Chapter

Brealey, Myers, and Allen

Principles of Corporate Finance

11th Global Edition

PAYOUT POLICY

16

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16-1 FACTS ABOUT PAYOUT

• Cash Dividend versus Stock Repurchase• Cash Dividend

• Dividends are rarely cut back, managers do not increase dividends unless confident that dividend can be maintained

• Stock Repurchase

• Repurchases are more flexible and repurchases are tax-advantaged

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FIGURE 16.1 DIVIDEND AND STOCK REPURCHASES

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16-1 FACTS ABOUT PAYOUT

• Dividend Payments• Cash Dividend

• Payment of cash by firm to shareholders

• Ex-Dividend Date

• Date that determines when stockholder is entitled to dividend payment

• Record Date

• Person who owns stock on this date receives dividend

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16-1 FACTS ABOUT PAYOUT

• Dividend Payments• Stock Dividend

• Distribution of additional shares to firm’s stockholders

• Stock Splits

• Issue of additional shares to firm’s stockholders

• Stock Repurchase

• Firm buys back stock from its shareholders

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FIGURE 16.2 EXXON MOBIL'S DIVIDEND

Exxon Mobildeclares quarterly dividend

of $.42 per share

Shares start to

trade ex- dividend

Dividend will be paid

to shareholdersregistered

on this date

Dividend checksmailed

to shareholders

January 5, 2012

February 8, 2012

February 10, 2012

March 9, 2012

Declaration date

Ex-dividend date

Recorddate

Paymentdate

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16-1 FACTS ABOUT PAYOUT• Types of Dividends

• Cash Dividend

• Regular Cash Dividend

• Special Cash Dividend

• Stock Dividend

• Stock Repurchase (4 methods)

• Buy Shares on Market

• Tender Offer to Shareholders

• Dutch Auction

• Private Negotiation (greenmail)

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FIGURE 16.3 DIVIDEND POLICY SURVEY 2004

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16-2 INFORMATION CONTENT OF DIVIDEND AND REPURCHASES

• Payout Decision• Managers are reluctant to make dividend changes that may be reversed

• Managers worry about rescinding dividend increases and raising new funds to maintain payout

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16-2 INFORMATION CONTENT OF DIVIDEND AND REPURCHASES

• Payout Decision• To avoid risk of reduction in payout, managers “smooth” dividends

• Dividend changes follow shifts in long-run sustainable earnings

• Transitory earnings changes unlikely to affect dividend payouts

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16-2 INFORMATION CONTENT OF DIVIDEND AND REPURCHASES

• Payout Decisions • Managers focus on dividend changes over absolute levels

• Paying a dividend of $2.00 per share is important if last year's dividend was $1.50

• Paying a dividend of $2.00 is not important if last year's dividend was $2.00

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16-2 INFORMATION CONTENT OF DIVIDEND AND REPURCHASES

• Information Content of Dividends • Dividend stock repurchase decisions contain information

• Asymmetric information may be conveyed

• Dividend increases could mean overpriced stock or increased future profits

• Signal varies based on prior information about company

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16-2 INFORMATION CONTENT OF DIVIDEND AND REPURCHASES

• Information in Payouts• Varying attitudes toward dividend targets

• DIV1 = target dividend

= target ratio × EPS1

• Dividend change

• DIV1 – DIV0 = target change

= target ratio × EPS1 – DIV0

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16-3 DIVIDENDS OR REPURCHASES? PAYOUT CONTROVERSY

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16-3 DIVIDENDS OR REPURCHASES? PAYOUT CONTROVERSY

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16-3 DIVIDENDS OR REPURCHASES? PAYOUT CONTROVERSY

• Important Repurchases• Calculate Market Capitalization

• Done by forecasting and discounting free cash flow paid to shareholders

• To calculate share price, divide market capitalization by number of outstanding shares

• Calculate Value of Dividends Per Share

• Account for increased dividend growth rate per share

• Caused by declining number of shares as shares are repurchased

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16-3 DIVIDENDS OR REPURCHASES? PAYOUT CONTROVERSY

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FIGURE 16.4 DIVIDEND POLICY

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FIGURE 16.5 DIVIDEND POLICY

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16-4 THE RIGHTISTS

• Dividend Theories• Leftists

• Dividends do not affect value

• Rightists

• Dividends increase value

• Middle of Roaders

• Leftist theory with some reality thrown in

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16-4 THE RIGHTISTS

• Dividends Increase Value • Dividend increases send good news about cash-flow earnings

• Dividend cuts send bad news

• High-dividend payout policy will be costly to firms that do not have cash flow to support it

• Dividend increases signal company’s good fortune

• Increase in manager’s confidence in future cash flow

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16-5 TAXES AND RADICAL LEFT

• Taxes and Dividend Policy • Capital gains taxed at lower rate than dividend income so companies should pay lowest dividend possible

• Dividend policy should adjust to changes in tax code

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TABLE 16.1 TAXES DIVIDEND POLICY

Returns to Shareholders Taxed Twice

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TABLE 16.2 TAXES DIVIDEND POLICY

Australian Tax Credit to Shareholders