Dividend policy Flashcards
(20 cards)
What is a dividend?
is a cash payment made to the shareholders as a reward of their investment - can be in the form of dividend income and a capital gain (or loss from selling a bond/share). Dividends come from net profit.
When is a dividend paid?
a distribution of after tax earning is usually paid semi annually (twice per year), interim (mid year) and final (after year end). It is recommended by directors and approved by shareholders at AGM
What is Xd or ex-div?
Dividend will be paid to those holding the shares on this date - 2-3 weeks, processed after 48 hours.
What is a cum-div?
The price of the share between announcement and ex-div date (cum is Latin word for ‘with’)
When will share price fall?
Share price will fall on ex-dividend date as the shareholder who buys immediately after the Xd date does not have the right to receive the dividend.
What is done to maximise shareholder wealth?
- primary objective of management - maximise shareholder wealth, maximise company value/share price.
- return to shareholder - dividend (income), increases in share price (capital growth)
How are dividends measured?
for one company: dividend per share (DPS) e.g. D0, D1 in DGM.
for multiple companies: dividend yield = DPS/share price
What is the dividend decision?
considers how much the company should retain to reinvest in the company and howe much it should distribute to shareholders (dividend). If the company has a positive NPV project in which to invest the money, should it retain the funds rather than having to raise funds externally?
How much can dividends be?
- dividends can only be paid out of distributable profits (companies)
- lenders will put constraints on dividend payments (restrictive covenants)
- liquidity = dividend is cash, so company has to have cash to make the payment. A real limiting factor for many companies.
- investment opportunities - retained earnings are a major source of finance.
Why can dividends be irrelevant?
-Modigliani and Mill suggested that share valuation is a function of earnings, in perfect market (no taxes, no transaction costs), dividend policy does not affect firm value.
- investment decisions which deliver future profitability are the determinants of share price, investors can create their own dividend by selling shares if they want cash.
- share valuation is independent of the level of dividend, it doesnt matter whether a firm pays dividends or reivest profits - what matters is investment policy.
- optimal investment polic - invest in all projects with posistive NPV. Surplus funds (no positive NPV projects left) can be paid as dividends. Dividends is a resisual decision.
How are dividends relevant?
- Litner (1956) and Gordon (1959) - current dividends are preferred due to their certainty. Current dividends provide a reliable return.
Future profits are less attractive, suggests that dividend policy is relevant to market value as investors will value those companies who pay out dividends more highly.
What is the dividend growth model?
Market value of a company is equal to PV of its future dividends. Higher the dividend the greater the market value.
What is the calculation for a value of a share?
value of share = D1/(r-g)
How are dividends used as a signal?
Asymmetry of information, managers/directors know more about the company and its prospects than shareholders.
Strong dividend see as ‘good news’. Directors are confident of profit and cash flow.
Dividend decrease is taken as a negative signal of future problems.
A company considering cutting its dividends need to explain clearly why they have taken this action.
Company needs to manage shareholder expectations.
What is the clientele effect on dividends?
Some shareholders (retirees) rely on dividends as income to meet liabilities.
Other investors are looking for long term capital returns.
Investors cluster in companies whose politics suit them.
If the company changes its dividend policy the investors may sell their shares and look for others whose policy suits them.
Tax considerations - dividends are taxed more heavily than capital gains. Investors may prefer companies that retain earnings or do share buybacks instead of paying dividends.
What agency costs are associated with dividends?
dividends can help reduce agency problems - paying out cash limits manager ability to invest in wasteful projects.
Helps discipline management by reducing excess free cash flow.
What is a fixed percentage pay-out ratio?
easy to operate, clear message to investors, does not consider cash constraints, not suitable for companies with volatile profits, ignores investment decisions, avoids frequent changes to the dividend.
What is a zero-dividend policy?
easy to operate and clear, allows company to use all retained earnings to re-invest, particularly useful for new companies or those requiring significant upfront investment.
What is a constant dividend/constant growth dividend?
real or nominal terms?, dividend kept in line with long term growth in earnings, used in mature companies with stable earnings, failure to make dividends sends a very negative signal to the market, limits opportunities for investment as dividends become the ‘first’ decision rather than the residual, companies who undertake this policy keep growth very low as not to disappoint shareholders in a bad year.
What are the alternatives to dividends?
- scrip dividends = give additional share instead of dividends, allows company to retain cash, maybe tax efficient for investors (stock buybacks)
- share repurchases = enhance value of each remaining share, can increase EPS
- non- cash benefits = gifts vouchers, discount on services
- special dividends = return surplus cash to shareholders as a one off payment, return cash to investors where company has no positive NPV projects in which to invest.
