12-Distributions-FIN6406

12-Distributions-FIN6406 - Distributions to Shareholders n...

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Distributions  Distributions 11 Distributions to Shareholders n Investors’ payout preferences n Dividend policy theory n Signaling and clientele effects n Residual dividend model n Stock repurchases n Stock dividends and stock splits
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Distributions  Distributions 22 What is “dividend policy”? It is the decision about what to do with firm’s earnings (net income). How much to distribute versus how much to reinvest in the firm. Distribution methods: l cash dividends l common stock repurchases
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Distributions  Distributions 33 Do investors prefer high or low payouts? There are three theories: n Irrelevance: Investors do not care what payout is set. n Bird-in-the-hand: Investors prefer a high payout. n Tax preference: Investors prefer a low payout in order to get growth and capital gains.
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Distributions  Distributions 44 Dividend Irrelevance Theory n 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. n support irrelevance but their theory is based on unrealistic assumptions (no taxes or brokerage costs), and may not be true.
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Distributions  Distributions 55 Bird-in-the-Hand Theory n Investors think dividends are less risky than potential future capital gains, hence they like dividends . n If so, a high payout would result in a low cost of equity (Rs), hence a high stock price P0.
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Distributions  Distributions 66 Tax Preference Theory n Retained earnings lead to capital gains, which may be taxed at lower rates than dividends. Capital gains taxes are also deferred in time. n This could cause investors to prefer firms with low payouts , i.e. low payout results in a low cost of equity (Rs), hence a high P0.
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 Distributions 77 What are the implications of the three theories for managers? Theory
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12-Distributions-FIN6406 - Distributions to Shareholders n...

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