FINANCE IN A CANADIAN SETTING Sixth Canadian Edition

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FINANCE IN A CANADIAN SETTING Sixth Canadian
Edition

• Lusztig, Cleary, Schwab

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• CHAPTER
• SEVENTEEN
• Dividend Policy

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Learning Objectives

• 1. Discuss when a company should pay out
  dividends and why.
• 2. Explain how dividend policy may create value
  in its own right.
• 3. Define the terms ex-dividend date, date
  recorded, and payment date, and demonstrate how
  they each play a role in share prices.

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Learning Objectives

• 4. Describe stock splits, and compare them to
  stock dividends.
• 5. Understand how a company repurchases its own
  shares, and why and how this affects earnings per
  share (EPS) and the market price per share.

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Introduction

• The chapter looks at
• the conceptual foundations of dividend policy
• how investors should explore alternative dividend
  policies
• the practical aspects that often influence the
  formulation of dividend policy by firms
• relevant institutional setting and the
  alternative forms of dividend payments

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Dividend Policy - Conceptual Considerations

• Four factors that affect a firms decision on
  dividend policy include
• 1. Investors propensity for current income
• not a major concern to the firm when formulating
  dividend policy
• 2. Reinvestment opportunities versus current
  dividends
• important to both the investor and the firm
• firm should retain earnings whenever it can
  achieve yields greater than those of a
  shareholder who reinvests the same funds at the
  same risk level

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Dividend Policy-Conceptual Considerations

• Dividend policy and investors taxes
• difficult to formulate because of the complex tax
  system and the heterogeneity of individual
  investors
• Dividend policy as a financing decision
• the firms total uses of funds for dividends and
  new investments over any time period can not
  exceed its source of funds from earnings and
  external financing

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Dividend Policy in Practice

• Approximate number of firms on the major
  exchanges that pay dividends are
• 50 on TSE
• 75 on NYSE
• Dividend payout ratio the proportion of
  earnings that a firm pays out in dividends
• Dividend yield relates the dividend income
  received by shareholders to the price of the
  common share on a percentage basis

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Dividend Policy in Practice

• When setting dividend policy management tries to
• avoid making changes in their payout ratio that
  may have to be reversed
• strive to maintain an uninterrupted record of
  dividend payments
• have target payout ratios and periodically adjust
  the dividend payout towards the target

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Dividend Policy in Practice
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Dividend Policy in Practice
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Dividend Policy in Practice

• Other factors which may influence a companys
  dividend policy are
• 1. corporate control
• 2. the firms cash position
• 3. restrictions imposed by creditors
• 4. restrictions on foreign transfers
• 5. corporate growth potential

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Payment Procedures

• Dividends are
• payable only when declared by the corporations
  board of directors
• distributed quarterly or semi-annually
• labeled regular, extra, or liquidating
• usually paid in cash
• The corporation sets a date of record and payment
  is made to shareholders appearing on the
  companys books at the date of record.

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Payment Procedures

• To allow for processing delays, the date of
  record precedes the payment date
• Shares are said to trade ex-dividends when a
  purchaser is no longer entitled to the dividend
  just declared
• Ex-dividend date - is the two days prior to the
  date of record

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Payment Procedures

• Dividend Payment Time Line

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Stock Dividends

• Stock dividends
• are occasionally issued by corporations
• are issued on a pro rata basis to their
  shareholders
• do not affect the value of the firm
• do not affect shareholders wealth

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Stock Splits

• Stock splits
• are similar to stock dividends in that, in both
  cases, additional share certificates are issued
  and distributed without cost to current
  shareholders
• are proposed to alter the stock price, moving the
  share into a range investors find more attractive
• do not change the value of the firm

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Repurchase of Shares

• Stock repurchase programs
• are an alternative to issuing dividends
• are often practiced in Canada and U.S.
• take place in the open market or, after filing an
  appropriate notice, a company can offer to buy
  back a proportion of the outstanding shares
• shareholders trade-off cash dividends against
  capital gains

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Summary

• 1. Dividends ought to be paid only if the firm
  has surplus cash that cannot be reinvested to
  yield a positive net present value or,
  equivalently, whenever the firms returns on
  reinvestments fall below the returns that
  shareholders could achieve on their own in the
  marketplace. In practice, most firms have a
  strong commitment to maintain stable or steadily
  increasing dividends, and dividend payments often
  appear to take precedence over other uses of
  funds, including new investments.

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Summary

• 2. Other practical considerations that influence
  dividend policy include the firms cash and
  liquidity position, restrictions to protect
  creditors, and restrictions on foreign transfers.
• 3. Stock dividends are an alternative to cash
  dividends. Stock dividends involve issuance of
  additional share certificates to existing
  shareholders.

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Summary

• 4. A stock split should not affect the wealth
  position of shareholders as it leaves the
  proportional ownership of each shareholder and
  the value of the firm unchanged.
• 5. The purchase by a firm of its own shares may
  be an alternative to paying cash dividends. With
  the number of outstanding shares reduced,
  earnings per share will increase and the market
  price of the remaining shares should appreciate.

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Summary

• 6. Miller and Modigliani developed the
  theoretical framework for analyzing dividend
  policy. The relevance of dividend policy for
  share prices stems from market imperfections such
  as transaction costs, taxes, and limited investor
  information.