Dividend PolicyWhat are dividends?Why do companies pay dividends?Does dividend policy affect value?Why could dividends affect value?What are the influences on the dividend decision?
What are dividends?Cash payments to shareholdersPaid out of after-tax profitsInterim dividendFinal dividendFinal dividend voted on at AGM
Dividends can be paid from past and present earnings but cannot be paid from any capital reserveCompanies whose external liabilities exceed their assets cannot legally pay dividends.Profits vs cash flow
Why do companies pay dividends?Reward to shareholders?What is the Total Shareholders’ Return (TSR) made up of?Why else might companies pay dividends?
Do all companies pay the sameamount of dividends?Amount paid is discretionaryZero dividend policy% of after-tax profitConstant dividend or constantly growing dividend
Marks and Spencer plc (M&S Annual Report 2009) Year 2009 2008 2007 2006 2005 EPS 32.3p 49.2p 39.1p 31.3p 17.6p (basic) Div 17.8p 22.5p 18.3p 14.0p 12.1p per share
Marks and Spencer dividendsWhat do you notice about M&S dividends?What do you think has influenced the level of dividends paid to shareholders?
What influences the level ofdividend? Variability of profits But dividends are cash flows Investment opportunities Ability/willingness to raise external finance Influence of investors Nature of business/stage of business in lifecycle Market expectations?
Alternatives to cash dividends Scrip dividends Saves cash Lowers gearing Share repurchase Reduces liquidity Increases underlying share value Non-pecuniary benefits Discounts Complementary goods/services Eg Channel Tunnel, Legal and General
Do dividends affect Value?Residual Theory Dividend payments depend on the investment opportunities available to the firm This implies that investors are indifferent between dividend payments and increases in share prices due to reinvested earnings The dividend decision is a passive decision??
Dividend IrrelevanceModigliani and Miller 1961 the value of the firm is determined by the earnings power of its assets and the split between dividends and retained earnings is irrelevant.Shareholders can manufacture their own level of dividendsAssumptions no tax no transaction costs
Why might Dividends affect Value?Dividends may be preferred to an increase in share price Certainty LiquidityTax impact Different tax treatments between dividends and capital gains Clientele effect
The Clientele EffectDividends themselves do not affect share priceCompanies with particular dividend policies attract groups of investors according to their tax situationA change in dividend policy will bring about a change in share price due to the demand and supply by different investor groups for that type of investment.
Why might Dividends affect Value?Dividends as a basis for company valuation Dividend Valuation Model (Gordon) MP of a share = PV of future dividend payments P0 = D1/(ke – g) P0 = Current Share Price D1 = next yr’s dividend ke = cost of equity g = annual growth rate of divs
ExampleShareholders require a 12% return on their investment and the company has just paid a dividend of 80p per share. Dividends have grown on average by 3.4% per year. What is the theoretical share price using the dividend growth model?
Signalling EffectsDividends carry information to the market (information asymmetry)Dividends are usually stableA change in dividend policy may make investors believe that management is announcing a change in future profitability but …..
Do dividends affect share prices(value)?All research is inconclusiveDividend policy can be observed and share prices can be observedButOther factors cause movements in share pricesIt is difficult to separate out the clientele effect from the signalling effect
What have we discussed today?Influences on dividend paymentsThe debate about the link between dividends and share price (value)Why we cannot answer the question about the link between dividends and value