Dividend Payout: measures the percentage of earnings that the company pays in dividends Dividends / Earnings
Dividend Yield : measures the return that an investor can make from dividends alone =Dividends / Stock Price
Three Schools Of Thought On
Dividends 1.
If (a) there are no tax disadvantages associated with dividends (b) companies can issue stock, at no cost, to raise equity, whenever needed
Dividends do not matter, and dividend policy does
not affect value. 2. If dividends have a tax disadvantage Dividends are bad, and increasing dividends will reduce value 3. If stockholders like dividends, or dividends operate as a signal of future prospects, Dividends are good, and increasing dividends will increase value
A clientele based explanation
Basis: Investors may form clienteles based upon their tax brackets. Investors in high tax brackets may invest in stocks which do not pay dividends those in low tax brackets may invest in dividend paying stocks.
Evidence: A study of 914 investors' portfolios was carried
out to see if their portfolio positions were affected by their tax brackets. The study found that Older investors were more likely to hold high dividend stocks Poorer investors tended to hold high dividend stocks
Results from Regression: Clientele
Effect
Determinants of Dividend Policy
Investment Opportunities: More investment opportunities - > Lower dividends
Stability in earnings: More stable earnings -> Higher Dividends
Alternative sources of capital:
More alternative sources -> Higher Dividends
Constraints: More constraints imposed by bondholders and lenders -> Lower Dividends
Signaling Incentives: More options to supply information to financial markets - Lower need to pay dividends as signal
and stock splits Not a true dividend: not paid in cash Increases the number of outstanding shares Stock dividend: 20% --20% increase in # shares Stock splits: 3-for-2 split = 50% stock dividend
Popular trading range:
Stocks are usually traded by a unit of 100 shares (round lot) When the price of stock is too high, investors may be short of money to buy the stock lots. => Dividing stocks to smaller units which trade at a lower price.
Minicase Electronic Timing, Inc
Linear Technology div policy
Basic description: Exhibit 1 Dividend policy: exhibit 3 1986: first IPO 1992 starting paying dividends: increasing the div by about 0.01$ per share each year 2002: significant drop in sales: -47% in sales, - 54% in profit 2003: an other increase in dividend to 33.1% of payout ratio.
Historical payout policy
Analyzing Exhibit 3 How does dividend change? How does repurchase change? Has the firm a long-run target payout ratio? (analyzing exhibit 2) Linking with the findings of Lintner, how do you interpret the variation of the payout ratio?
Funding requirement Do you think whether a payout ratio of 33.1% presents any problems for Linear? Analyzing Exhibit 2, what is the trend of change of net income, operating cash flow, relative to sales? How about the pre-capital expenditure cash flow as compared to the capital expenditure? Look at the cash balance in 2003, what do you think the cash position of Linear?
Funding requirements Exhibit TN-1: Both Net income in % sales and cash flow in % of sales remains stable, even if the sales dropped by 47% in 2002 The pre-capital expenditure cash flow ranged from 4-19 times capital expenditures. Large cash balance in 2003: 1.57billion or 16.2% of its market value. => Linear is able to pay a dividend of 33% pre-investment cash flow while still meeting its investment needs.
Should Linear return cash to its
shareholders? Taxes: look at Exhibit 7, what do you infer about the dividend return and capital gain in the presence of corporate and personal taxes?
Should Linear return cash to its
shareholders? Agency: investment opportunity of Linear Read the 4th paragraph in page 3. What do you infer in respect to the business plan of Linear? Has the manager incentive to work for the maximum value of the firm? (compensation plan for the CEO, ref ex.6) What do you infer the cost of carrying cash inside the company?
How should Linear return cash to
its shareholders? Consider the various theories that make the dividend policy relevant. What do you think the pricing behavior for a $ 1 dividend? On the announcement day On the ex-div day? Table
How should Linear return cash to
its shareholders? EPS effects: Back to the MM world, what are the different effects on stock price and the EPS under the following payout policy? (data from Ex-2) Retain all cash Repurchase stock Pay dividend
Table
How should Linear return cash to
its shareholders? Taxes: What is the price behavior on the announcement day and the ex-dividend day?
If dividends result in higher taxes,
why do firms pay dividends? Signaling: Analyze Ex-3, what is the market price responds to the dividend increase? Asquith and Mullins (JoB) find that the reaction of stock price is about 5%. Table
If dividends result in higher taxes,
why do firms pay dividends? Agency: What is the signal conveyed about the agency relation inside the company? With the executive stock options, what do you think the managers incentive in paying dividend? Compute the loss of the CEO if it exercise its stock option after ex-div date (Ex-6)
If dividends result in higher taxes,
why do firms pay dividends? Clientele effect: From a tax rate clientele, who prefers the dividends to capital gain? From a transaction cost clientele, small investors prefer what kind of payout policy? Read the 2nd paragraph in p. 3, which kind of clienteles does Linear try to attract? Read the description of Janus Capital (5-6 paragraph). How does this owner like Linears dividend policy? (Table)
Other determinants?market conditions Dividend policy changes Early 1960s, most listed firms paid a div 1999, fewer than 21% firms paid 2002-03, div initiates again and increased slightly. (ex-9b)
What account for the change over time?
Change in taxes? Ex-7 Changes in the investment opportunity? Ex 9 Changes in the distribution of firms? In response to the scandals at Enron, Worldcom, etc?
What should Paul Coghlan
recommend to the board? A better way? Div/ stock repurchase Ability to return cash? What happened? In the end, Linear increased it dividend by $0.01 per share. The stock price rose by 8.7% on a day.
