361-CH14Concise - 14-1CHAPTER 14Distributions to...

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Unformatted text preview: 14-1CHAPTER 14Distributions to shareholders: Dividends and share repurchasesInvestor preferences on dividendsSignaling effectsResidual modelDividend reinvestment plansStock repurchasesStock dividends and stock splits14-2What is dividend policy?The decision to pay out earnings versus retaining and reinvesting them.Dividend policy issues include:High or low dividend payout?Stable or irregular dividends?How frequently to pay dividends?Announce the dividend policy?14-3Do investors prefer high or low dividend payouts?3 theories of dividend policy:1. Dividend irrelevance: Investors dont care about dividend payout.2. Bird-in-the-hand: Investors prefer a high payout.3. Tax preference: Investors prefer a low payout.14-4Dividend irrelevance theoryInvestors 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 dont want cash, they can use dividends to buy more stock.Proposed by Modigliani and Miller and based on unrealistic assumptions (no taxes or brokerage costs), hence may not be true. Implication: Any DIV payout policy is OK.14-5Bird-in-the-hand theoryInvestors 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 DIV payout would result in a high P.Implication: Set a high DIV payout.14-6Tax Preference TheoryRetained earnings lead to long-term capital gains, which used to be taxed at lower rates than dividends: 20% v. 38.6%. Capital gains taxes are also deferred, and investors can control the timing vs. dividend income which is taxed when received. If an investor holds a stock until his/her death, beneficiaries can use the date of the death as the cost basis and escape all previously accrued capital gains.This could cause investors to prefer firms with low payouts to minimize taxes, i.e., a high (low) payout results in a low (high) P....
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This note was uploaded on 01/23/2012 for the course BUS 361 taught by Professor Staff during the Fall '11 term at University of Michigan.

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361-CH14Concise - 14-1CHAPTER 14Distributions to...

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