somehow worth more than that same 1 in a bank account held by the corporation o

Somehow worth more than that same 1 in a bank account

This preview shows page 3 - 6 out of 7 pages.

somehow worth more than that same $1 in a bank account held by the corporation o This argument is very flawed because a shareholder can create a bird in hand by selling some stock o Tax and legal benefits from high dividends Corporate investors A significant tax break on dividends occurs when a corporation owns stock in another corporation o Granted at least 70 percent dividend exclusion This does not apply to capital gains, and so this group of investors is not favorably taxed on capital gains High dividend, low capital gain stocks may therefore be more appropriate for corporations to hold o Also leads some corporations to hold high-yielding stocks instead of long-term bonds because there is no similar tax exclusion of interest payments to corporate bondholders
Image of page 3
Tax-exempt investors This group includes some of the largest investors in the economy, such as pension funds, endowment funds, and trust funds o These funds are set up for the benefit of others; the managers have fiduciary responsibility to invest the money prudently o Also, institutions such as university endowment funds and trust funds are frequently prohibited from spending any of the principal Might prefer to hold high-dividend yield stocks so they have some ability to spend Information content of dividends o It is found with some consistency that stock prices rise when the current dividend is unexpectedly increased, and they generally fall when the dividend is unexpectedly decreased o A dividend cut is often a signal that the firm is in trouble Usually not voluntary; signals that management does not think that the current dividend policy can be maintained o Management will raise the dividend only when future earnings, general cash flow, and general prospects are expected to rise to such an extent that the dividend will not have to be cut back later o These reactions can be attributed to changes in the expected amount of future dividends, not necessarily change in dividend payout policy Information content effect : the market’s reaction to a change in corporate dividend payout The dividend changes convey information about the firm to the market, making it difficult to interpret the effect of the dividend policy of the firm The clientele effect o The observable fact that stocks attract particular groups based on dividend yield and the resulting tax effects Left with a simple supply and demand market (dividend market) for desired dividend payouts by different companies If this market is in equilibrium, where all clientele are satisfied, firms will theoretically leave their dividend payout policies unchanged Establishing a dividend policy o Residual dividend approach Assume firms will wish to minimize the need to sell new equity and maintain its current capital structure If a firm wishes to avoid new equity sales, it will need to rely on internally generated equity to finance new positive NPV projects Dividends will then only be paid out with what is left over, which is called the residual
Image of page 4
A policy under which the firm’s objective is to meet its investment needs and maintain its desired debt-equity ratio before paying dividends
Image of page 5
Image of page 6

You've reached the end of your free preview.

Want to read all 7 pages?

  • Fall '07
  • CURTIS,R.
  • Dividend, dividend Avoid dividend

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture