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1 CHAPTER 23 BEYOND CASH DIVIDENDS: BUYBACKS, SPIN OFFS AND DIVESTITURES Shares of stock in a firm give their holders equal claims on all of the assets of the firm, after the firm has met its debt obligations. Thus, the value of a share in Boeing or the Home Depot is determined by three variables – the value of the assets in these firms, the value of debt claims against them and the number of shares outstanding. There are several ways in which a firm can change this value per share. Investment decisions can alter the value of the assets by changing the expected cash flows. Changing the financial mix can alter asset value (by changing the cost of capital), the value of debt, and the number of shares outstanding. Dividend decisions affect the value per share by reducing the firm’s assets (with the payment of cash). In this chapter, we consider other ways in which firms can affect their value per share. We begin with stock buybacks; like dividends, stock buybacks reduce the value of a firm’s assets, but unlike dividends, they reduce the number of shares outstanding. While we presented evidence on the magnitude of stock buybacks in the last chapter, we consider the choice between dividends and stock buybacks in this one. When should a firm opt to buy back stock rather than increase dividends, or in the more extreme scenario, replace dividend payments with a stock buyback program? We also look at a variant of stock buybacks, where firms enter into forward contracts to buy stock in future periods. We next consider stock dividends and splits, actions that change the number of shares outstanding without altering the value of the underlying assets. We look at why firms may split their stock or pay stock dividends, and how markets react to these actions. Finally, we consider actions that change the nature of a stockholders’ claims on a firm’s assets. We begin with divestitures, where firms sell some of their assets to another firm or entity; divestitures are often followed either by stock buybacks or special dividends. As an alternative, firms can also spin off or split off assets, and existing stockholders
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2 receive new claims on the spun off assets that they can choose to keep or sell; these spun off units become independent entities and the firm receives no cash from the spin offs. In contrast, in an equity carve out, firms issue stock on portions of the firm to financial markets to raise cash for investments; in this case, the firm usually retains a controlling interest in the carved out entity. We also consider tracking stock, where existing stockholders receive new claims on portions of the firm, but these entities remain part of the firm. We close this chapter by examining how firms choose among these alternative actions, all of which affect their stockholders, albeit in different ways. Alternative Ways of Returning Cash to Stockholders
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