Chapter 18 Dividend Policy 18-1
18-1 Chapter 18 Dividend Policy
Dividend Policy Passive versus Active dividend Policies Factors Influencing Dividend Policy Dividend Stability Stock Dividends and stock Splits Stock Repurchase Administrative Considerations 182
18-2 Dividend Policy Passive Versus Active Dividend Policies Factors Influencing Dividend Policy Dividend Stability Stock Dividends and Stock Splits Stock Repurchase Administrative Considerations
Dividends as a Passive residual Can the payment of cash dividends affect shareholder wealth? If so, what dividend-payout ratio will maximize shareholder wealth? The firm uses earnings plus the additional financing that the increased equity can support to finance any expected positive-NPV projects. Any unused earnings are paid out in the form of dividends. This describes a passive dividend policy. 183
18-3 Dividends as a Passive Residual The firm uses earnings plus the additional financing that the increased equity can support to finance any expected positive-NPV projects. Any unused earnings are paid out in the form of dividends. This describes a passive dividend policy. Can the payment of cash dividends affect shareholder wealth? If so, what dividend-payout ratio will maximize shareholder wealth?
Irrelevance of dividends A. Current dividends versus retention of earnings M&M contend that the effect of dividend payments on shareholder wealth is exactly offset by other means of financing. The dividend plus the new stock price after dilution exactly equals the stock price prior to the dividend distribution 184
18-4 Irrelevance of Dividends M&M contend that the effect of dividend payments on shareholder wealth is exactly offset by other means of financing. The dividend plus the new stock price after dilution exactly equals the stock price prior to the dividend distribution. A. Current dividends versus retention of earnings
Irrelevance of dividends B. Conservation of value M&M and the total-value principle ensures that the sum of market value plus current dividends of two firms identical in all respects other than dividend-payout ratios will be the same Investors can create any dividend policy they desire by selling shares when thethe dividend payout is too low or buying shares when the dividend payout is excessive 185
18-5 Irrelevance of Dividends M&M and the total-value principle ensures that the sum of market value plus current dividends of two firms identical in all respects other than dividend-payout ratios will be the same. Investors can create any dividend policy they desire by selling shares when the the dividend payout is too low or buying shares when the dividend payout is excessive. B. Conservation of value
Relevance of dividends A. Preference for dividends Uncertainty surrounding future company profitability leads certain investors to prefer the certainty of current dividends Investors prefer large dividends Investors do not like to manufacture homemade dividends, but prefer the company to distribute them directly. 18-6
18-6 Relevance of Dividends Uncertainty surrounding future company profitability leads certain investors to prefer the certainty of current dividends. Investors prefer large dividends. Investors do not like to manufacture homemade dividends, but prefer the company to distribute them directly. A. Preference for dividends
Relevance of dividends B. Taxes on the investor Capital gains taxes are deferred until the actual sale of stock. This creates a timing option. Capital gains are preferred to dividends, everything else equaL. Thus, high dividend- yielding stocks should sell at a discount to generate a higher before-tax rate of return Certain institutional investors pay no tax 18-7
18-7 Relevance of Dividends Capital gains taxes are deferred until the actual sale of stock. This creates a timing option. Capital gains are preferred to dividends, everything else equal. Thus, high dividendyielding stocks should sell at a discount to generate a higher before-tax rate of return. Certain institutional investors pay no tax. B. Taxes on the investor
Relevance of dividends B. Taxes on the investor(continued) Corporations can typically exclude 70% of dividend income from taxation. Thus, corporations generally prefer to receive dividends rather than capital gaIns. The result is clienteles of investors with different dividend preferences. In equilibrium, there will be the proper distribution of firms with differing dividend policies to exactly meet the needs of investors n Thus, dividend-payout decisions are irrelevant. 188
18-8 Relevance of Dividends Corporations can typically exclude 70% of dividend income from taxation. Thus, corporations generally prefer to receive dividends rather than capital gains. The result is clienteles of investors with different dividend preferences. In equilibrium, there will be the proper distribution of firms with differing dividend policies to exactly meet the needs of investors. Thus, dividend-payout decisions are irrelevant. B. Taxes on the investor (continued)
Other Dividend issues Flotation costs Transaction costs and divisibility of securities Institutional restrictions Financial signaling 189
18-9 Other Dividend Issues Flotation costs Transaction costs and divisibility of securities Institutional restrictions Financial signaling
Empirical Testing of Dividend Policy Tax Effect Dividends are taxed more heavily than capital gains, so before-tax returns should be higher for high dividend-paying firms Empirical results are mixed - recently the evidence is largely consistent with dividend neutrality Financial Signaling Expect that increases (decreases)in dividends lead to positive(negative)excess stock returns. Empirical results are consistent with these 18-10 expectations
18-10 Empirical Testing of Dividend Policy Tax Effect Dividends are taxed more heavily than capital gains, so before-tax returns should be higher for highdividend-paying firms. Empirical results are mixed -- recently the evidence is largely consistent with dividend neutrality. Financial Signaling Expect that increases (decreases) in dividends lead to positive (negative) excess stock returns. Empirical results are consistent with these expectations
