Payout Policy

Question 1

What is Payout Policy about?

Answer 1

What proportion of a company’s net earnings should be paid to shareholders and what proportion should be retained for investment?

Question 2

What is the basic timeline of the Dividend Declaration Procedure?

Answer 2

1. Announcement
2. Ex-Dividend Date
3. Books Close
4. Payment Date

Question 3

What occurs on the Announcement Date of a Dividend Declaration?

Answer 3

Board of Directors announces the dividend, detailing the amount of the dividend (and the extent to which it is franked), as well as the ex-dividend, books close, and payment dates.

Question 4

What is the importance of the Ex-Dividend date?

Answer 4

If shares are sold on or after this date the BUYER of the shares is NOT entitled to the dividend.

Question 5

What does the Books Close Date indicate?

Answer 5

The date the company’s books close for determining who is currently a shareholder and by extension entitled to the dividend.
(Arbitrary Date)

Question 6

What occurs on the Payment Date?

Answer 6

Money is transferred from the company’s account to shareholders’ accounts.

Question 7

How would the market react to a company announcing a higher dividend than expected?

Answer 7

The share price would increase.

Question 8

How would the market react to a company announcing a lower dividend than expected?

Answer 8

The share price would decrease.

Question 9

If I purchase a share on the 27th of August, will I receive the dividend if the Ex-Dividend date is the 28th?

Answer 9

Yes.

Question 10

If I purchase a share on the 28th of August, will I receive the dividend if the Ex-Dividend date is the 28th?

Answer 10

No.

Question 11

Why do share prices usually fall on the Ex-Dividend date?

Answer 11

They fall to adjust for the share price without the forthcoming dividend.

Question 12

What are the three main alternative payout policies that a company may adopt?

Answer 12

1. Residual
2. Stable (or progressive)
3. Constant

Question 13

What does a Residual Payout Policy involve?

Answer 13

A company pays out the residual of any profits that, in the opinion of management, cannot be invested profitably.

Question 14

How does the Residual Payout Policy’s payout change over time?

Answer 14

It fluctuates significantly from year to year.

Question 15

What does a Stable (or Progressive) Payout Policy involve?

Answer 15

Long-run target Dividend Payout Ratio. A target proportion of profit to be paid out in other words.

Question 16

When would a Stable (or progressive) Payout Policy increase their dividend per share?

Answer 16

When expected long-run profit per share has increased.

Question 17

When would a Stable (or progressive) Payout Policy decrease their dividend per share?

Answer 17

When expected long-run profit per share has decreased.

Question 18

How does a the Stable (or progressive) Payout Policy’s payout change over time?

Answer 18

The payout remains relatively stable year to year.

Question 19

What does a Constant Payout Policy involve?

Answer 19

A company sets a constant proportion of profits each year.

Question 20

How does a Constant Payout Policy’s payout change over time?

Answer 20

As profit per share changes from year to year, so will dividend per share in the same proportion.

Question 21

Do Managers want to cut dividend per share?

Answer 21

No, they have a strong desire not to as dividend per share is priority.

Question 22

Do Managers want to increase dividend per share?

Answer 22

No, they see little benefit in doing so.

Question 23

Why are share repurchases optimal for Managers?

Answer 23

They are seen as a more flexible way of paying out to shareholders.

Question 24

Why are transaction costs important?

Answer 24

Without them shareholders could develop the payout they wanted.

Question 25

Who is incentivised to hold shares due to transaction costs?

Answer 25

Retirees who may require regular income, or shareholders who don't require a regular income but are interested in long-term return.

Question 26

What are dividend clienteles?

Answer 26

Groups of investors who choose to invest in companies that have dividend policies that meet their requirements.

Question 27

What are flotation costs?

Answer 27

Costs incurred when a company issues new securities.

Question 28

What type of costs are flotation costs?

Answer 28

Underwriting fees, legal fees, advertising fees, registration fees etc.

Question 29

How do companies use Payout Policy to avoid flotation costs?

Answer 29

Some companies use a Residual Dividend Policy.

Question 30

Why do Low Tax paying individuals prefer full payout of earnings as dividends?

Answer 30

So that they can access the franking credits.

Question 31

Do High Tax paying individuals prefer payout of earnings as dividends?

Answer 31

Sometimes, it depends on the level of tax on capital gains associated.

Question 32

Do Foreign Investors prefer payout of earnings as dividends?

Answer 32

Sometimes, they may prefer to invest in those that do not pay dividends as their tax on retained earnings (as capital gains) may be less than that on dividends.

Question 33

Who generally has the most information about a company?

Answer 33

Managers.

Question 34

How does the announcement of dividend per share signal information to shareholders?

Answer 34

``` Increase = Good News Decrease = Bad News ```

Question 35

What are Agency Costs?

Answer 35

The costs associated with the conflict of interest between managers and shareholders.

Question 36

Why would high dividends reduce agency costs?

Answer 36

1. Exposes the company to scrutiny associated with raising external capital. 2. Managers can't invest free cash flows in unprofitable projects. 3. Managers more likely to act in the best interest of shareholders.

Question 37

What is a share buyback?

Answer 37

When a company pays cash to shareholders by repurchasing the shares and cancelling them.

Question 38

How does repurchasing shares impact performance measurement?

Answer 38

Using surplus cash should increase earnings per share, but can also increase risk if repurchased through borrowing.

Question 39

What information does share repurchasing signal?

Answer 39

Provides new information, such as the likelihood of higher than expected earnings in the future.

Question 40

Why would a company repurchase shares as opposed to increasing dividend per share?

Answer 40

A share repurchase is not an implicit promise to make future repurchases, and thus has more flexibility when compared with a dividend increase.

Question 41

What is a Dividend Reinvestment Plan?

Answer 41

An offering to the shareholder to use all or part of their dividend to purchase additional shares without incurring brokerage fees.