Dividend Policy and

Internal Financing
Capule, Marilou G.
Mangahas, Nicole S.
Sison, Ana Phauline A.
Dividend Payment vs. Profit Retention
COMPONENTS OF DIVIDEND POLICY

1. Dividend payout ratio – amount of dividends paid relative to

the company’s earnings

EXAMPLE :
Dividend/share = P2.00
Earnings/share = P4.00
Payout ratio = P2.00 / P4.00 = 50%
Dividend Payment vs. Profit Retention
COMPONENTS OF DIVIDEND POLICY
2. Stability of dividends over time
Does dividend policy affect stock price?
3 BASIC VIEWS
VIEW 1 – Dividend policy is Irrelevant
1. Assumption that investment and borrowing decisions have
already been made and that these decisions will not be
altered by the amount of any dividend payment.

2. “Perfect Capital Markets” are assumed to exist

 Investors can buy and sell stocks without incurring any
transaction costs
 Issuance of stocks without any cost in doing so
 No corporate or personal taxes
 Readily available company information
Does dividend policy affect stock price?
 No conflicts of interest between management and
stockholders
 No financial distress and bankruptcy

Which dividend plan is preferable?

STEP 1: Compute the dividend streams
STEP 2: Determine the Present Value of Cash Flow streams
STEP 3: Select the best dividend plan

VIEW 2 – High dividends increase stock value

“Bird-in-the-hand” dividend theory – dividends are more certain
than capital gains
Does dividend policy affect stock price?
VIEW 3 – Low dividends increase stock value
The objective is to maintain the after-tax return on investment
relative to the risk assumed
THOUGH,
- minimizing the effective tax rate on the income
- deferring the payment of taxes
Low dividend policy
- policy of paying low dividends will result in higher stock price

Dividends hurt investors

Dividends help investors

Residual dividend theory
- theory asserting that dividends to be paid should equal capital
left over after the financing of profitable investments

Clientele effect
- belief that individuals and institutions that need current
income will invest in companies that have high dividend payouts

- other investors prefer to avoid taxes by holding securities that

offer only small dividend income, but large capital gains as the
capital gains are deferred until realized. Thus we have a
“clientele” of investors.
Information Asymmetry
- difference in accessibility to information between
management and investors may result in a lower stock price
than would occur under conditions of certainty

Agency costs
- the costs, such as a reduced stock price, associated with
potential conflict between managers and investors when these
two groups are not the same

Expectations theory
- effect of new information about a company on the firm’s stock
price depends more on how the new information compares to
expectations than on the actual announcement itself
Other practical considerations :
1. Legal restrictions
a. Statutory restrictions
b. Restrictions in debt and preferred stock contracts

2. Liquidity position

3. Absence or lack of other sources of financing

4. Earnings predictability

5. Ownership control

6. Inflation
Alternative dividend policies
1. Constant dividend payout ratio – percentage of earnings
paid out in dividends is held constant

2. Stable dollar dividend per share payout – maintains

relatively stable dollar dividend per share over time

3. Small, regular dividend plus year-end extra dividend payout

– firm pays a small regular dividend plus an extra dividend
only if the firm has experienced a good year
Increasing – stream hypothesis of dividend policy –
smoothing of dividend stream in order to minimize the effects of
company reversals.
Dividend payment procedures
• Declaration date – the date upon which a dividend is formally
declared by the board of directors
• Date of Record – Date at which the stock transfer books are to
be closed for determining which investor is to receive the next
dividend payment
• Ex-dividend date – the date upon which stock brokerage
companies have uniformly decided to terminate the right of
ownership to the dividend, which is two days prior to the
record date
• Payment date – the date on which the company mails a
dividend check to each investor
Stock dividend and Stock splits
• Stock dividend – A distribution of shares of up to 25 percent of
the number of shares currently outstanding issued on a pro
rata basis to the current stockholders.

• Stock split – A stock dividend exceeding 25 percent of the

number of shares currently outstanding
Stock Repurchase
Stock repurchase (Stock buyback) – The repurchase of common
stock by the issuing firm for any of a variety of reasons resulting
in a reduction of shares outstanding

3 methods for stock repurchase

1. Shares could be bought in the market
2. Make a tender offer to the firm’s shareholders
Tender offer – the formal offer by the company to buy a
specified number of shares at a predetermined and stated price.
3. The purchase of the stock from one or more major
stockholders – made on a negotiated bank care to ensure
fair and equitable price.