Chapter 13

Payout Policy
1
Universidad Interamericana de PR
Elia Enid Santana Agrinsoni
F00267334
Profa. Lydia E. Santiago

Cash Dividend - Payment of cash by the firm

to its shareholders.
Ex-Dividend Date - Date that determines
whether a stockholder is entitled to a dividend
payment; anyone holding stock before this
date is entitled to a dividend.
Record Date - Person who owns stock on this
date received the dividend.
2

Stock Dividend - Distribution of additional

shares to a firms stockholders.
Stock Splits - Issue of additional shares to
firms stockholders.
Stock Repurchase - Firm buys back stock
from its shareholders.
3

$ Billions

U.S. Data 1980 - 2006

November 15

November 27

November 29

January 2

The date on which

the firm announces
it intends to pay a
dividend

Shares start to trade

without the dividend
thus the phrase exdividend

Shareholders
registered on this
date will receive the
dividend

The date on which

dividend checks are
mailed to the
shareholders

Record
Date

Payment
Date

Declaration
Date

Ex-dividend
Date

Example - Amoeba Products has 2 million shares

currently outstanding at a price of $15 per share.
The company declares a 50% stock dividend. How
many shares will be outstanding after the dividend
is paid?

Answer
2 mil x .50 = 1 mil + 2 mil = 3 mil shares

Example - cont - After the stock dividend

what is the new price per share and what
is the new value of the firm?
Answer
The value of the firm was 2 mil x $15 per

share, or $30 mil. After the dividend the

value will remain the same.

Price per share = $30 mil / 3 mil sh =

$10 per sh.

Stock Repurchase (4 methods)

1.

Open market repurchase

2.

Tender Offer to Shareholders

3.

Auction (Dutch Auction)

4.

Direct Negotiation (Green Mail)

Example - Cash dividend versus share repurchase

Assets
A. Original balance sheet
Cash
$150,000
Other assets
850,000
Value of Firm 1,000,000

Liabilities & Equity

Debt
0
Equity
1,000,000
Value of Firm 1,000,000

Shares outstanding = 100,000

Price per share = $1,000,000 / 100,000 = $10

10

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Example - Cash dividend versus share repurchase

11

Example - Cash dividend versus share repurchase

Assets
C. After stock repurchase
Cash
Other assets

$50,000
850,000

Value of Firm 900,000

Liabilities & Equity

Debt
Equity

0
900,000

Value of Firm 900,000

Shares outstanding = 90,000

Price per share = $900,000 / 90,000 = $10

12

Senior Executive Dividend Policy Features

(How Dividends are Determined)
1. Managers are reluctant to make dividend
changes that might have to be reversed.
2. Managers smooth dividends and hate
to cut them. Dividends changes follow
shifts in long-run, sustainable levels of
earnings.
3. Managers focus more on dividend
changes than on absolute levels.
13

Dividend Decision Survey (2004)

Executives who agree or strongly agree (%)

14

Factors in the Dividend Decision Process

1. Target payout ratios
2. Repurchase decisions
3. Information content of dividends and

repurchases

15

 Since investors do not need dividends to convert shares

to cash they will not pay higher prices for firms with
higher dividend payouts. In other words, dividend policy
will have no impact on the value of the firm.

16

Example - Assume Rational Demiconductor has no extra

cash, but declares a $1,000 dividend. They also require
$1,000 for current investment needs. Using M&M Theory,
and given the following balance sheet information, show
how the value of the firm is not altered when new shares
are issued to pay for the dividend.

Record Date
Cash 1,000
Asset Value 9,000
Total Value 10,000
New Proj NPV 2,000
# of Shares 1,000
price/share $12

17

Example - Assume Rational Demiconductor has no extra cash,

but declares a $1,000 dividend. They also require $1,000 for
current investment needs. Using M&M Theory, and given the
following balance sheet information, show how the value of the
firm is not altered when new shares are issued
to pay for
the dividend.

Record Date
Cash
1,000
Asset Value 9,000
Total Value 10,000
New Proj NPV 2,000
# of Shares 1,000
price/share $12

Pmt Date
0
9,000
+
9,000
2,000
1,000
$11
18

Example - Assume Rational Demiconductor has no extra cash,

but declares a $1,000 dividend. They also require $1,000 for
current investment needs. Using M&M Theory, and given the
following balance sheet information, show how the value of the
firm is not altered when new shares are issued
to pay for the
dividend.

Record Date
Pmt Date Post Pmt
Cash 1,000 0
1,000 (91 sh @ $11)
Asset Value 9,000 9,000 9,000
Total Value 10,000
+
9,000 10,000
New Proj NPV 2,000
2,000 2,000
# of Shares 1,000
1,000 1,091
price/share $12 $11 $11
NEW SHARES ARE ISSUED

19

Example - continued - Shareholder Value

Record
Stock
Cash
Total Value

12,000
0
12,000

Stock = 1,000 sh @ $12 = 12,000

20

Example - continued - Shareholder Value

Record
Stock
Cash
Total Value

12,000
0
12,000

Pmt
11,000

1,000
12,000

Stock = 1,000sh @ $11 = 11,000

21

Example - continued - Shareholder Value

Record
Pmt Post
Stock 12,000
11,000
12,000
Cash
0
1,000
0
Total Value

12,000

12,000

12,000

Stock = 1,091sh @ $115 = 12,000

Assume stockholders purchase the new issue with the

cash dividend proceeds.

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Market Imperfections
There are natural clients for high-payout
stocks, but it does not follow that any
particular firm can benefit by increasing its
dividends. The high dividend clientele
already have plenty of high dividend stock to
choose from.
These clients increase the price of the stock
through their demand for a dividend paying
stock.
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Dividends as Signals
Dividend increases send good news about
cash flows and earnings. Dividend cuts
send bad news.
Because a high dividend payout policy will
be costly to firms that do not have the cash
flow to support it, dividend increases signal
a companys good fortune and its
managers confidence in future cash flows.
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Next years price

Dividend
Total pretax payoff

Firm A
$112.50
$0
$112.50

Firm B
$102.50
$10.00
$112.50

Todays stock price

$100

$97.78

Capital gain
Pretax rate of return (%)
Tax on dividend @ 40%

$12.50
12.5
100 = 12. 5%
$0

$4.72
14. 72
97. 78 = 15. 05%
.40 x $10 = $4.00

Tax on capital gain @ 20% .20 x $12.50 = $2.50

Total after tax income
(0 + 12.50) - 2.50
(dividend plus capital
= $10.00
gains less taxes)
10
Aftertax rate of return (%)
. 10 = 10%
100 =

.20 x $4.72 = $.94

(10.00 + 4.72)
- (4.00-.94)
= $9.78
9. 78
. 10 = 10%
97. 78 =
25

Tax Consequences
Companies can convert dividends into capital
gains by shifting their dividend policies. If
dividends are taxed more heavily than capital
gains, taxpaying investors should welcome
such a move and value the firm more favorably.
In such a tax environment, the total cash flow
retained by the firm and/or held by
shareholders will be higher than if dividends are
paid.
26

Gitman, Lawrence J. & Zutter Chad J. Principles of Managerial

Finance Brief Edition, 13th edition, Pearson/Prentice
Hall, 559-596.
KALAY, A. (2014). International Payout Policy, Information
Asymmetry, and Agency Costs. Journal Of
Accounting Research, 52(2), 457-472.
doi:10.1111/1475-679X.12046
Benavides, J., Berggrun, L., & Perafan, H. (2016). Dividend payout
policies: Evidence from Latin America. Finance Research
Letters, 17197-210. doi:10.1016/j.frl.2016.03.012
Floyd, E., Li, N., & Skinner, D. J. (2015). Payout policy through the
financial crisis: The growth of repurchases and the resilience
of dividends. Journal Of Financial Economics, 118299-316.
doi:10.1016/j.jfineco.2015.08.002