Chapter 15-Dividend Policy and Internal Financing

1
Dividend Policy and Internal Financing
Chapter 17
.
2

• Learning Objectives
• Describe the tradeoff between paying dividends
  and retaining the profits within the company.
• Explain the relationship between a corporations
  dividend policy and the market price of its
  common stock.
• Describe practical considerations that may be
  important to the firms dividend policy.
• Distinguish between the types of dividend policy
  corporations frequently use.
• Specify the procedures a company follows in
  administering the dividend payment.
• Describe why and how firm might choose to pay
  non-cash dividends (stock dividends and stock
  splits) instead of cash dividends.
• Explain the purpose and procedures related to
  stock repurchases.

3
Dividend Policy and Internal Financing
Dividend Policy
Dividend per Share Earnings per Share
Dividend Payout Ratio
4
Dividend Policy and Internal Financing
Dividend Policy
Dividend per Share Earnings per Share
Dividend Payout Ratio

• A firm calculates and reports Earnings per Share

5
Dividend Policy and Internal Financing
Dividend Policy
Dividend per Share Earnings per Share
Dividend Payout Ratio

• A firm calculates and reports earn Earnings per
  Share
• Management will reinvest part of earnings per
  share in the company and pay part as dividend

6
Dividend Policy and Internal Financing
Dividend Policy
Dividend per Share Earnings per Share
Dividend Payout Ratio

• A firm calculates and reports earn Earnings per
  Share
• Management will reinvest part of earnings per
  share in the company and pay part as dividend

Income Statement
Sales 3,000,000 Net Income 1,000,000 Dividends
Paid Addition to RE
1 Million Shares Outstanding
7
Dividend Policy and Internal Financing
Dividend Policy
Dividend per Share Earnings per Share
Dividend Payout Ratio

• Stockholders earn Earnings per Share
• Management will reinvest part of earnings per
  share in the company and pay part as dividend

Income Statement
Sales 3,000,000 Net Income 1,000,000 Dividends
Paid Addition to RE
1 Million Shares Outstanding
EPS 1.00
8
Dividend Policy and Internal Financing
Dividend Policy
Dividend per Share Earnings per Share
Dividend Payout Ratio

• Stockholders earn Earnings per Share
• Management will reinvest part of earnings per
  share in the company and pay part as dividend

Income Statement
If have a 50 dividend payout each share of stock
will receive a 50 dividend
Sales 3,000,000 Net Income 1,000,000 Dividends
Paid Addition to RE
1 Million Shares Outstanding
9
Dividend Policy and Internal Financing
Dividend Policy
Dividend per Share Earnings per Share
Dividend Payout Ratio

• Stockholders earn Earnings per Share
• Management will reinvest part of earnings per
  share in the company and pay part as dividend

Income Statement
If have a 50 dividend payout each share of stock
will receive a 50 dividend
Sales 3,000,000 Net Income 1,000,000 Dividends
Paid 500,000 Addition to RE 500,000
500,000 paid to stockholders and 500,000 is
reinvested in the firm
1 Million Shares Outstanding
10
Dividend Policy and Internal Financing
Dividend Policy
Dividend per Share Earnings per Share
Dividend Payout Ratio

• Stockholders earn Earnings per Share
• Management will reinvest part of earnings per
  share in the company and pay part as dividend

Income Statement
If it has a 0 dividend payout, all earnings are
reinvested in the firm
Sales 3,000,000 Net Income 1,000,000 Dividends
Paid Addition to RE
1 Million Shares Outstanding
11
Dividend Policy and Internal Financing
Dividend Policy
Dividend per Share Earnings per Share
Dividend Payout Ratio

• Stockholders earn Earnings per Share
• Management will reinvest part of earnings per
  share in the company and pay part as dividend

Income Statement
If have a 0 dividend payout, all earnings are
reinvested in the firm
Sales 3,000,000 Net Income 1,000,000 Dividends
Paid 0 Addition to
RE 1,000,000
0 paid to stockholders and 1,000,000 is
reinvested in the firm
1 Million Shares Outstanding
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Can Dividend Policy Affect Share Price

• Three Theories of Dividends
• Irrelevance
• Dividends Increase Stock Price
• Dividends Decrease Stock Price

13
Can Dividend Policy Affect Share Price
View 1 Irrelevance Dividend Policy does not
affect stock price

• Assumes Perfect Markets
• No brokerage fees
• No floatation costs of issuing shares
• No taxes
• Equal access to information
• Manager's act in shareholders' best interests

14
Can Dividend Policy Affect Share Price
View 1 Irrelevance Dividend Policy does not
affect stock price

• Assumes Perfect Markets
• No brokerage fees
• No floatation costs of issuing shares
• No taxes
• Equal access to information
• Manager's act in shareholders' best interests

52 Weeks Yld Vol Net Hi Lo Stock Sym Di
v PE 100s Hi Lo Close Chg s 42½ 29 MKPS MK 1.75
5.1 24 5067 35 33 34¼ -1
When dividend of 1.75 is paid. the stock price
falls by exactly the same amount.
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Can Dividend Policy Affect Share Price
View 1 Irrelevance Dividend Policy does not
affect stock price

• Assumes Perfect Markets
• No brokerage fees
• No floatation costs of issuing shares
• No taxes
• Equal access to information
• Manager's act in shareholders' best interests

52 Weeks Yld Vol Net Hi Lo Stock Sym Di
v PE 100s Hi Lo Close Chg s 42½ 29 MKPS MK 1.75
5.1 24 5067 35 33 34¼ -1
When dividend of 1.75 is paid. the stock price
falls by exactly the same amount.
34.25 1.75 32.50
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Can Dividend Policy Affect Share Price
View 1 Irrelevance Dividend Policy does not
affect stock price

• Assumes Perfect Markets
• No brokerage fees
• No floatation costs of issuing shares
• No taxes
• Equal access to information
• Manager's act in shareholders' best interests

Dividends are Irrelevant Since

• No net gain to investor

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Can Dividend Policy Affect Share Price
View 1 Irrelevance Dividend Policy does not
affect stock price

• Assumes Perfect Markets
• No brokerage fees
• No floatation costs of issuing shares
• No taxes
• Equal access to information
• Manager's act in shareholders' best interests

Dividends are Irrelevant Since

• No net gain to investor
• Without receiving dividend, an investor can sell
  shares of stock costlessly and create their own
  "dividend"

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Can Dividend Policy Affect Share Price
View 1 Irrelevance Dividend Policy does not
affect stock price

• Assumes Perfect Markets
• No brokerage fees
• No floatation costs of issuing shares
• No taxes
• Equal access to information
• Manager's act in shareholders' best interests

Dividends are Irrelevant Since

• No net gain to investor
• Without receiving dividend, an investor can sell
  shares of stock costlessly and create their own
  "dividend"
• If the firm pays a large dividend, but needs cash
  to invest can sell additional shares of stock
  costlessly.

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Can Dividend Policy Affect Share Price
View 2 High Dividends Increase Stock Value

• Theory states
• Dividends are more predicable that capital gains,
  so investors prefer dividends--"Bird in the Hand
  theory

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Can Dividend Policy Affect Share Price
View 2 High Dividends Increase Stock Value

• Theory states
• Dividends are more predicable that capital gains,
  so investors prefer dividends--"Bird in the Hand
  theory"
• To be indifferent, investors will require a
  higher rate on capital gains than dividends

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Can Dividend Policy Affect Share Price
View 2 High Dividends Increase Stock Value

• Theory states
• Dividends are more predicable that capital gains,
  so investors prefer dividends-- "Bird in the Hand
  theory
• To be indifferent, investors will require a
  higher rate on capital gains than dividends
• Critics of this theory
• Point out cash flows of overall firm are not
  affected by dividends
• If investors want cash, they should leave money
  in a bank account

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Can Dividend Policy Affect Share Price
View 2 High Dividends Increase Stock Value

• Theory states
• Dividends are more predicable that capital gains,
  so investors prefer dividends--"Bird in the Hand
  theory
• Investors will require a higher rate on capital
  gains than dividends
• Critics of this theory
• Point out cash flows of overall firm are not
  affected by dividends
• If investors want cash, they should leave money
  in a bank account
• Many investment advisors believe this theory
  most finance professors do not

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Can Dividend Policy Affect Share Price
View 3 Low Dividends Increase Stock Value

• Based on Tax Effects
• Individual investors must pay taxes on dividends
  as the dividends are received

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Can Dividend Policy Affect Share Price
View 3 Low Dividends Increase Stock Value

• Based on Tax Effects
• Individual investors must pay taxes on dividends
  as the dividends are received
• Individual investors can defer taxes on capital
  gains until they sell the stock

Before 1987, Capital Gains were taxed at a lower
rate than dividends. Again today, capital gain
taxes are lower than current income taxes
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Can Dividend Policy Affect Share Price
View 3 Low Dividends Increase Stock Value

• Based on Tax Effects
• Individual investors must pay taxes on dividends
  as the dividends are received
• Individual investors can defer taxes on capital
  gains until they sell the stock

Before 1987, Capital Gains were taxed at a lower
rate than dividends

• However, corporations may exclude 70 of
  dividends from corporate income taxes, so they
  may actually prefer a higher level of dividends

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Can Dividend Policy Affect Share Price
View 3 Low Dividends Increase Stock Value

• Based on Tax Effects
• Individual investors must pay taxes on dividends
  as the dividends are received
• Individual investors can defer taxes on capital
  gains until they sell the stock

Before 1987, Capital Gains were taxed at a lower
rate than dividends

• However, corporations may exclude 70 of
  dividends from corporate income taxes, so they
  may actually prefer a higher level of dividends
• Investors prefer the dividend policy that gives
  the highest after-tax return

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Residual Dividend Theory
Recognizes that floatation costs involved in
issuing new stock are very high
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Residual Dividend Theory
Recognizes that floatation costs involved in
issuing new stock are very high
Companies with investment opportunities which
require capital would prefer to use internal
funds rather than issue new stock
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Residual Dividend Theory
Recognizes that floatation costs involved in
issuing new stock are very high
Companies with investment opportunities which
require capital would prefer to use internal
funds rather than issue new stock

• Residual Dividend Method
• Accept all investments with positive net present
  values

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Residual Dividend Theory
Recognizes that floatation costs involved in
issuing new stock are very high
Companies with investment opportunities which
require capital would prefer to use internal
funds rather than issue new stock

• Residual Dividend Method
• Accept all investments with positive net present
  values
• Use retained earnings to finance investments to
  the extent possible

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Residual Dividend Theory
Recognizes that floatation costs involved in
issuing new stock are very high
Companies with investment opportunities which
require capital would prefer to use internal
funds rather than issue new stock

• Residual Dividend Method
• Accept all investments with positive net present
  values
• Use retained earnings to finance investments to
  the extent possible
• If earnings left over after making investments,
  pay a dividend with the residual

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Residual Dividend Theory
Recognizes that floatation costs are involved in
issuing new stock are very high
Companies with investment opportunities which
require capital would prefer to use internal
funds rather than issue new stock

• Residual Dividend Method
• Accept all investments with positive net present
  values
• Use retained earnings to finance investments when
  possible
• If retained earnings left over after making
  investments, pay a dividend with the residual
• If there are no residual funds, pay no dividend

33
Residual Dividend Theory
Recognizes that floatation costs when issuing new
stock are very high
Companies with investment opportunities which
require capital would prefer to use internal
funds rather than issue new stock

• Residual Dividend Method
• Accept all investments with positive net present
  values
• Use retained earnings to finance investments when
  possible
• If retained earnings left over after making
  investments, pay a dividend with the residual
• If there are no residual funds, pay no dividend

Residual Theory minimizes floatation costs
34
The Clientele Effect
Relaxes the assumption of no brokerage fees in
reality, investors must pay brokerage fees every
time they buy or sell stock
35
The Clientele Effect
Relaxes the assumption of no brokerage fees in
reality, investors must pay brokerage fees every
time they buy or sell stock
Recognizes that investors are not all alike
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The Clientele Effect
Relaxes the assumption of no brokerage fees in
reality, investors must pay brokerage fees every
time they buy or sell stock
Recognizes that investors are not all alike

• The Clientele Effect
• Some investors need regular cash from stock to
  avoid brokerage fees should purchase and hold
  high dividend paying stocks

37
The Clientele Effect
Relaxes the assumption of no brokerage fees in
reality, investors must pay brokerage fees every
time they buy or sell stock
Recognizes that investors are not all alike

• The Clientele Effect
• Some investors need regular cash from stock to
  avoid brokerage fees should purchase and hold
  high dividend paying stocks
• Other investors prefer no cash from stocks to
  defer taxes and brokerage fees on reinvested cash
  (dividends), these investors should buy low or no
  dividend paying stocks

38
The Clientele Effect
Recognizes that investors are not all alike

• The Clientele Effect
• Some investors need regular cash from stock to
  avoid brokerage fees should purchase and hold
  high dividend paying stocks
• Other investors prefer no cash from stocks to
  defer taxes and brokerage fees on reinvested cash
  (dividends), these investors should buy low or no
  dividend paying stocks
• There is no correct dividend policy. Firms should
  have a stated dividend policy to keep clientele
  of investors

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The Information Effect
Changes in dividends may provide a signal of
firm's financial condition
Dividend Increase - May signal managers expect
higher earnings in the future
40
The Information Effect
Changes in dividends may provide a signal of
firm's financial condition
Dividend Decrease - May signal managers expect
earnings downturn
41
The Information Effect
Changes in dividends may provide a signal of
firm's financial condition
Dividend Decrease - May signal managers expect
earnings downturn
In practice, stock price usually rises with a
unexpected dividend increase and falls with a
dividend decrease
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Drop Agency Costs
43
Agency Costs
Relaxes the assumption that managers always act
in stockholders' best interests
44
Agency Costs
Relaxes the assumption that managers always act
in stockholders' best interests
Agency Costs are costs of the conflict between
managers and stockholders
45
Agency Costs
Relaxes the assumption that managers always act
in stockholders' best interests
Agency Costs are costs of the conflict between
managers and stockholders
One cost that stockholders would like to avoid
would be reduced stock price
46
Agency Costs
Relaxes the assumption that managers always act
in stockholders' best interests
Agency Costs are costs of the conflict between
managers and stockholders
One cost that stockholders would like to avoid
would be reduced stock price

• Dividends may be used as a tool to reduce agency
  costs
• Dividends force cash out of the firm

47
Agency Costs
Relaxes the assumption that managers always act
in stockholders' best interests
Agency Costs are costs of the conflict between
managers and stockholders
One cost that stockholders would like to avoid
would be reduced stock price

• Dividends may be used as a tool to reduce agency
  costs
• Dividends force cash out of the firm
• To raise new funds for investment, managers must
  disclose information about the uses of the funds

48
Agency Costs
Relaxes the assumption that managers always act
in stockholders' best interests
Agency Costs are costs of the conflict between
managers and stockholders
One cost that stockholders would like to avoid
would be reduced stock price

• Dividends may be used as a tool to reduce agency
  costs
• Dividends force cash out of the firm
• To raise new funds for investment, managers must
  disclose information about the uses of the funds
• Dividends result in monitoring of manager's
  actions

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Expectations Theory
Investors have expectations of managers' actions
50
Expectations Theory
Investors have expectations of managers' actions
If managers announce a dividend at the level that
investors expect, stock price will not be affected
51
Expectations Theory
Investors have expectations of managers' actions
If managers announce a dividend at the level that
investors expect, stock price will not be affected
2.25/share
Manager
Investor
52
Expectations Theory
Investors have expectations of managers' actions
If managers announce a dividend at the level that
investors expect, stock price will not be affected
2.25/share
Manager
Investor
53
Expectations Theory
Investors have expectations of managers' actions
If managers announce unexpectedly high or low
dividend, stock price will be affected
54
Expectations Theory
Investors have expectations of managers' actions
If managers announce unexpectedly high or low
dividend, stock price will be affected
2.25/share
Manager
Investor
55
Expectations Theory
Investors have expectations of managers' actions
If managers announce unexpectedly high or low
dividend, stock price will be affected
2.25/share
Manager
Investor
56
Expectations Theory
Investors have expectations of managers' actions
If managers announce unexpectedly high or low
dividend, stock price will be affected
2.25/share
If dividend is lower than expected, investors may
believe earnings will be lower than expected and
stock price will go down
Manager
Investor
57
Expectations Theory
Investors have expectations of managers' actions
If managers announce unexpectedly high or low
dividend, stock price will be affected
2.25/share
Manager
Investor
58
Expectations Theory
Investors have expectations of managers' actions
If managers announce unexpectedly high or low
dividend, stock price will be affected
2.25/share
Manager
Investor
59
Expectations Theory
Investors have expectations of managers' actions
If managers announce unexpectedly high or low
dividend, stock price will be affected
2.25/share
If dividend is higher than expected, investors
may believe earnings will be higher than expected
and stock price will go up
Manager
Investor
60
Summary of Dividend Theories

• Tests of dividend policy have not found
  conclusively that dividends affect stock price
• The majority of managers believe that dividend
  policy is important
• There are tax disadvantages to paying dividends
• Almost all companies pay regular dividends
• Dividend Policy is a "puzzle" to academic
  researchers

61
Dividends in Practice
What determines dividends?

• There may be legal restrictions on dividends
• State laws have restrictions on dividends if
  company is not financially sound
• Bond and Preferred Stock contracts may restrict
  dividends
• Liquidity Position
• The firm must have sufficient cash to pay the
  dividend
• Sources of Financing
• Small firms may not be able to easily raise money
  in the capital markets so they will have low
  dividends
• Earnings Predictability
• Firms with stable earnings typically pays higher
  dividends as it expects to have future profits
  needed to pay dividend

62
Alternative Dividend Policies
Constant Dividend Payout Ratio every year firm
pays the same percentage of earnings as a
dividend to shareholders
63
Alternative Dividend Policies
Constant Dividend Payout Ratio every year firm
pays the same percentage of earnings as a
dividend to shareholders
Example Firm pays a constant 40 dividend
annually
64
Alternative Dividend Policies
Constant Dividend Payout Ratio every year firm
pays the same percentage of earnings as a
dividend to shareholders
Example Firm pays a constant 40 dividend
annually
1994 1995 1996 EPS 2.00 5.00 3.00 Dividend
65
Alternative Dividend Policies
Constant Dividend Payout Ratio every year firm
pays the same percentage of earnings as a
dividend to shareholders
Example Firm pays a constant 40 dividend
annually
1994 1995 1996 EPS 2.00 5.00 3.00 Dividend 0.
80
2.00 x .40
66
Alternative Dividend Policies
Constant Dividend Payout Ratio every year firm
pays the same percentage of earnings as a
dividend to shareholders
Example Firm pays a constant 40 dividend
annually
1994 1995 1996 EPS 2.00 5.00 3.00 Dividend 0.
80 2.00
5.00 x .40
67
Alternative Dividend Policies
Constant Dividend Payout Ratio every year firm
pays the same percentage of earnings as a
dividend to shareholders
Example Firm pays a constant 40 dividend
annually
1994 1995 1996 EPS 2.00 5.00 3.00 Dividend 0.
80 2.00 1.20
3.00 x .40
68
Alternative Dividend Policies
Constant Dividend Payout Ratio every year firm
pays the same percentage of earnings as a
dividend to shareholders
Example Firm pays a constant 40 dividend
annually
1994 1995 1996 EPS 2.00 5.00 3.00 Dividend 0.
80 2.00 1.20
Dollar dividend fluctuates every year
69
Alternative Dividend Policies
Stable Dollar Dividend Dividend does not change
quickly small increases in dollar dividend when
management is certain higher dividend can be
maintained.
70
Alternative Dividend Policies
Stable Dollar Dividend Dividend does not change
quickly small increases in dollar dividend when
management is certain higher dividend can be
maintained.
Example
1991 1992 1993 1994 1995 1996 EPS 2.00 2.20 2.
10 3.00 2.90 3.10 Dividend
71
Alternative Dividend Policies
Stable Dollar Dividend Dividend does not change
quickly small increases in dollar dividend when
management is certain higher dividend can be
maintained.
Example
1991 1992 1993 1994 1995 1996 EPS 2.00 2.20 2.
10 3.00 2.90 3.10 Dividend 0.80 0.80 0.80 0
.80 0.80 1.20
72
Alternative Dividend Policies
Stable Dollar Dividend Dividend does not change
quickly small increases in dollar dividend when
management is certain higher dividend can be
maintained.
Example
1991 1992 1993 1994 1995 1996 EPS 2.00 2.20 2.
10 3.00 2.90 3.10 Dividend 0.80 0.80 0.80 0
.80 0.80 1.20
Increase dividend in 1996 when EPS levels out
around 3.00
73
Alternative Dividend Policies
Summary

• Constant Dividend Payout
• Stable Dollar Dividend
• Small regular dividend plus year-end extra
  payment
• Regular dividend is small, if earnings permit pay
  an extra dividend at end of year

74
Alternative Dividend Policies
Summary

• Constant Dividend Payout
• Stable Dollar Dividend
• Small regular dividend plus year-end extra
  payment
• Regular dividend is small, if earnings permit pay
  an extra dividend at end of year
• Most popular method is the Stable Dollar Dividend

75
Dividend Payment Procedures
Dividends are usually paid quarterly
76
Dividend Payment Procedures
Dividends are usually paid quarterly

• Example
• On August 25, 1995 Southside Bankshares
  announced a quarterly dividend of 1 per share to
  be paid to share holders on record September 9,
  1995, payable September 15, 1995

77
Dividend Payment Procedures
Dividends are usually paid quarterly

• Example
• On August 25, 1995 Southside Bankshares
  announced a quarterly dividend of 1 per share to
  be paid to share holders on record September 9,
  1995, payable September 15, 1995

25 31 1 5 9 15
August
September
Declaration Date
Date that dividend is announced
78
Dividend Payment Procedures
Dividends are usually paid quarterly

• Example
• On August 25, 1995 Southside Bankshares
  announced a quarterly dividend of 1 per share to
  be paid to share holders on record September 9,
  1995, payable September 15, 1995

25 31 1 5 9 15
August
September
Date of Record
Declaration Date
All owners of record will receive the dividend.
79
Dividend Payment Procedures
Dividends are usually paid quarterly

• Example
• On August 25, 1995 Southside Bankshares
  announced a quarterly dividend of 1 per share to
  be paid to share holders on record September 9,
  1995, payable September 15, 1995

25 31 1 5 9 15
August
September
- 4 days
Declaration Date
Date of Record
80
Dividend Payment Procedures
Dividends are usually paid quarterly

• Example
• On August 25, 1995 Southside Bankshares
  announced a quarterly dividend of 1 per share to
  be paid to share holders on record September 9,
  1995, payable September 15, 1995

25 31 1 5 9 15
August
September
Date of Record
Declaration Date
Ex-Dividend Date
To allow time for the official list of
stockholders to be updated, stockholders must buy
stock before the ex-dividend date (4 days prior
to date of record)
81
Dividend Payment Procedures
Dividends are usually paid quarterly

• Example
• On August 25, 1995 Southside Bankshares
  announced a quarterly dividend of 1 per share to
  be paid to share holders on record September 9,
  1995, payable September 15, 1995

25 31 1 5 9 15
August
September
Payable Date
Date of Record
Declaration Date
Ex-Dividend Date
Date that the dividend is paid out to the
stockholders.
82
Stock Dividends and Splits

• Stock Dividends
• Company issues new shares and sends them on a pro
  rata basis to current shareholders instead of
  using cash to pay a dividend

83
Stock Dividends and Splits

• Company issues new shares and sends them on a pro
  rata basis to current shareholders instead of
  using cash to pay a dividend
• Number of shares increase, no money is collected
  or paid by the company

84
Stock Dividends and Splits

• Company issues new shares and sends them on a pro
  rata basis to current shareholders instead of
  using cash to pay a dividend
• Number of shares increase, no money is collected
  or paid by the company
• With a 10 stock dividend, an investor will
  receive one tenth of a share for every share
  owned.

85
Stock Dividends and Splits

• Company issues new shares and sends them on a pro
  rata basis to current shareholders instead of
  using cash to pay a dividend
• Number of shares increase, no money is collected
  or paid by the company
• With a 10 stock dividend, an investor will
  receive one tenth of a share for every share
  owned.

25 31 1 5 9 15
August
September
Payable Date
Ex-Dividend Date
An investor who is holding 100 shares on the
ex-dividend date . . .
86
Stock Dividends and Splits

• Company issues new shares and sends them on a pro
  rata basis to current shareholders instead of
  using cash to pay a dividend
• Number of shares increase, no money is collected
  or paid by the company
• With a 10 stock dividend, an investor will
  receive one tenth of a share for every share
  owned.

25 31 1 5 9 15
August
September
Payable Date
Ex-Dividend Date
An investor who is holding 100 shares on the
ex-dividend date . . .
. . . will receive an additional 10 shares on the
payable date, for a total holding of 110 shares.
87
Stock Dividends and Splits

• Company issues new shares and sends them on a pro
  rata basis to current shareholders instead of
  using cash to pay a dividend
• Number of shares increase, no money is collected
  or paid by the company
• With a 10 stock dividend, an investor will
  receive one tenth of a share for every share
  owned.
• If company issues more than a 25 stock dividend
  it is considered a stock split
• Only difference between a stock dividend and
  stock split is accounting treatment on the
  balance sheet.

88
Rationale for Stock Split or Dividend
Are Investors Better Off?

• Example
• Katie Corporation announces a 50 stock split.
  Before the split Katie has 100,000 shares of
  stock outstanding at a price of 50 per share.

89
Rationale for Stock Split or Dividend
Are Investors Better Off?

• Example
• Katie Corporation announces a 50 stock split.
  Before the split Katie has 100,000 shares of
  stock outstanding at a price of 50 per share.

Investors will receive one-half a share for
every share outstanding
90
Rationale for Stock Split or Dividend
Are Investors Better Off?

• Example
• Katie Corporation announces a 50 stock split.
  Before the split Katie has 100,000 shares of
  stock outstanding at a price of 50 per share.

Investors will receive one-half a share for
every share outstanding
No new money going into the firm so overall the
stock will still be worth 50 x 100,000 5
million
91
Rationale for Stock Split or Dividend
Are Investors Better Off?

• Example
• Katie Corporation announces a 50 stock split.
  Before the split Katie has 100,000 shares of
  stock outstanding at a price of 50 per share.

Investors will receive one-half a share for
every share outstanding
No new money going into the firm so overall the
stock will still be worth 50 x 100,000 5
million
5 million 150,000 shares
33.33
Each share will be worth
92
Rationale for Stock Split or Dividend
Are Investors Better Off?

• Example
• Katie Corporation announces a 50 stock
  dividend. Before the dividend Katie has 100,000
  shares of stock outstanding at a price of 50 per
  share.

Investors will receive one-half a share for
every share outstanding
No new money going into the firm so overall the
stock will still be worth 50 x 100,000 5
million
5 million 150,000 shares
33.33
Each share will be worth
Price before div 1 dividend
50 1 .50
33.33

Alternative way to solve
93
Rationale for Stock Split or Dividend
Are Investors Better Off?

• Example
• Katie Corporation announces a 50 stock split.
  Before the split Katie has 100,000 shares of
  stock outstanding at a price of 50 per share.

Investors will receive one-half a share for
every share outstanding
No new money going into the firm so overall the
stock will still be worth 50 x 100,000 5
million
5 million 150,000 shares
33.33
Each share will be worth
Price before div 1 dividend
50 1 .50
33.33

Alternative way to solve
Investors are no better off, have 50 more shares
of stock, each share is worth less.
94
Rationale for Stock Split or Dividend
If Investors wealth is not increased, why issue
stock dividends?

• Optimal Price Range
• Some managers believe stock price should not be
  too high an will split the stock or reduce the
  dividend to reduce the price
• Information
• Stock splits and dividends are seen as a signal
  that the company is growing
• Cash Dividend Substitute
• Companies who do not have cash available to pay a
  regular dividend may issue a stock dividend
  instead

95
Stock Repurchases
Company buys back its own stock from investors

• Repurchase as an alternative to dividend
• Investors who sell shares receive cash -- must
  pay taxes on any capital gain.
• Investors who do not want cash simple do not sell
  shares
• Company pays excess cash to stockholders.
• Repurchase as a financing method
• Firm may issue debt and then repurchase stock
• This would result in a higher debt ratio
• Repurchase as an investment decision
• If management thinks that their stock price is
  too low, may buy back its own stock

96
Stock Repurchase Procedure

• Market Purchase
• Firm buys its own shares through a broker at the
  market price.

97
Stock Repurchase Procedure

• Market Purchase
• Firm buys its own shares through a broker at the
  market price.
• Tender Offer
• Company announces it will repurchase shares at a
  fixed price.

Must announce a price above the current market
price to induce shareholders to sell
98
Stock Repurchase Procedure

• Market Purchase
• Firm buys its own shares through a broker at the
  market price.
• Tender Offer
• Company announces it will repurchase shares at a
  fixed price.
• Negotiated Offer
• Company negotiates buying stock from specific
  group of stockholders.
• Often done to buy out dissident shareholders.

99
Stock Repurchase Procedure

• Market Purchase
• Firm buys its own shares through a broker at the
  market price.
• Tender Offer
• Company announces it will repurchase shares at a
  fixed price.
• Negotiated Offer
• Company negotiates buying stock from specific
  group of stockholders.
• Often done to buy out dissident shareholders.

Greenmail - Dissident shareholders ask management
to buy their shares at an inflated price or
dissidents will take over the firm
100
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