Lecture 8 - Dividends and Other payouts Flashcards
Different ways to pay shareholders
Cash dividends
Stock dividends
Stock splits
Share repurchase
A process by which a company buys back its own shares from the capital market thereby reducing the number of outstanding shares
Since the shares on the market are owned by shareholders, it is effectively a payment by a company to its shareholders
3 approaches to share repurchases
Open market purchases
Tender offer
Targeted repurchase
5 factors to consider when analysing dividends vs share repurchases
Flexibility
Offset to dilution
Undervaluation
Taxes
Executive compensation
Real world factors favouring a high dividend policy
Desire for current income
Agency costs
Dividend signalling
Behavioural finance
Signalling theory
The share price rises when firms announce increases in dividends
Firms will increase dividends if they expect better outlook for the company
The dividend increase is perceived as a managers signal that the firm will do well
The rise in share price following a dividend increase is called the information content effect of dividends
Clientele effect and dividend preference for each
High tax individuals:
- Don’t like dividends
- Desire zero to low payout shares
Low tax individuals:
- Like some dividends
- Desire low to medium payout shares
Tax free institutions:
- Like dividends
- Desire medium to high payout shares
Pros of paying dividends
- Appeal to investors who desire stable cash flow but do not want transaction costs
- Managers can pay dividends to keep cash from bondholders
- The board of directors can use dividends to reduce cash available to managers
- Managers may increase dividends to signal their optimism concerning future cash flow
Cons of paying dividends
-Dividends are taxed as ordinary income
-Dividends can reduce internal sources of financing
- Dividend cuts are hard to make without adversely affecting a firms share price
