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1. INTRODUCTION
A dividend is a pro rata distribution to shareholders that is declared by the
companys board of directors and may or may not require approval by
shareholders.
A repurchase of stock is a distribution in the form of the company buying back
its stock from shareholders.
The board of directors determines the companys payout policy.
Cash dividends and share repurchases are both methods of distributing cash
to shareholders.
- The effects on financial ratios and on shareholders investment returns are
different between these two methods.
- These distributions may provide information about the companys future
prospects.
- Issuing companies cannot deduct distributions to shareholders for tax
purposes.
2. DIVIDENDS: FORMS
Cash Distributions
Noncash
Distributions
Regular Cash
Dividend
Stock Dividend
Extra Dividend
Stock Split
Liquidating Dividend
LIQUIDATING DIVIDENDS
A liquidating dividend is a distribution of cash to shareholders when
- Going out of business, or
- Selling a portion of the business, or
- Paying a dividend when retained earnings are not positive.
STOCK DIVIDENDS
A stock dividend is the distribution of additional shares of stock to
shareholders on a pro rata basis.
- Also known as a bonus issue of shares.
Generally stated as a percentage of current shares outstanding.
A stock dividend does not change a shareholders proportionate ownership, the
shareholder does not receive cash, and there are no tax consequences.
Advantages for the issuer:
1. More shares outstanding and, therefore, potential for more shareholders.
2. Lowers the stocks price, which may make it more attractive as an
investment.
3. No economic effect.
4. Does not affect financial ratios.
STOCK SPLITS
A stock split is a proportionate increase in the number of shares outstanding.
Stated in the following form:
Number of new shares : Number of old shares
So, 2:1 means that for each share held before the split, the shareholder holds
two shares after the split.
Stock splits do not affect the dividend yield or the dividend payout ratio.
Accounting: Memorandum entry, no change in accounts.
The announcement is generally viewed as a positive signal.
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Declaration
Date
Ex-Dividend
Date
Holder-ofRecord Date
Payment Date
Corporation
Issues
Dividend
Declaration
Established by
Markets Based on
the Trade
Settlement Cycle
Established by
Corporation as
Date of
Ownership of
Stock
Established by
Corporation as
Date the
Dividend Is
Actually Paid
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4. SHARE REPURCHASES
A share repurchase is the transaction in which the stock issuer buys back its
shares from investors.
- Also known as a share buyback.
Once repurchased, the shares become treasury shares (or treasury stock).
Share repurchases are restricted by regulations in some countries.
Motives for repurchasing shares include the following:
- Signal that the stock is undervalued.
- Flexibility of distributing cash without the expectation of cash dividends.
- Tax efficiency when the tax rate on capital gains is less than that of cash
dividends.
- Offset share increases from executive stock options.
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Fixed Price
Tender Offer
Dutch Auction
Tender Offer
Direct
Negotiation
Use brokers to
buy shares.
Method provides
flexibility for the
company.
Specify the
number of
shares and the
share price.
Buy pro rata if
oversubscribed.
Specify the
number of
shares and the
range of prices.
Shareholders
determine the
number of
shares they will
sell back and
specify the price
within the range.
Negotiate with a
specific
shareholder.
Method may be
used to prevent
activist
shareholder
from getting on
board.
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5. CONCLUDING REMARKS
Share repurchases have a positive effect on share prices.
Dividend initiations have a positive effect on share prices.
Dividend increases have a positive effect on share prices.
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6. SUMMARY
Dividends can take the form of regular or irregular cash payments, stock
dividends, or stock splits.
Regular cash dividends represent a commitment to pay cash to stockholders
on a quarterly, semiannual, or annual basis.
The key dates for cash dividends, stock dividends, and stock splits are the
declaration date, the ex-date, the shareholder-of-record date, and the payment
date.
Share repurchases, or buybacks, most often occur in the open market.
Alternatively, tender offers occur at a fixed price or at a price range through a
Dutch auction.
Share repurchases made with excess cash have the potential to increase
earnings per share, whereas share repurchases made with borrowed funds can
increase, decrease, or not affect earnings per share, depending on the after-tax
borrowing rate.
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SUMMARY (CONTINUED)
A share repurchase is equivalent to the payment of a cash dividend of equal
amount in its effect on shareholders wealth, all other things being equal.
Announcement of a share repurchase is sometimes accompanied by positive
excess returns in the market when the market price is viewed as reflecting
managements view that the stock is undervalued.
Initiation of regular cash dividends can also have a positive impact on share
value.
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