33 Real-World Factors Favoring High Dividends ¡ Desire for Current Income ¡ Behavioral Finance l It forces investors to be disciplined. ¡ Tax Arbitrage l Investors can create positions in high dividend yield securities that avoid tax liabilities. Real World Factors Favoring High Dividends
34 Real-World Factors Favoring High Dividends ¡ Agency Costs l High dividends reduce free cash flow. ¡ Information Content of Dividends and Dividend Signaling Real World Factors Favoring High Dividends
35 The Clientele Effect ¡ Clienteles for various dividend payout policies are likely to form in the following way: Group Stock Type High Tax Bracket Individuals Low Tax Bracket Individuals Tax-Free Institutions Corporations Zero-to-Low payout Low-to-Medium payout Medium payout High payout Once the clienteles have been satisfied, a corporation is unlikely to create value by changing its dividend policy. The Clientele Effect
36 What We Know and Do Not Know ¡ Dividends are substantial ¡ Corporations “ smooth ” dividends. ¡ Fewer companies are paying dividends. ¡ Dividends provide information to the market. What We Know and Do Not Know about Dividend Policy
37 What We Know and Do Not Know ¡ Firms should follow a sensible policy: l Do not forgo positive NPV projects just to pay a dividend. l Avoid issuing stock to pay dividends. l Consider share repurchase when there are few better uses for the cash. What We Know and Do Not Know about Dividend Policy
39 Revision Topics and Checkpoints ¡ What are the different types of dividends, and how is a dividend paid? ¡ What is the clientele effect, and how does it affect dividend policy irrelevance? ¡ What is the information content of dividend changes? ¡ What are stock dividends, and how do they differ from cash dividends? ¡ How are share repurchases an alternative to dividends, and why might investors prefer them?
Back to our case…
Source: The Standard, 4 Aug, 2016
Think about it ¡ Why does HK Bank “waste” the cash to buy back shares given the business performance has worsened? ¡ Why share price jumped when HK Bank announced the stock buyback? ¡ If HK Bank has excess cash, why not paying out more dividend instead of stock buyback?
Concept check (CFA practice exercise) ¡ A company has 35 million shares outstanding with a current market price of $49.75 per share. The company has maintained a $1.00 per share quarterly dividend for several years, but for the next quarter, management is considering whether to implement a $35 million share repurchase in place of the regular quarterly dividend. Assuming the tax treatments and information effects of either alternative are the same, the net impact of the share repurchase, compared to the payment of a cash dividend, is to: A. decrease shareholder wealth.
- Fall '15