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1. Introduction to Dividend Policy.
1. Should a company pay dividends? There is an ongoing debate about whether a company should pay out its earnings as dividends or retain them for firm growth. There is further debate about which policy investors prefer.
2. Life Cycle of the Firm. Firms that are new and growing generally pay low or no dividends. Mature firms that are no longer in a growth phase often pay high and increasing dividends. See Slide 2 (38.0K) and Life Cycle Growth and Dividend Policy (55.0K) . Management must make a decision about retained earnings and how much of net income should be retained as opposed to paid out as dividends. See Dividends vs Retainded Earnings (56.0K) . The process of paying out "what's left" to shareholders is called the ______ Critical Concept. The issue is whether or not shareholders of the company want current funds in the form of dividends or if they want delay gratification in the form of capital gains.
3. Are Dividends Relevant? Some argue that dividend policy does not matter as it is not relevant to the shareholder when they receive their income. Others argue that dividends are relevant since there is some risk attached to retaining earnings and expecting to receive them in the future. Dividends also have information content. Firms that pay a good dividend every quarterly are usually seen by investors as more financially sound than those that don't. If a firm lowers its dividend payout ratio, then investors think the firm is in financial trouble. The best policy may be to set a low dividend payout ratio.
2. Other Factors Influencing Dividend Policy
1. Legal basis of dividends. Most states forbid firms to pay dividends that would impair the initial capital contributions to the firm. As a result, dividends may only be distributed from past and current earnings.
2. Cash position of the firm. A firm should complete a cash flow analysis before announcing its dividend policy.
3. Access to Capital Markets. Large firms that have easy access to the capital markets are in a better position to pay dividends than other firms since they can issue stock or debt if need be. Smaller firms may want to hold on to their retained earnings.
4. Desire for control. If a firm pays a high dividend and must lower it, shareholders may want management changes. Also, small firms often don't pay dividends for fear of diluting the cash position of the firm.
5. Tax position of shareholders. Some investors who are in a high tax bracket prefer that firms ______Critical Concept. However, investors in a lower tax bracket prefer dividends. This is called the clientele effect. The ______ Key Term addresses the type of investor that prefers dividends vs capital gains. See Other Factors Influencing Dividend Policy (40.0K) .
3. Dividend Payment Procedures
1. Key Dates. There are three key dates associated with paying dividends. The _____ Key Term is the day the firm decides which shareholders are entitled to a cash dividend. The _____ Key Term is the day on which you must own a company's stock to be entitled to a cash dividend, which is two business days before the holder-of-record date. The ______ Key Term is the day on which actual payment is made to the shareholders.
4. Stock Dividend
1. What is a stock dividend? The ______ Key Term is a distribution of more shares of stock to a company's investors. The usual amount of a stock dividend is 10%. As a result of a stock dividend, shares outstanding go up.
2. What is a stock dividend worth to an investor? Nothing! Shares outstanding go up and earnings per share go down proportionately. A stock dividend may only be of value to an investor if the cash dividend remains the same because ______ Critical Concept.
3. Use of stock dividends. Firms often use stock dividends in place of cash dividends if they are retaining money for growth. This sends positive information to investors. The stock dividend is also used when firms can't pay cash dividends. See Cash and Stock Dividends (51.0K)
5. Stock Splits
1. What is a stock split? A stock split is similar to a stock dividend except more shares are issued. If a firm declares a 2 for 1 split, it will issue each shareholder an additional share for every share they own. However, the stock price will be cut to half the current value.
2. Why do firms declare stock splits? Firms generally declare stock splits to Critical Concept. See Slide Stock Splits (62.0K)
6. Repurchase of Stock
1. When do firms repurchase their own stock? If a firm has excess cash, it may repurchase its own stock leaving fewer shares outstanding and increasing the earnings per share. Stock repurchase may be an alternative to paying cash dividends. The benefits to the shareholder are the same under a cash dividend policy and stock repurchase. Firms also repurchase their stock if the stock price is low. See Slide Repurchase of Stock (60.0K) . The market often sees stock repurchases as a signal of future prosperity.
7. Dividend Reinvestment Plans
1. What is a dividend reinvestment plan? Dividend reinvestment plans allow investors _____ Critical Concept. They actually return cash to the firm since shares are purchased from dividends paid.