16-2 Topics Covered Facts About Payout How Firms Pay Dividends and Repurchase Stock How Do Companies Decide on Payouts? Information in Dividends and Stock Repurchases The Payout Controversy The Rightists Taxes and the Radical Left The Middle of the Roaders
16-5 Dividend PaymentsApril 15, 2009 May 11, 2009 May 13, 2009 June 10, 2009 Exxon Mobil Dividend will be paid Dividend checks declares regular Shares start to to shareholders are mailedquarterly dividend trade ex dividend. registered to shareholders.of $.42 per share. on this date. Declaration Ex-dividend Record Payment Date Date Date Date
16-6 Types of DividendsCash DividendRegular Cash DividendSpecial Cash DividendStock DividendStock Repurchase (4 methods) 1. Buy shares on the market 2. Tender Offer to Shareholders 3. Dutch Auction 4. Private Negotiation (Green Mail)
16-7 Dividend PaymentsCash Dividend - Payment of cash by the firmto its shareholders.Ex-Dividend Date - Date that determineswhether a stockholder is entitled to a dividendpayment; anyone holding stock before thisdate is entitled to a dividend.Record Date - Person who owns stock on thisdate received the dividend.
16-8 Dividend PaymentsStock Dividend - Distribution of additionalshares to a firm’s stockholders.Stock Splits - Issue of additional shares tofirm’s stockholders.Stock Repurchase - Firm buys back stockfrom its shareholders.
16-9 The Payout Decision Dividend Decision Survey (2004) The cost of external capital is lower than the cost of a dividend cutRather than reducing dividends we would raise new funds to undertake a profitable project We consider the change in the dividend We are reluctant to make a change that may have to be reversed We look at the current dividend level We try to maintain a smooth dividend stream We try to avoid reducing the dividend 0 10 20 30 40 50 60 70 80 90 100 Executives who agree or strongly agree (%)
16-10 The Payout DecisionLintner’s “Stylized Facts,”as updated by Brav, Graham, Harvey, Michaely (2004)1. Managers are reluctant to make dividend changes that may have to be reversed. They are particularly worried about having to rescind a dividend increase and, if necessary, would choose to raise new funds to maintain the payout.2. To avoid the risk of a reduction in payout, managers smooth” dividends. Consequently, dividend changes follow shifts in long-run sustainable earnings. Transitory earnings changes are unlikely to affect dividend payouts.3. Managers focus more on dividend changes than on absolute levels. Thus paying a $2.00 dividend is an important financial decision if last year’s dividend was $1.00, but no big deal if last year’s dividend was $2.00.
16-11 Information in Payouts Dividends and stock repurchase decisions contain information The information contained in the decisions varies Asymmetric information may be conveyed Dividend increases could mean overpriced stock or increased future profits The signal varies based on prior information about the company
16-12 Information in PayoutsAttitudes concerning dividend targets vary DIV1 target dividend target ratio EPS1Dividend Change DIV1 - DIV0 target change target ratio EPS1 - DIV0
16-13 Information in Payouts Dividend changes confirm the followingDIV - DIV0 1 adjustment rate target change adjustment rate target ratio EPS1 - DIV0
16-14 Dividend Policy Impact of Dividend Changes on EPS Change EPS/Price at t = 0 as % 15 10 5 0 -5 Div Rise Div Cut -10 -15 YearSource: Healy & Palepu (1988)
16-15 Dividend Policy Before After Dividend Dividend New stockholders Total value of firm Each share worth this before … … and worth this after Old stockholders Total number Total number of shares of sharesExample of 1/3rd of worth paid as dividend and raising money via new shares
16-16 Dividend Policy Dividend financed No dividend, no by stock issue stock issue New stockholders New stockholders Shares CashFirm Cash Shares Cash Old stockholders Old stockholders
16-17 Dividend Policy is IrrelevantSince investors do not need dividends to convert shares to cash they will not pay higher prices for firms with higher dividend payouts. In other words, dividend policy will have no impact on the value of the firm.
16-18 Dividend Policy is IrrelevantExample - Assume Rational Demiconductor has no extra cash, but declares a $1,000 dividend. They also require $1,000 for current investment needs. Using M&M Theory, and given the following balance sheet information, show how the value of the firm is not altered when new shares are issued to pay for the dividend.Record DateCash 1,000Asset Value 9,000Total Value 10,000 +New Proj NPV 2,000# of Shares 1,000price/share $12
16-19 Dividend Policy is IrrelevantExample - Assume Rational Demiconductor has no extra cash, but declares a $1,000 dividend. They also require $1,000 for current investment needs. Using M&M Theory, and given the following balance sheet information, show how the value of the firm is not altered when new shares are issued to pay for the dividend.Record Date Pmt DateCash 1,000 0Asset Value 9,000 9,000Total Value 10,000 + 9,000New Proj NPV 2,000 2,000# of Shares 1,000 1,000price/share $12 $11
16-20 Dividend Policy is IrrelevantExample - Assume Rational Demiconductor has no extra cash, but declares a $1,000 dividend. They also require $1,000 for current investment needs. Using M&M Theory, and given the following balance sheet information, show how the value of the firm is not altered when new shares are issued to pay for the dividend.Record Date Pmt Date Post PmtCash 1,000 0 1,000 (91 sh @ $11)Asset Value 9,000 9,000 9,000Total Value 10,000 + 9,000 10,000New Proj NPV 2,000 2,000 2,000# of Shares 1,000 1,000 1,091price/share $12 $11 $11 NEW SHARES ARE ISSUED
16-21 Dividend Policy is IrrelevantExample - continued - Shareholder Value RecordStock 12,000Cash 0Total Value 12,000Stock = 1,000 sh @ $12 = 12,000
16-22 Dividend Policy is IrrelevantExample - continued - Shareholder Value Record PmtStock 12,000 11,000Cash 0 1,000Total Value 12,000 12,000Stock = 1,000sh @ $11 = 11,000
16-23 Dividend Policy is IrrelevantExample - continued - Shareholder Value Record Pmt PostStock 12,000 11,000 12,000Cash 0 1,000 0Total Value 12,000 12,000 12,000Stock = 1,091sh @ $115 = 12,000 Assume stockholders purchase the new issue with the cash dividend proceeds.
16-24 Dividend TheoriesLeftists (M&M) - Dividend does not effect valueRightists - Dividends increase valueMiddle of the roaders - Leftist theory with some reality thrown in.Residual Dividend Policy
16-25 Dividends Increase ValueMarket Imperfections and Clientele Effect There are natural clients for high-payout stocks, but it does not follow that any particular firm can benefit by increasing its dividends. The high dividend clientele already have plenty of high dividend stock to choose from. These clients increase the price of the stock through their demand for a dividend paying stock.
16-26 Dividends Increase ValueDividends as Signals Dividend increases send good news about cash flows and earnings. Dividend cuts send bad news. Because a high dividend payout policy will be costly to firms that do not have the cash flow to support it, dividend increases signal a company’s good fortune and its manager’s confidence in future cash flows.
16-27 Dividends Decrease ValueTax Consequences Companies can convert dividends into capital gains by shifting their dividend policies. If dividends are taxed more heavily than capital gains, taxpaying investors should welcome such a move and value the firm more favorably. In such a tax environment, the total cash flow retained by the firm and/or held by shareholders will be higher than if dividends are paid.
16-28 Taxes and Dividend PolicySince capital gains are taxed at a lower rate than dividend income, companies should pay the lowest dividend possible.Dividend policy should adjust to changes in the tax code.
16-29 Taxes and Dividend Policy Firm A Firm B (no dividend) (high dividend)Next year s price 112.50 102.50Dividend 0 10Total pretax payoff 112.50 112.50Today s stock price 100 97.78Capital gain 12.50 4.72 12.5 14.72Pretax rate of return (%) 100 100 12.5 97.78 100 15.05Tax on div @ 50% 0 .40 10 4.00Tax on Cap Gain @ 20% .20 12.50 2.50 .20 4.72 0.94Total After Tax income (0 12.50) 2.50 10 (10 4.72) (4 0.94) 9.78(div cap gain - taxes) 10 9.78After tax rate of return (%) 100 100 10.0 97.78 100 10.0
16-30 Taxes and Dividend PolicyIn U.S., shareholders are taxed twice (figures in dollars) Cash Flow Operating Income 100.00 Corporate tax at 35% 35.00 After Tax income (paid as div) 65.00 Income tax paid by investors at 15.0% 9.75 Cash to Shareholder 55.25
16-31 Taxes and Dividend Policy Under imputed tax systems, such as that in Australia, Shareholders receive a tax credit for the corporate tax the firm pays (figures in Australian dollars) Rate of Income tax 15% 30% 47%Operating Income 100 100 100Corporate tax (Tc=.30) 30 30 30After Tax income 70 70 70Grossed up Dividend 100 100 100Income tax 15 30 47Tax credit for Corp Pmt -30 -30 -30Tax due from shareholder -15 0 17Cash to Shareholder 85 70 53