest%ent policy of the fir% is set ahead of ti%e and is not altered by changes in dividend policy.I
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19.+ ,epurchase of Stock

*nstead of declaring cash dividends/ fir%s can rid the%selves of e.cess cash through buying shares of their own stock. ,ecently/ share repurchase has beco%e an i%portant way of distributing earnings to shareholders.

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Stock ,epurchase versus ividend

Consider a fir% that wishes to distribute ?199/999 to its shareholders. Assets ).Original balance sheet 'iabilities & #$%ity

Cash ?1-9/999 ebt 9 Other 7-9/999 5:uity 1/999/999 Balue)ssets of 1/999/999 Balue of 1/999/999 2ir% outstanding 199/999 2ir% Shares D "rice per shareD ?1/999/999 J199/999 D ?19

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Stock ,epurchase versus ividend

*f they distribute the ?199/999 as a cash dividend/ the balance sheet will look like this( Assets Cash Other )ssets ?-9/999 7-9/999 ebt 5:uity 'iabilities & #$%ity 9 999/999 '. )fter ?1 per share cash dividend

Balu of 2ir% 999/999 Balu of 2ir% 999/999 e e Shares outstanding D 199/999 "rice per share D ?999/999J199/999 D ?9
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Stock ,epurchase versus ividend

*f they distribute the ?199/999 through a stock repurchase/ the balance sheet will look like this( Assets C. )fter stock repurchase ?-9/999 Cash 'iabilities& #$%ity 9 999/999 999/999

ebt Other 7-9/999 5:uity )ssets Balue of 999/999 Balue of 2ir% outstandingD 99/999 2ir% Shares

"rice pershare D ?999/999 J 99/999 D ?19

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Share ,epurchase

2le.ibility for shareholders Keeps stock price higher

<ood for insiders who hold stock options

)s an invest%ent of the fir% FundervaluationG !a. benefits

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19.- "ersonal !a.es/ ividends/ and Stock ,epurchases

!o get the result that dividend policy is irrelevant/ we needed three assu%ptions(

8o ta.es 8o transactions costs 8o uncertainty

*n the United States/ both cash dividends and capital gains are FcurrentlyG ta.ed at a %a.i%u% rate of 1percent. Since capital gains can be deferred/ the ta. rate on dividends is greater than the effective rate on capital gains.
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2ir%s without Sufficient Cash

*nvest%ent 'ankers

!he direct costs of stock issuance will add to this effect.

Stock 3olders

Cash( stock issue 2ir% Cash( dividends !a.es

*n a world of personal ta.es/ fir%s should not issue stock to pay <ov. a dividend.
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2ir%s with Sufficient Cash

!he above argu%ent does not necessarily apply to fir%s with e.cess cash. Consider a fir% that has ?1 %illion in cash after selecting all available positive NPV pro ects.

Select additional capital budgeting proEects Fby assu%ption/ these are negative 8"BG. )c:uire other co%panies "urchase financial assets ,epurchase shares

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!a.es and ividends

*n the presence of personal ta.es(

1. #. &.

) fir% should not issue stock to pay a dividend. $anagers have an incentive to seek alternative uses for funds to reduce dividends. !hough personal ta.es %itigate against the pay%ent of dividends/ these ta.es are not sufficient to lead fir%s to eli%inate all dividends.

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19.0 ,eal-1orld 2actors 2avoring 3igh ividends

esire for Current *nco%e 'ehavioral 2inance

*t forces investors to be disciplined. *nvestors can create positions in high dividend yield securities that avoid ta. liabilities. 3igh dividends reduce free cash flow.
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!a. )rbitrage

)gency Costs

19.4 !he Clientele 5ffect

Clienteles for various dividend payout policies are likely to for% in the following way( Group Stock ype
Lero-to-Kow payout Kow-to-$ediu% payout $ediu% payout 3igh payout

3igh !a. 'racket *ndividuals Kow !a. 'racket *ndividuals !a.-2ree *nstitutions Corporations

!nce the clienteles have been satis"ied# a corporation is unlikely to create value by changing its dividend policy.
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19.7 1hat 1e Know and o 8ot Know

Corporations Hs%oothI dividends. 2ewer co%panies are paying dividends. ividends provide infor%ation to the %arket. 2ir%s should follow a sensible policy(

o not forgo positive 8"B proEects Eust to pay a dividend. )void issuing stock to pay dividends. Consider share repurchase when there are few better uses for the cash.
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19.9 "utting *t )ll !ogether

)ggregate payouts are %assive and have increased over ti%e. ividends are concentrated a%ong a s%all nu%ber of large/ %ature fir%s. $anagers are reluctant to cut dividends. $anagers s%ooth dividends. Stock prices react to unanticipated changes in dividends.
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19.19 Stock ividends

"ay additional shares of stock instead of cash *ncreases the nu%ber of outstanding shares S%all stock dividend

Kess than #9 to #-M *f you own 199 shares and the co%pany declared a 19M stock dividend/ you would receive an additional 19 shares.

Karge stock dividend = %ore than #9 to #-M

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Stock Splits

Stock splits = essentially the sa%e as a stock dividend e.cept it is e.pressed as a ratio

2or e.a%ple/ a # for 1 stock split is the sa%e as a 199M stock dividend.

Stock price is reduced when the stock splits. Co%%on e.planation for split is to return price to a H%ore desirable trading range.I

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Nuick NuiO
1hat are the different types of dividends/ and how is a dividend paid6 1hat is the clientele effect/ and how does it affect dividend policy irrelevance6 1hat is the infor%ation content of dividend changes6 1hat are stock dividends/ and how do they differ fro% cash dividends6 3ow are share repurchases an alternative to dividends/ and why %ight investors prefer the%6

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