17 Distributions to Shareholders

17 Distributions to Shareholders - 17 - 1 Distributions to...

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17 - 1 CHAPTER 17 Distributions to Shareholders: Dividends and Repurchases Theories of investor preferences Signaling effects Residual model Dividend reinvestment plans Stock repurchases Stock dividends and stock splits
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17 - 2 What is “dividend policy”? It’s the decision to pay out earnings versus retaining and reinvesting them. Includes these elements: 1. High or low payout? 2. Stable or irregular dividends? 3. How frequent? 4. Do we announce the policy?
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17 - 3 Do investors prefer high or low payouts? There are three theories: Dividends are irrelevant: Investors don’t care about payout. Bird-in-the-hand: Investors prefer a high payout. Tax preference: Investors prefer a low payout, hence growth.
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17 - 4 Dividend Irrelevance Theory Investors are indifferent between dividends and retention-generated capital gains. If they want cash, they can sell stock. If they don’t want cash, 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.
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17 - 5 Bird-in-the-Hand Theory Investors think dividends are less risky than potential future capital gains, hence they like dividends. If so, investors would value high payout firms more highly, i.e., a high payout would result in a high P 0 .
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17 - 6 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 deferred . This could cause investors to prefer firms with low payouts, i.e., a high payout results in a low P 0 .
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17 - 7 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???
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17 - 8 Possible Stock Price Effects Stock Price ($) Payout 50% 100% 40 30 20 10 Bird-in-Hand Indifference Tax preference 0
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17 - 9 Possible Cost of Equity Effects Cost of equity (%) Payout 50% 100% 15 20 10 Tax Preference Indifference Bird-in-Hand 0
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This note was uploaded on 04/24/2010 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.

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17 Distributions to Shareholders - 17 - 1 Distributions to...

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