1、14-1CHAPTER 14Distributions to Shareholders:Dividends and RepurchasesnTheories of investor preferencesnSignaling effectsnResidual modelnDividend reinvestment plansnStock dividends and stock splitsnStock repurchases14-2What is“dividend policy”?nIts the decision to pay out earnings versus retaining an
2、d reinvesting them.Includes these elements:1.High or low payout?2.Stable or irregular dividends?3.How frequent?4.Do we announce the policy?14-3Dividend Payout Ratios forSelected IndustriesIndustryPayout ratioBanking38.29Computer Software Services13.70Drug38.06Electric Utilities(Eastern U.S.)67.09Int
3、ernet n/aSemiconductors24.91Steel51.96Tobacco55.00Water utilities67.35*None of the internet companies included in the Value Line Investment Survey paid a dividend.14-4Do investors prefer high or low payouts?There are three theories:nDividends are irrelevant:Investors dont care about payout.nBird-in-
4、the-hand:Investors prefer a high payout.nTax preference:Investors prefer a low payout,hence growth.14-5Dividend Irrelevance TheorynInvestors are indifferent between dividends and retention-generated capital gains.If they want cash,they can sell stock.If they dont want cash,they can use dividends to
5、buy stock.nModigliani-Miller support irrelevance.nTheory is based on unrealistic assumptions(no taxes or brokerage costs),hence may not be true.Need empirical test.14-6Bird-in-the-Hand TheorynInvestors think dividends are less risky than potential future capital gains,hence they like dividends.nIf s
6、o,investors would value high payout firms more highly,i.e.,a high payout would result in a high P0.14-7Tax Preference TheorynRetained earnings lead to capital gains,which are taxed at lower rates than dividends:28%maximum vs.up to 39.6%.Capital gains taxes are also deferred.nThis could cause investo
7、rs to prefer firms with low payouts,i.e.,a high payout results in a low P0.14-8Implications of 3 Theories for ManagersTheoryImplicationIrrelevanceAny payout OKBird-in-the-handSet high payoutTax preferenceSet low payoutBut which,if any,is correct?14-9Which theory is most correct?nEmpirical testing ha
8、s not been able to determine which theory,if any,is correct.nThus,managers use judgment when setting policy.nAnalysis is used,but it must be applied with judgment.14-10Whats the“information content,”or“signaling,”hypothesis?nManagers hate to cut dividends,so wont raise dividends unless they think ra
9、ise is sustainable.So,investors view dividend increases as signals of managements view of the future.nTherefore,a stock price increase at time of a dividend increase could reflect higher expectations for future EPS,not a desire for dividends.14-11Whats the“clientele effect”?nDifferent groups of inve
10、stors,or clienteles,prefer different dividend policies.nFirms past dividend policy determines its current clientele of investors.nClientele effects impede changing dividend policy.Taxes&brokerage costs hurt investors who have to switch companies.14-12Whats the“residual dividend model”?nFind the reta
11、ined earnings needed for the capital budget.nPay out any leftover earnings(the residual)as dividends.nThis policy minimizes flotation and equity signaling costs,hence minimizes the WACC.14-13Using the Residual Model to Calculate Dividends PaidDividends=.NetincomeTargetequityratioTotalcapitalbudget)(
12、14-14Data for SSCnCapital budget:$800,000.Given.nTarget capital structure:40%debt,60%equity.Want to maintain.nForecasted net income:$600,000.nHow much of the$600,000 should we pay out as dividends?14-15Of the$800,000 capital budget,0.6($800,000)=$480,000 must be equity to keep at target capital stru
13、cture.0.4($800,000)=$320,000 will be debt.With$600,000 of net income,the residual is$600,000-$480,000=$120,000=dividends paid.Payout ratio=$120,000/$600,000 =0.20=20%.14-16How would a drop in NI to$400,000 affect the dividend?A rise to$800,000?nNI=$400,000:Need$480,000 of equity,so should retain the
14、 whole$400,000.Dividends=0.nNI=$800,000:Dividends=$800,000-$480,000=$320,000.Payout=$320,000/$800,000=40%.14-17How would a change in investment opportunities affect dividend under the residual policy?nFewer good investments would lead to smaller capital budget,hence to a higher dividend payout.nMore
15、 good investments would lead to a lower dividend payout.14-18Advantages and Disadvantages of the Residual Dividend PolicynAdvantages:Minimizes new stock issues and flotation costs.nDisadvantages:Results in variable dividends,sends conflicting signals,increases risk,and doesnt appeal to any specific
16、clientele.nConclusion:Consider residual policy when setting target payout,but dont follow it rigidly.14-19Setting Dividend PolicynForecast capital needs over a planning horizon,often 5 years.nSet a target capital structure.nEstimate annual equity needs.nSet target payout based on the residual model.
17、nGenerally,some dividend growth rate emerges.Maintain target growth rate if possible,varying capital structure somewhat if necessary.14-20Stock RepurchasesReasons for repurchases:n As an alternative to distributing cash as dividends.n To dispose of one-time cash from an asset sale.n To make a large
18、capital structure change.Repurchases:Buying own stock back from stockholders.14-21Advantages of RepurchasesnStockholders can tender or not.nHelps avoid setting a high dividend that cannot be maintained.nRepurchased stock can be used in takeovers or resold to raise cash as needed.nIncome received is
19、capital gains rather than higher-taxed dividends.nStockholders may take as a positive signal-management thinks stock is undervalued.14-22Disadvantages of Repurchasesn May be viewed as a negative signal(firm has poor investment opportunities).n IRS could impose penalties if repurchases were primarily
20、 to avoid taxes on dividends.n Selling stockholders may not be well informed,hence be treated unfairly.n Firm may have to bid up price to complete purchase,thus paying too much for its own stock.14-23Whats a“dividend reinvestmentplan(DRIP)”?nShareholders can automatically reinvest their dividends in
21、 shares of the companys common stock.Get more stock than cash.nThere are two types of plans:lOpen marketlNew stock14-24Open Market Purchase PlannDollars to be reinvested are turned over to trustee,who buys shares on the open market.nBrokerage costs are reduced by volume purchases.nConvenient,easy wa
22、y to invest,thus useful for investors.14-25New Stock PlannFirm issues new stock to DRIP enrollees,keeps money and uses it to buy assets.nNo fees are charged,plus sells stock at discount of 5%from market price,which is about equal to flotation costs of underwritten stock offering.14-26Optional invest
23、ments sometimes possible,up to$150,000 or so.Firms that need new equity capital use new stock plans.Firms with no need for new equity capital use open market purchase plans.Most NYSE listed companies have a DRIP.Useful for investors.14-27Stock Dividends vs.Stock SplitsnStock dividend:Firm issues new
24、 shares in lieu of paying a cash dividend.If 10%,get 10 shares for each 100 shares owned.nStock split:Firm increases the number of shares outstanding,say 2:1.Sends shareholders more shares.14-28Both stock dividends and stock splits increase the number of shares outstanding,so“the pie is divided into
25、 smaller pieces.”Unless the stock dividend or split conveys information,or is accompanied by another event like higher dividends,the stock price falls so as to keep each investors wealth unchanged.But splits/stock dividends may get us to an“optimal price range.”14-29When should a firm consider splitting its stock?nTheres a widespread belief that the optimal price range for stocks is$20 to$80.nStock splits can be used to keep the price in the optimal range.nStock splits generally occur when management is confident,so are interpreted as positive signals.
