This document discusses dividend policy and share repurchases. It notes that dividends distribute value to shareholders, and outlines important dates related to dividend declarations including the declaration date, record date, ex-dividend date, and payment date. It also discusses the tax advantages of share repurchases over dividends and some reasons why firms may opt to repurchase shares rather than pay dividends, such as signaling undervaluation or improving financial flexibility.

2. Subject: Corporate Governance
Presentation: Dividend Issues
SUBMITTED BY: SUBMITTED TO:
Hasan Mukhtar Bajwa SIR Awad Raheel
Hafiz Jawad Mehtab
Wajid Ali
Afraz Hamid

4. Dividend is distribution of value to the shareholders.
Usually, firms pay dividends in the form of cash or
additional stock.
There are several important dates to note when a firm’s
board of directors declares that a dividend . These
include
Declaration Date: This is the date on which company’s
board of directors declares that a dividend will be paid.
The board determines the amount of dividend, the board
declare a dividend payment either in cash dividend, stock
split option or stock repurchase.

5. Record Date: This is the date on which a company reviews
its book to determine its shareholders of record. Shareholders
who hold a particular stock on this date will receive the firm’s
dividend payment.
Ex-Dividend Date : After the record Date has been
determined, it is two business days prior to the record date. If
an investor buys a stock before ex-dividend date, then he or
she will receive the dividend payment. If an investor purchases
the stock on or after the ex-dividend date, then he or she is not
entitled to receive the dividend.

6. Payment Date : The dividend checks are mailed to
shareholders of record.

7.  A company’s business decisions involve investment, financing and payout
policies.
 Directors of companies must decide how much cash, if any, to pay to
shareholders and whether the payment should be in the form of dividends or
repurchase shares.
 The amount of money involved in payment suggests payout decision is a
significant issue in many companies operation.
 It is evident from empirical studies that investors supply capital to business
only because they have the reasonable expectation of eventually receiving
payouts from company in one form or another. (De Anglo & De Anglo,
2007)
 The decision on the company’s payout policy should be consistent with the
overall financial objective of maximising shareholders’ wealth.

8. Managers can do two things with current year’s earning
 Distribute as cash dividend or
 Retain them in company
With retain earning
 Make additional investments
 Pay down debt

9.  Dividends are an active decision variable (Lintner). In a
much larger study, some of the findings by Bray et. al. (2005)
were consistent with those of Lintner:
◦ Maintaining current level of dividend per share is a high priority and is
of similar importance to investment decisions.
◦ Managers see little reward for increasing dividends.
◦ Dividends are inflexible and smoothed relative to profits.
◦ Share repurchases are very flexible with no need for smoothing —
repurchases are made using the residual cash flow after investment
spending.

10.  Asymmetric Information:
 A situation in which one party in a transaction has more or superior
information compared to another. This often happens in transactions
where the seller knows more than the buyer, although the reverse can
happen as well. Potentially, this could be a harmful situation because
one party can take advantage of the other party's lack of knowledge.
 AGENCY COST:
 A type of internal cost that arises from, or must be paid to, an agent
acting on behalf of a principal. Agency costs arise because of core
problems such as conflicts of interest between shareholders and
management. Shareholders wish for management to run the
company in a way that increases shareholder value. But management
may wish to grow the company in ways that maximize their personal
power and wealth that may not be in the best interests of
shareholders.

11.  corporate governance mechanisms are designed to
mitigate agency costs, they may accomplish this by
reducing asymmetric information. This can happen
directly through incentives that encourage managers to
reveal information concerning their level of effort and
perquisite consumption, in order to qualify for incentive
payments. This can also happen indirectly, as many
corporate governance mechanisms are designed to
improve monitoring, making it difficult for managers to
conceal the extent of their shirking and of their
perquisites consumption.

12.  Independent and active boards, a greater reliance on
performance related payment systems, and the use of debt
financing all reduce asymmetric information, whereas greater
ownership concentration is associated with increased
information asymmetry.
 Number of non-executive directors serving in the board, the
number of audit committee meetings per year, the ratio of
CEO benefits to total CEO income, the fraction of outstanding
shares held by block-holders and the total debt ratio are the
most important factors in mitigating information asymmetry.

13.  If you are a stockholder in Willamette Industries, how much
information do you have about its worldwide operations and its
competitors?
 How much can you really find out about its future prospects by
reading current financial statements or, these days, Web page message
boards?
Answer : Best answer is to send cash dividend checks with reflect the
company’s prospects and financial position.

14.  Managers are reluctant to lose control over this cash.
 Managerial compensation, power and status are related to the size of
firm.
 Managers are more interested in “growth of firm”, instead of
shareholder value.
 Cash dividends, therefore are a way of removing free cash flow from
managerial control in firms that face limited investment opportunities.

15.  Mature and declining industries will have limited investment
opportunities.
 New and expanding industries have more growth
opportunities.
 Shareholder of mature and declining industries will expect
more cash dividend, because of negative NPV.
 On other hand the shareholders of new and expanding
industries are less concerned with cash dividends.

16.  Common law countries: stronger investor protection law.
 Civil law countries: Less stronger then common law countries.
 Divided payout ratios of new and expanding companies, measured by
growth in sales, were lower than those of mature companies in
common law countries.
 Dividend payout ratio of mature companies in civil law countries
were significantly lower than those of mature companies in common
law countries.
Note: Combination of governance structure and investor protection
laws result in reducing agency cost.

17.  Share buyback
 Effects of tax : 40 per on cash dividend and 20 per on capital gains
 Lump-sum buyback sees increase by 20 % in price of stock
 Over time, depending on market conditions, price go up by 3%.

18.  Use firm’s excess cash to buy stock back
 Repurchases are an alternative to dividends for distributing
cash to shareholders, with some advantages over paying
cash
 Advantages of Stock Repurchases:
1. Cash is distributed to shareholders who want it
• Only shareholders who decide to sell get cash
2. As repurchases are usually done over time, firm has flexibility to
scale back or reverse decision

19. 3. Tax advantage to shareholders since cash distributed comes to
shareholders as a capital gain rather than classified as dividend –
dividends are taxed at higher rate
4. Purchasing stock provides signal to market that firm believes share
undervalued – typically results in increase in share price
5. In some firms, control by certain shareholders is important and a
reduction in number of shares increases their percentage ownership

20.  Assume that any investments a firm makes
are NPV = 0
 Investments themselves would not create or destroy
value.
 As before, dividends then merely determine
where an investor gets income from –
dividends versus capital gains
 Is dividend policy irrelevant in this case?
 Do investors care how they get income?

21.  Dividend policy determines how investors receive
income.
 This is an important issue because dividends are
taxed more heavily than capital gains.
 In Canada:
 Only 50% of a capital gain is taxable
 Dividends are taxed as regular income, although dividend
tax credit reduces the excess taxation
 Ceteris paribus, investors prefer income to be in
form of capital gains.

22.  Because dividends are taxed more highly than capital
gains, taxable investors prefer small or no dividends (all
else being equal).
 Firm’s which pay dividends have to offer higher before tax returns in
order to compensate investors for the higher tax they must pay.
 Implication: Firm’s with high dividends should have lower share prices than
identical firms with lower dividends.
 Dividend policy does matter.
 Implication: Tax free investors (e.g. pension funds) will prefer to invest
in high dividend stocks.

23.  Note: even if dividends and capital gains are taxed at
same rate, there is still a tax advantage in capital gains
 Tax timing option
 Taxes on capital gains are only paid when realized
 Investors can therefore decide when to sell shares and pay tax
 Valuable option
 Investors can sell shares and realize gain when most advantageous for
tax purposes
 Dividends do not have this option
 Also means that taxes on capital gains can be delayed
 Present value of taxes to be paid is less if the shares are to be sold far
into the future

24.  In the extreme, the tax disadvantage of
dividends means that firms should pay no
dividends
 As long as they have NPV > 0 or NPV = 0 projects to
invest in, investors prefer not to get any dividends paid to
them.
 What mitigates the tax effect?
 Why do firms pay dividends?

25.  Dividend substitution
◦ If capital gains are taxed more favorably than dividends.
◦ Some supporting evidence from the US, where dividend payout
ratios have been falling in the 1980s and 1990s.
 Improved performance measures
◦ EPS may rise, but if cash is returned rather than used to retire debt,
financial risk is increased and P/E ratio along with share price may
fall.
◦ Return of funds that cannot be profitably used will raise share
price.
 Signalling and undervaluation
◦ Managers buying back company stock indicates that
they believe the stock is undervalued by the market.
◦ Alternatively, a buy-back announcement could be accompanied by
some new information, e.g. sale of unprofitable asset/division.

26.  Resource allocation and agency costs
◦ Share repurchase returns capital to shareholders, who can reallocate funds into
profitable activities through the capital market.
◦ Reduces the potential for managers to inefficiently use free cash
(i.e. reduces agency costs).
 Financial flexibility
◦ Payment of dividends is a long-term commitment, and sudden major changes
(especially decreases) in dividend policy are unappreciated by market.
◦ Buy-backs offer an alternative way to make distributions that may not be permanent.
 Employee share options
◦ Unlike paying dividends, share repurchases do not lead to the ex-dividend price drop-
off.
◦ Option holders (typically management) prefer a share repurchase to a dividend payout
as a means of distributing profits to shareholders.