Term
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Definition
Regular cash dividend – cash payments made directly to stockholders, usually each quarter
Extra cash dividend – indication that the “extra” amount may not be repeated in the future
Special cash dividend – similar to extra dividend, but definitely won’t be repeated
Liquidating dividend – some or all of the business has been sold |
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Term
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Definition
Declaration Date – Board declares the dividend and it becomes a liability of the firm
Ex-dividend Date
Occurs two business days before date of record
If you buy stock on or after this date, you will not receive the dividend
Stock price generally drops by about the amount of the dividend
Date of Record – Holders of record are determined and they will receive the dividend payment
Date of Payment – checks are mailed |
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Term
| Does Dividend Policy Matter? |
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Definition
Dividends matter – the value of the stock is based on the present value of expected future dividends
Dividend policy may not matter
Dividend policy is the decision to pay dividends versus retaining funds to reinvest in the firm
In theory, if the firm reinvests capital now, it will grow and can pay higher dividends in the future |
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Term
Why low payout is desireable |
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Definition
Individuals in upper income tax brackets might prefer lower dividend payouts, given the immediate tax liability, in favor of higher capital gains with the deferred tax liability
Flotation costs – low payouts can decrease the amount of capital that needs to be raised, thereby lowering flotation costs
Dividend restrictions – debt contracts might limit the percentage of income that can be paid out as dividends |
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Term
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Definition
Desire for current income
Individuals that need current income, i.e. retirees
Groups that are prohibited from spending principal (trusts and endowments)
Uncertainty resolution – no guarantee that the higher future dividends will materialize
Taxes
Dividend exclusion for corporations
Tax-exempt investors don’t have to worry about differential treatment between dividends and capital gains |
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Term
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Definition
Asymmetric information – managers have more information about the health of the company than investors
Changes in dividends convey information
Dividend increases
Management believes it can be sustained
Expectation of higher future dividends, increasing present value
Signal of a healthy, growing firm
Dividend decreases
Management believes it can no longer sustain the current level of dividends
Expectation of lower dividends indefinitely; decreasing present value
Signal of a firm that is having financial difficulties |
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Term
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Definition
Determine capital budget
Determine target capital structure
Finance investments with a combination of debt and equity in line with the target capital structure
Remember that retained earnings are equity
If additional equity is needed, issue new shares
If there are excess earnings, then pay the remainder out in dividends |
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Term
Compromise dividend policy |
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Definition
Goals, ranked in order of importance
Avoid cutting back on positive NPV projects to pay a dividend
Avoid dividend cuts
Avoid the need to sell equity
Maintain a target debt/equity ratio
Maintain a target dividend payout ratio
Companies want to accept positive NPV projects, while avoiding negative signals |
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Term
| Management view on dividend policy |
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Definition
Managements’ View of Dividend Policy
Agree or Strongly Agree
93.8% Try to avoid reducing dividends per share
89.6% Try to maintain a smooth dividend from year to year
41.7% pay dividends to attract investors subject to “prudent man” restrictions
Important or Very Important
84.1% Maintaining consistency with historic dividend policy
71.9% Stability of future earnings
9.3% Flotation costs to issue new equity |
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Term
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Definition
Company buys back its own shares of stock
Tender offer – company states a purchase price and a desired number of shares
Open market – buys stock in the open market
Similar to a cash dividend in that it returns cash from the firm to the stockholders
This is another argument for dividend policy irrelevance in the absence of taxes or other imperfections |
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Term
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Definition
Company buys back its own shares of stock
Tender offer – company states a purchase price and a desired number of shares
Open market – buys stock in the open market
Similar to a cash dividend in that it returns cash from the firm to the stockholders
This is another argument for dividend policy irrelevance in the absence of taxes or other imperfections |
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Term
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Definition
Stock repurchase allows investors to decide if they want the current cash flow and associated tax consequences
In our current tax structure, repurchases may be more desirable due to the options provided stockholders
The IRS recognizes this and will not allow a stock repurchase for the sole purpose of allowing investors to avoid taxes |
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Term
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Definition
Stock splits – essentially the same as a stock dividend except expressed as a ratio
For example, a 2 for 1 stock split is the same as a 100% stock dividend
Stock price is reduced when the stock splits
Common explanation for split is to return price to a “more desirable trading range” |
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Term
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Definition
Pay additional shares of stock instead of cash
Increases the number of outstanding shares
Small stock dividend
Less than 20 to 25%
If you own 100 shares and the company declared a 10% stock dividend, you would receive an additional 10 shares
Large stock dividend – more than 20 to 25% |
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