Flashcards in Chapter 16 Deck (35):
2 ways for a corporation to pay out to investors?
Dividends and buying back shares
When are dividends increased and why?
Difficult to cut back dividends tf managers rarely increase them unless they are confident they can be maintained
Why might firms opt for paying investors back by buying back shares?
Tax advantaged and more flexible
What is a cash dividend?
Payment of cash to SHs by firm
Ex-dividend date = ?
Date that divides when stockholder is entitled to dividend payment
Stock often worth less if its going to miss this date for the buyer tf price falls by roughly the size of the dividend
What is the record date?
The person who owns a stock on this date receives the dividend
4 steps of paying a dividend?
1) BofD declares a dividend
2) Stock price falls on ex-dividend date
3) Payment to all stockholders that are registered
4) Checks mailed to shareholders on payment date
What are DRIPS?
Dividend reinvestment plans
How often at dividends usually paid?
What are stock dividends and stock splits? What do they do?
SDs: Give stockholders an additional x shares per y share they own for free
SSs: Issue of additional shares to firm's stockholders
Both methods decrease value/share and keep market value the same
What is a stock repurchase?
Firm buys back stock from shareholders
What are the 4 methods of stock repurchase and explain them if need be?
1) Buy shares on market (rules in place to prevent stock price manipulation)
2) Tender offer to shareholders (offer to buy back shares for maybe 20% above market price)
3) Dutch auction (shareholders submit offers to firm and they calculate the lowest price they can buy back the desired number of shares)
4) Private negotiation (greenmail)
3 themes found in dividend policy?
1) Managers reluctant to make a change in dividnds that may have to be reversed (tf may borrow/issue new shares to payout)
2) Managers 'smooth' payments to avoid having to reduce dividends (follow firm's LR trend in growth)
3) More focus on the changes in a dividends level than its absolute value from investors perspective
Explain the information content of dividends?
Change in dividend levels signal to investors info about the firm tf increase often leads to an increase in the firm's share price and vice versa
Asymmetric info here can lead to moral hazards from managers
Tf signal sent is also relative to previous dividend changes in the firm and what they meant
Different views on dividends vs repurchases?
Right: argues that investors pay more for firms with generous, stable dividends
Left: argues repurchases are better because:
-higher stock prices
-capital gains have been taxed at a lower effective rate than dividends
Miller and Modigliani (MM): argues choice between dividends and repurchases has no effect on value (see notes and understand example!)
2 steps to calculating market capitalization?
Calculate aggregate value of all shares:
1) Forecast and discount free cash flow paid out to SHs
2) Calculate price/share
(see book and notes)
How to calculate dividends per share?
Calculate the present value of dividends per share, taking into account the increased growth rate of div/share caused by declining no. shares as they are repurchased (see notes again don't get)
Check top of 2nd page of ch16 notes to check i know and understand it all!!!
If a firm has surplus cash=0 and borrowing is fixed, but they want to impress investors by paying a larger dividend, how can they do this? Explain the implication of this.
They have to print more shares and sell them
Since new SHs will only part with their cash if you offer shares as much as they cost, there must be a transfer of wealth from old SHs to new SHs
Tf the new SHs get shares at ex-dividend price, the old SHs lose the value of the dividend on their shares tf the capital loss bourne by old SH is offest by the extra cash dividend they received
SUMMARY: firms that sell shares to pay dividends are just recycling cash! (read notes just below, is important stuff also)
2 evaluative points regarding analysis just done on dividend payouts?
1) assumes new shares are sold at a fair price (EMH)
2) assumes no taxes/issue costs etc.
Explain a factor that may affect whether a shareholder buys shares that pay dividends or does repurchases? (Rightists)
Elderly SHs may look for dividends to be a steady source of cash to live on
It's easier than selling off some of the stocks every period!
Explain why the clientele effect wouldn't lead to higher stock prices for firms that pay dividends?
Since clients who want high dividends will already have high dividend stocks, tf if they wanted more they would sell firm A's stock for different ones, but if not then if firm A pays higher dividends anyway this means they're just giving the client something they're indifferent for tf won't increase the price of the stock
Explain another argument in favour of dividends?
Argument that paying dividends means managers are less likely to waste/misuse funds
See purple writing top of page 2 side 2
What does the increased payout of dividends in mature firms signal?
That in developed economies in particular, corporate governance works
What is the tax argument for repurchases over dividends? (Leftists)
Whenever capital gains are taxed less than dividends, firms should pay the lowest cash dividend they can get away with then distribute the rest of the cash in form of repurchases
If they do this, taxpaying investors will view the firm more favourably tf the value of the firm should rise
This will lead to the total cash flow retained by firm and investors combined being higher than if DIVs are paid (reduce governments 'slice')
Explain two evaluative points on the leftists tax argument for repurchases over dividends?
1) If leftists ARE correct, why should any firm ever pay a cash dividend?
2) The difference between dividends and capital gains tax is a lot less than it was historically (eg. 2012 top rate for both was 15%)
Explain the tax advantage (other than sometimes the size of the tax) that capital gains have over dividends?
In many countries, capital gains taxes can be deferred until the shares are sold, but dividend taxes are immediate
This means the longer the investors wait to sell, the lower the PV of their tax liability
Explain the US's tax system on SHs returns?
SHs returns are taxed twice, once at the corporate level (corporate tax) and once in the hands of the SH (CG/income tax)
See example notes to see how this works
Explain Australia's tax policy on SHs returns?
They allow SHs to deduct from their tax bill the share of corporate tax the firm has already paid
If CT greater than IT also allows them to get a refund
Tf acts all as one layer of tax levied on the SH
Explain the payout policy for young firms? 2 advantages of doing this?
They have plenty of profitable investment opportunities tf retain and reinvest cash flow instead of borrowing/issuing new shares
a) avoids cost of issuing securities
b) minimises SHs taxes
Explain the payout policy for firms as they mature?
As firms mature, positive NPV opportunities become more scarce -> cash accumulation
Investors begin to worry about excessive perks/overinvestment -> pressure on managers to pay out (page 417 for more info)
3 questions to determine if time to send some cash back to investors?
1) If the firm making a positive free cash flow after making all +ve NPV investments, and is it likely to continue?
2) Is firm's debt ratio prudent?
3) Are the firm's holding of cash a sufficient cushion for any unexpected setbacks and a sufficient war chest for unexpected investment opportunities?
If yes to all 3 then free cash is surplus tf time to payout
What is residual dividend policy?
A dividend policy whereby the firm commits to using funds to pay for capital expenditures (up til IRR=COC), and only after this point do they repay excess cash in dividends