DIVIDENS AND
PAYOUT POLICY
Lecture 9
Ph.D Chung Thúy An
Finance and Banking
an.ct@ou.edu.vn
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.
Different Types of Payouts
1. Many companies pay a regular cash dividend.
• Public companies often pay quarterly.
• Sometimes firms will pay an extra cash dividend.
• The extreme case would be a liquidating dividend.
2. Companies will often declare stock dividends.
• No cash leaves the firm.
• The firm increases the number of shares outstanding.
3. Some companies declare a stock split.
• Regular splits increase the number of shares outstanding.
4. Other companies use stock buybacks (stock repurchase).
Procedure for Cash Dividend
THU THU FRI MON
15TH 29TH 30TH 16TH
JAN JAN JAN FEB
DECLARATION EX-DIVIDEND RECORD PAYMENT
DATE DATE DATE DATE
Declaration date: The board of directors declares a payment of dividends.
Record date: The declared dividends are distributable to shareholders of record
on a specific date.
Ex-dividend date: Seller of the stock retains the dividend. Date that determines
whether a stockholder is entitled to a dividend payment; anyone holding stock
immediately before this date is entitled to a dividend.
Payment date: The dividend checks are mailed to shareholders of record.
Price Behavior
In a perfect world, the stock price will fall by the amount of the dividend on the
ex-dividend date.
Taxes complicate things a bit. Empirically, the price drop is less than the dividend
and occurs within the first few minutes of the ex-dividend date.
Repurchase of Stock
Instead of declaring cash dividends, firms can rid themselves of excess cash
through buying shares of their own stock.
Recently, share repurchase has become an important way of distributing
earnings to shareholders.
Stock Repurchase versus Dividend – I
Consider a firm that wishes to distribute $100,000 to its shareholders.
Stock Repurchase versus Dividend
If they distribute the $100,000 as a cash dividend, the balance sheet will look like
this:
Stock Repurchase versus Dividend
If they distribute the $100,000 through a stock repurchase, the balance sheet will
look like this:
Share Repurchase
• Flexibility for shareholders
• Keeps stock price higher
• Good for insiders who hold stock options.
• As an investment of the firm (undervaluation)
• Tax benefits
Firms without Sufficient Cash
• The direct costs of stock issuance
will add to this effect.
• In a world of personal taxes, firms
should not issue stock to pay a
dividend.
Firms with Sufficient Cash
The above argument does not necessarily apply to firms with excess cash.
Consider a firm that has $1 million in cash after selecting all available positive
NPV projects.
• Select additional capital budgeting projects (by assumption, these are
negative NPV)
• Acquire other companies.
• Purchase financial assets.
• Repurchase shares.
Real-World Factors Favoring a High-Dividend
Policy
Desire for Current Income
Behavioral Finance
• It forces investors to be disciplined.
Tax Arbitrage
• Investors can create positions in high-dividend yield securities that avoid
tax liabilities.
Agency Costs
• High dividends reduce free cash flow.
What We Know and Do Not Know
Corporations “smooth” dividends.
Fewer companies are paying dividends.
Dividends provide information to the market.
Firms should follow a sensible policy:
• Do not forgo positive NPV projects just to pay a dividend.
• Avoid issuing stock to pay dividends.
• Consider share repurchase when there are few better uses for the cash.
Putting It All Together
Aggregate payouts are massive and have increased over time.
Dividends (and repurchases) are concentrated among a small number of large,
mature firms.
Managers are reluctant to cut dividends.
Managers smooth dividends.
Stock prices react to unanticipated changes in dividends.
The magnitude of repurchases tends to vary with transitory earnings.
General Dividend Guidelines
• Over time, pay out all free cash flows.
• Avoid cutting positive NPV projects to pay dividends or buy back shares.
• Do not initiate dividends until the firm is generating substantial free cash
flows.
• Set the current regular dividend consistent with a long-run target payout
ratio.
• Set the level of dividends low enough to avoid expensive future external
financing.
• Use repurchases to distribute transitory cash flow increases.
Stock Dividends
Pay additional shares of stock instead of cash.
Increases the number of outstanding shares.
Small stock dividend.
• Less than 20 to 25 percent.
• Example: If you own 100 shares and the company declared a 10 percent
stock dividend, you would receive an additional 10 shares.
Large stock dividend – more than 20 to 25 percent
Stock Splits
Stock split – essentially the same as a stock dividend except it is expressed as a
ratio.
• For example, a 2-for-1 stock split is the same as a 100 percent stock
dividend.
Stock price is reduced when the stock splits.
Common explanation for split is to return price to a “more desirable trading
range.”
THANK YOU
