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1、,CHAPTER 14 Distributions to Shareholders: Dividends and Repurchases,Theories of investor preferences Signaling effects Residual model Dividend reinvestment plans Stock dividends and stock splits Stock repurchases,What is “dividend policy”?,Its the decision to pay out earnings versus retaining and r
2、einvesting them. Includes these elements: 1. High or low payout? 2. Stable or irregular dividends? 3. How frequent? 4. Do we announce the policy?,Dividend Payout Ratios for Selected Industries,Industry Payout ratio Banking 38.29 Computer Software Services 13.70 Drug 38.06 Electric Utilities (Eastern
3、 U. S.) 67.09 Internet n/a Semiconductors 24.91 Steel 51.96 Tobacco 55.00 Water utilities 67.35,*None of the internet companies included in the Value Line Investment Survey paid a dividend.,Do investors prefer high or low payouts? There are three theories:,Dividends are irrelevant: Investors dont ca
4、re about payout. Bird-in-the-hand: Investors prefer a high payout. Tax preference: Investors prefer a low payout, hence growth.,Dividend Irrelevance Theory,Investors are indifferent between dividends and retention-generated capital gains. If they want cash, they can sell stock. If they dont want cas
5、h, they can use dividends to buy stock. Modigliani-Miller support irrelevance. Theory is based on unrealistic assumptions (no taxes or brokerage costs), hence may not be true. Need empirical test.,Bird-in-the-Hand Theory,Investors think dividends are less risky than potential future capital gains, h
6、ence they like dividends. If so, investors would value high payout firms more highly, i.e., a high payout would result in a high P0.,Tax Preference Theory,Retained earnings lead to capital gains, which are taxed at lower rates than dividends: 28% maximum vs. up to 39.6%. Capital gains taxes are also
7、 deferred. This could cause investors to prefer firms with low payouts, i.e., a high payout results in a low P0.,Implications of 3 Theories for Managers,Theory,Implication,Irrelevance,Any payout OK,Bird-in-the-hand,Set high payout,Tax preference,Set low payout,But which, if any, is correct?,Which th
8、eory is most correct?,Empirical testing has not been able to determine which theory, if any, is correct. Thus, managers use judgment when setting policy. Analysis is used, but it must be applied with judgment.,Whats the “information content,” or “signaling,” hypothesis?,Managers hate to cut dividend
9、s, so wont raise dividends unless they think raise is sustainable. So, investors view dividend increases as signals of managements view of the future. Therefore, a stock price increase at time of a dividend increase could reflect higher expectations for future EPS, not a desire for dividends.,Whats
10、the “clientele effect”?,Different groups of investors, or clienteles, prefer different dividend policies. Firms past dividend policy determines its current clientele of investors. Clientele effects impede changing dividend policy. Taxes & brokerage costs hurt investors who have to switch companies.,
11、Whats the “residual dividend model”?,Find the retained earnings needed for the capital budget. Pay out any leftover earnings (the residual) as dividends. This policy minimizes flotation and equity signaling costs, hence minimizes the WACC.,Using the Residual Model to Calculate Dividends Paid,Data fo
12、r SSC,Capital budget: $800,000. Given. Target capital structure: 40% debt, 60% equity. Want to maintain. Forecasted net income: $600,000. How much of the $600,000 should we pay out as dividends?,Of the $800,000 capital budget, 0.6($800,000) = $480,000 must be equity to keep at target capital structu
13、re. 0.4($800,000) = $320,000 will be debt. With $600,000 of net income, the residual is $600,000 - $480,000 = $120,000 = dividends paid. Payout ratio = $120,000/$600,000 = 0.20 = 20%.,How would a drop in NI to $400,000 affect the dividend? A rise to $800,000?,NI = $400,000: Need $480,000 of equity,
14、so should retain the whole $400,000. Dividends = 0. NI = $800,000: Dividends = $800,000 - $480,000 = $320,000. Payout = $320,000/$800,000 = 40%.,How would a change in investment opportunities affect dividend under the residual policy?,Fewer good investments would lead to smaller capital budget, henc
15、e to a higher dividend payout. More good investments would lead to a lower dividend payout.,Advantages and Disadvantages of the Residual Dividend Policy,Advantages: Minimizes new stock issues and flotation costs. Disadvantages: Results in variable dividends, sends conflicting signals, increases risk
16、, and doesnt appeal to any specific clientele. Conclusion: Consider residual policy when setting target payout, but dont follow it rigidly.,Setting Dividend Policy,Forecast capital needs over a planning horizon, often 5 years. Set a target capital structure. Estimate annual equity needs. Set target payout based on the residual model. Generally, some dividend growth rate emerges. Maintain target growth rate if possible, varying capital structure
