Jan.

4
Declare
dividend

Jan.30

Feb.1

Ex-div. Record
date
date

Mar. 11
Payment
date

Dividend Payments
1) Declaration Date: the board of
directors declares the dividend,
determines the amount of the dividend,
and decides on the payment date.

Jan.4
Declare
dividend

Jan.30

Feb.1

Ex-div. Record
date
date

Mar. 11
Payment
date

Dividend Payments
2) Ex-Dividend Date:

Jan.4
Declare
dividend

Jan.30

Feb.1

Ex-div. Record
date
date

Mar. 11
Payment
date

Dividend Payments
2) Ex-Dividend Date: To receive the
dividend, you have to buy the stock before
the ex-dividend date. On this date, the
stock begins trading ex-dividend and
the stock price falls approximately by the
amount of the dividend.

Jan.4
Declare
dividend

Jan.30

Feb.1

Ex-div. Record
date
date

Mar. 11
Payment
date

Dividend Payments
3) Date of Record:

Jan.4
Declare
dividend

Jan.30

Feb.1

Ex-div. Record
date
date

Mar. 11
Payment
date

Dividend Payments
3) Date of Record: 2 days after the exdividend date, the firm receives the list of
stockholders eligible for the dividend.
Often, a bank trust department acts as
registrar and maintains this list for the
firm.

Jan.4
Declare
dividend

Jan.30

Feb.1

Ex-div. Record
date
date

Mar. 11
Payment
date

Dividend Payments
4) Payment Date: date on which the
firm mails the dividend checks to the
shareholders of record.

Stock Returns:
Return =

P1 - Po + D1
Po

Stock Returns:
Return =

P1 - Po
Po

P1 - Po + D1
Po
D1
+
Po

Stock Returns:
Return =

P1 - Po
Po

P1 - Po + D1
Po
D1
+
Po

Capital Gain

Stock Returns:
Return =

P1 - Po
Po

P1 - Po + D1
Po
D1
+
Po

Capital Gain

Dividend Yield

Dilemma: Should the firm use

retained earnings for:
a) Financing profitable capital
investments?
b) Paying dividends to stockholders?

Return =

P1 - Po
Po

D1
Po

If we retain earnings for profitable

investments,

Return =

P1 - Po
Po

D1
Po

If we retain earnings for profitable

investments, dividend yield will be zero,

Return =

P1 - Po
Po

D1
Po

If we retain earnings for profitable

investments, dividend yield will be zero,
but the stock price will increase, resulting
in a higher capital gain.

Return =

P1 - Po
Po

If we pay dividends,

D1
Po

Return =

P1 - Po
Po

D1
Po

If we pay dividends, stockholders receive

an immediate cash reward for investing,

Return =

P1 - Po
Po

D1
Po

If we pay dividends, stockholders receive

an immediate cash reward for investing,
but the capital gain will decrease, since
this cash is not invested in the firm.

So, dividend policy really

involves 2 decisions:
How much of the firms earnings
should be distributed to
shareholders as dividends, and
How much should be retained for
capital investment?

Is Dividend Policy Important?

Three viewpoints:
1) Dividends are Irrelevant. If we
assume perfect markets (no taxes,
no transaction costs, etc.) dividends
do not matter. If we pay a
dividend, shareholders dividend
yield rises, but capital gains
decrease.

Return =

P1 - Po
Po

D1
Po

With perfect markets, investors are

concerned only with total returns,
and do not care whether returns
come in the form of capital gains or
dividend yields.

Return =

P1 - Po
Po

D1
Po

With perfect markets, investors are

concerned only with total returns,
and do not care whether returns
come in the form of capital gains or
dividend yields.

Return =

P1 - Po
Po

D1
Po

With perfect markets, investors are

concerned only with total returns,
and do not care whether returns
come in the form of capital gains or
dividend yields.
Therefore, one dividend policy is as
good as another.

2) High Dividends are Best

Some investors may prefer a certain
dividend now over a risky expected
capital gain in the future.

2) High Dividends are Best

Some investors may prefer a certain
dividend now over a risky expected
capital gain in the future.

Return =

P1 - Po
Po

D1
Po

3) Low Dividends are Best

Dividends are taxed immediately.
Capital gains are not taxed until the
stock is sold.
Therefore, taxes on capital gains can
be deferred indefinitely.

Do Dividends Matter?
Other Considerations:
1) Residual Dividend Theory:
The firm pays a dividend only if it has
retained earnings left after financing
all profitable investment
opportunities.
This would maximize capital gains for
stockholders and minimize flotation
costs of issuing new common stock.

Do Dividends Matter?
2) Clientele Effects:
Different investor clienteles prefer different
dividend payout levels.
Some firms, such as utilities, pay out over
70% of their earnings as dividends. These
attract a clientele that prefers high
dividends.
Growth-oriented firms which pay low (or
no) dividends attract a clientele that prefers
price appreciation to dividends.

Do Dividends Matter?
3) Information Effects:
Unexpected dividend increases
usually cause stock prices to rise, and
unexpected dividend decreases cause
stock prices to fall.
Dividend changes convey information
to the market concerning the firms
future prospects.

Do Dividends Matter?
4) Agency Costs:
Paying dividends may reduce agency
costs between managers and
shareholders.
Paying dividends reduces retained
earnings and forces the firm to raise
external equity financing.
Raising external equity subjects the firm
to scrutiny of regulators (SEC) and
investors and therefore helps monitor the
performance of managers.

Do Dividends Matter?
5) Expectations Theory:
Investors form expectations concerning
the amount of a firms upcoming
dividend.
Expectations are based on past dividends,
expected earnings, investment and
financing decisions, the economy, etc.
The stock price will likely react if the
actual dividend is different from the
expected dividend.

Dividend Policies
1) Constant Dividend Payout Ratio: if
directors declare a constant payout
ratio of, for example, 30%, then for
every rupee of earnings available to
stockholders, 30 ps would be paid out
as dividends.
The ratio remains constant over time,
but the rupee value of dividends
changes as earnings change.

Dividend Policies
2) Stable Rupees Dividend Policy:
the firm tries to pay a fixed rupee
dividend each quarter.
Firms and stockholders prefer
stable dividends. Decreasing the
dividend sends a negative signal!

Dividend Policies
3) Small Regular Dividend plus YearEnd Extras
The firm pays a stable quarterly
dividend and includes an extra yearend dividend in prosperous years.
By identifying the year-end dividend
as extra, directors hope to avoid
signaling that this is a permanent
dividend.

Financial Signaling
Cash dividends speak louder than words
Occur if the dividend is more or less than
expected
Price of the stock may react to
unanticipated changes in dividends

Empirical Testing and

Implications for Payout
Ex-dividend day tests
Behavior of common stock prices
Dividend-yield approach
Relationship between dividend yields and
stock returns
Financial signaling studies
At the time of the dividend change find
that there is a significant earnings change

Implications for Corporate Policy

Tax effect consistent with dividend
neutrality
Signaling effect
Optimal dividend policy
Maximize shareholder wealth
Excess cash

Share Repurchase
Increased in importance relative to
dividends
Substitute for cash dividends
Employee stock options and share
repurchase
Means to compensate employees
Employees with existing stock options
prefer share repurchase

Method of Repurchase
Fixed-price tender offer
Formal offer to stockholders to purchase so
many shares at a set price

Dutch-auction tender offer

Dominant form of tender offer

Open-market purchase
SEC rules
Disclose intentions

Repurchasing as Part of a
Dividend
Decision
Fewer shares remaining outstanding

EPS rise
Dividends per share rise
Market price per share should rise
Equilibrium formula
S X Pc
P*
S n
Where S is the number of shares outstanding prior to the
distribution, Pc = is the current market price per share prior to
distribution, n is the number of shares to be repurchased.

Personal tax effect

Signaling effect
Differs with the method of repurchase

Stock Dividends and Stock Splits

Stock dividend: payment of additional
shares of stock to common stockholders.
Example: Citizens Bank corporation
announces a 5% stock dividend to all
shareholders of record. For each 100
shares held, shareholders receive another
5 shares.
Does the shareholders wealth increase?

Stock Dividends and Stock Splits

Stock Split: the firm increases the number
of shares outstanding and reduces the
price of each share.
Example: Joule, Inc. announces a 3-for-2
stock split. For each 100 shares held,
shareholders receive another 50 shares.
Does this increase shareholder wealth?
Are a stock dividend and a stock split the
same?

Stock Dividends and Stock Splits

Stock Splits and Stock Dividends are
economically the same: the number of
shares outstanding increases and the price
of each share drops. The value of the firm
does not change.
Example: A 3-for-2 stock split is the same
as a 50% stock dividend. For each 100
shares held, shareholders receive another
50 shares.

Stock Dividends and Stock Splits

Effects on Shareholder Wealth:

Stock Dividends and Stock Splits

Effects on Shareholder Wealth: these will
cut the company pie into more pieces
but will not create wealth. A 100% stock
dividend (or a 2-for-1 stock split) gives
shareholders 2 half-sized pieces for each
full-sized piece they previously owned.

Stock Dividends and Stock Splits

Effects on Shareholder Wealth: these will
cut the company pie into more pieces
but will not create wealth. A 100% stock
dividend (or a 2-for-1 stock split) gives
shareholders 2 half-sized pieces for each
full-sized piece they previously owned.
For example, this would double the
number of shares, but would cause a Rs.60
stock price to fall to Rs.30.

Stock Dividends and Stock Splits

Why bother?
Proponents argue that these are used to
reduce high stock prices to a more
popular trading range (generally Rs.15 to
Rs.70 per share).
Opponents argue that most stocks are
purchased by institutional investors who
have millions of rupees to invest and are
indifferent to price levels. Plus, stock splits
and stock dividends are expensive!

Stock Dividend Example

shares outstanding: 1,000,000

net income = Rs.6,000,000;
P/E = 10
25% stock dividend.
An investor has 120 shares. Does the
value of the investors shares
change?

Before the 25% stock dividend:

EPS = 6,000,000/1,000,000 = Rs.6
P/E = P/6 = 10, so P = Rs.60 per share.
Value = Rs.60 x 120 shares = Rs.7,200
After the 25% stock dividend:
# shares = 1,000,000 x 1.25 = 1,250,000.
EPS = 6,000,000/1,250,000 = Rs.4.80
P/E = P/4.80 = 10, so P = Rs.48 per share.
Investor now has 120 x 1.25 = 150 shares.
Value = Rs.48 x 150 = Rs.7,200

Stock Dividends
In-class Problem

shares outstanding: 250,000

net income = Rs.750,000;
stock price = Rs.84
50% stock dividend.
What is the new stock price?

Hint:

P/E =

stock price
net income
# shares

Before the 50% stock dividend:

EPS = 750,000 / 250,000 = Rs.3
P/E = 84 / 3 = 28.
After the 50% stock dividend:
# shares = 250,000 x 1.50 = 375,000.
EPS = 750,000 / 375,000 = Rs.2
P/E = P / 2 = 28, so P = Rs.56 per share.
(a 50% stock dividend is equivalent to a
3-for-2 stock split)

Stock Splits

Number of shares is increased through a

proportional reduction in the par value
May increase cash dividends
Place the stock in a more-popular trading range
Informational or signaling effect
Asymmetric information

Perceived earnings
Not the stock dividend nor split itself

Reverse stock split

Reduce the number of shares

Usually a negative signal

Managerial Considerations as to
Dividend/Share-Repurchase Policy

Funds needs of the firm

Ability to borrow
Control
Nature of stockholders
Liquidity

Restrictions
Dividend stability
Target-payout ratios
Assessment of any
valuation information

Some Final Observations

Dividend in excess of residual implies a favorable
effect on shareholder wealth
Lack of clear empirical evidence
Many companies believe dividend payout affects
share price
Repurchase of stock
When sizable amount of excess funds exists
Increasingly more important