ch14 - CHAPTER14 Signalingeffects Residualmodel...

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    14-1 CHAPTER 14 Distributions to shareholders:    Dividends and share repurchases Theories of investor preferences Signaling effects Residual model Dividend reinvestment plans Stock dividends and stock splits Stock repurchases
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    14-2 What is dividend policy? The decision to pay out earnings versus  retaining and reinvesting them. Dividend policy includes High or low dividend payout? Stable or irregular dividends? How frequent to pay dividends? Announce the policy?
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    14-3 Do investors prefer high or low  dividend payouts? Three theories of dividend policy: Dividend irrelevance: Investors don’t  care about payout. Bird-in-the-hand: Investors prefer a high  payout. Tax preference: Investors prefer a low  payout.
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    14-4 Dividend irrelevance theory Investors are indifferent between  dividends and retention-generated capital  gains.  Investors can create their own  dividend policy: If they want cash, they can sell stock. If they don’t want cash, they can use  dividends to buy stock. Proposed by Modigliani and Miller and  based on unrealistic assumptions (no  taxes or brokerage costs), hence may not  be true.  Need an empirical test. Implication: any payout is OK.
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    14-5 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 . Implication: set a high payout.
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    14-6 Tax Preference Theory Retained earnings lead to long-term capital  gains, which are taxed at lower rates than  dividends:  20% vs. up to 38.6%.  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 . Implication: Set a low payout.
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    14-7 Possible stock price effects 40 30 20 10 0 50% 100% Payout Stock Price ($) Bird-in-the-Hand Irrelevance Tax preference
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    14-8 Possible cost of equity effects Tax preference Irrelevance Bird-in-the-Hand 30 25 20 15 10 5 0 50% 100% Payout Cost of Equity (%)
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    14-9 Which theory is most correct? Empirical testing has not been able to 
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ch14 - CHAPTER14 Signalingeffects Residualmodel...

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