Chapter 18 - Dividend policy

Chapter 18 - Dividend policy - Chapter 18 Dividend Policy...

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Date 1 Date 0 Chapter 18 Dividend Policy: Why Does It Matter? 18.1 Different Types of Dividends Dividend - cash distribution of earnings Distribution - sources other than current or accumulated retained earnings Liquidating dividend - distribution from capital Paying cash dividends reduces corporate cash and retained earnings shown in balance sheet – except liquidating dividend (paid-in capital is reduced) Stock dividend - no cash leaves firm; increase in number of shares outstanding; reduce value of each share Stock split - price should fall, strongly resembles a stock dividend except it is usually much larger 18.2 Standard Method of Cash Dividend Payment After declaration it becomes liability to pay dividends Amount is expressed as dollar per share ( dividend per share ), as percentage of market price ( dividend yield) , as percentage of earnings per share ( dividend payout) 1. Declaration date - board of directors declares payments to all holders at date x 2. Date of record - declared dividends are distributable to shareholders of record on a specific date 3. Ex-dividend date - stock of shares becomes ex-dividend on date the seller is entitled to keep the dividend. Date is before record date. Receive dividend if purchased the stock three business days before the date of record. Stock price should fall because market rationally attaches value to a cash dividend 4. Date of payment – dividend checks are mailed to stockholders Stock price should fall on the ex-dividend date → everybody now buying the stock is not entitled to the dividend Price drop is a matter of empirical investigation → Due to personal taxes , stock price should fall by less than dividend 18.3 The Benchmarking Case: An Illustration of the Irrelevance of Dividend Policy Current Policy: Dividends Set Equal to Cash Flow The indifference Proposition Change in dividend policy does not affect the value of a share (zero NPV investment) Assumptions 1. Neither tax nor brokerage fees, no single participants can affect market security price Perfect markets 2. homogeneous expectations 3. Investment policy of the firm is set ahead of time Trade-off between Dividends at Date 0 and Dividends at Date 1 1. How managers can vary dividend policy 2. how individuals can undo firm’s dividend policy No matter what dividend policy the firm established, a shareholder can undo it 1
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Chapter 18 Dividend Policy: Why Does It Matter? Homemade dividends Corporate dividend policy is being undone by a potentially dissatisfied stockholder The same diagonal line also represents choices available to shareholders 1. By varying dividend policy, managers can achieve any payout along diagonal line 2. Either by reinvesting excess dividends at date 0 or by selling off shares of stock at this date, any individual investor can achieve any net cash payout along diagonal line - Because corporations an individual investors can move only along the diagonal line, dividend policy in this model is irrelevant. Dividends and Investment Policy
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This note was uploaded on 11/16/2009 for the course F 3033 taught by Professor Hh during the Spring '09 term at Maastricht.

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Chapter 18 - Dividend policy - Chapter 18 Dividend Policy...

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