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I. Introduction
A. Types of Dividends
1. Regular Dividends - dividend that firm expects to continue paying
2. Extra/Special Dividend - dividend that may or may not be repeated
3. Liquidating Dividend - used to liquidate the firm
Conditions: creditors paid, R/E = 0
Tax treatment: not taxed => return of capital
B. Method of payment
1. Cash - $
2. Stock Dividend - distribution of shares rather than $
a. Impact on firm => only accounting #s changed
=> $ moved from R/E to C/S and Capital Surplus
b. Impact on investors => own same % of firm => no effect on wealth due to change in claim against firm.
Note: possible psychological, information, trading range, or transaction cost affects.
3. Payment in kind - paid in product of the firm
C. Some important dates
1. Declaration date board of directors declares that firm will pay dividend
2. Date of Record - whoever recorded as owning stock on this date is eligible for dividend
Note: date established by board of directors
3. Ex-Dividend date - 2 business days prior to date of record
Notes:
1) anyone who buys stock on or after this date does not receive div.
2) established by securities industry
=> time to do paperwork
3) price should fall between the day before the ex-dividend date and the ex-dividend date
=> 1st trade on ex-div. date will reflect this
Reason: no longer receive dividend => worth less than before ex-div. date
4. Payment date - check mailed
D. Legal Issues
1. Bond covenants - restrict dividends to protect B/H
2. Impairment of Capital Laws - dividends can't reduce R/E below 0
=> protects B/H
3. Improper Accumulation Laws - prevents S/H from avoiding taxes by not paying dividends
E. Stock Repurchases
=> firm purchases shares from existing S/H
1. Reasons for stock repurchase:
a.
=>
Main advantage =>
Key =>
b.
c.
d.
e.
targeted repurchase =>
Nuisance stockholders:
1)
2)
2. Methods of Repurchasing Shares
a.
b.
c.
Overview:
a) Company issues 1 put right to existing stockholders for every X shares owned
b) S/H either:
1]
2]
F. Advantages of Transferable Put Rights
Note: According to, Julia (Brown) Harman, one of my former students who is an investment banker, transferable put rights are not used at the moment because of a change in the way they must be accounted for. They must be recorded as a liability on the balance sheet and are subject to mark-to-market rules and now must flow through the income statement.
1.
Key:
=>
=>
=>
Ex. Assume the market value of Microsoftopolys assets is $4,400,000 and that the market value of Microsoftopolys debt is $1,000,000. Assume also that Microsoftopoly 80,000 shares outstanding.
Microsoftopolys market price per share = EMBED Equation.3
Assume also that Microsoftopoly has 3 stockholders as follows:
Shares Wealth
Bill 25,000 1,062,500 = 25,000 x 42.50
Susan 50,000 2,125,000 = 50,000 x 42.50
Joe 5000 212,500 = 5000 x 42.50
Finally, assume the firm wishes to use $600,000 of surplus cash to repurchase 10,000 shares at $60 per share and that the value of the outstanding debt doesnt change
Value per share after repurchase =
Option #1 => Tender Offer
1) Assume only Bill offers to sell shares back to Microsoftopoly. The wealth of each stockholder will be as follows:
Bill =
=> change in wealth =
Susan =
=> change in wealth =
Joe =
=> change in wealth =
=> Bill gains at expense of Susan and Joe
=> result:
2) Bill and Susan offer 10,000 each and Joe offers 5000 shares
Note: No one can offer to sell more shares than 1) co. offers to buy or 2) number of shares own.
Problems:
1)
=> solution:
2)
=> solution:
=> firm wants 10,000 of the 25,000 shared offered =>
=>
Bill = 4000(60) + (25,000 4000)(40) = 1,080,000
=> change in wealth = 17,500 = 1,080,000 1,062,500
Susan = 4000(60) + (50,000 4000)(40) = 2,080,000
=> change in wealth = - 45,000 = 2,080,000 2,125,000
Joe = 2000(60) + (5000 2000)(40) = 240,000
=> change in wealth = 27,500 = 240,000 212,500
Option #2 => Transferable Put Rights
Assumptions:
1) Microsoftopoly issues one put per outstanding share
2) Puts expire immediately
3) No taxes
Result => Microsoftopoly issues 80,000 puts to repurchase 10,000 shares at $60 per share
=> must return 8 puts with each share sold back to firm
Value per put =
Assume that Susan sells puts to Bill and that Bill and Joe exercise all their puts
Bill: # of shares can sell:
=> wealth =
Susan: wealth =
Joe: # of shares can sell:
=> wealth =
2.
=> w/ tender offer, too many shares may be tendered since everyone sells as many as possible (or suffers wealth redistribution)
=> w/ transferable put rights, control number of shares that can be offered back to the company.
3.
Key =>
With tender offer, everyone sells (or experience wealth transfer)
With trans. puts:
S/H with high tax from exercising => high tax rate or low basis
=>
S/H with low tax from exercising => low tax rate or high basis
=>
Result =>
Example: Assume all 3 stockholders bought stock for $30 per share. Assume also that the tax rate for Bill is 5% and for Susan and Joe is 15%.
=> Stocks basis for all stockholders is $30.
Taxes if pay dividends
Note: dividend per share EMBED Equation.3
Bill = 7.50(25,000)(.05) = 9375
Susan = 7.50(50,000)(.15) = 56,250
Joe = 7.50(5000)(.15) = 5625
Total = 71,250
Taxes if tender offer
Note: assume everyone acts in own best interest
Bill = 4000(60-30)*.05 = 6000
Susan = 4000(60-30)*.15 = 18,000
Joe = 2000(60-30)*.15 = 9000
Total = 33,000
Taxes if transferable put rights
=> when TPRs issued, stock value is $40 and puts value is $2.50
=> Stocks initial basis is split between stock and puts as follows:
Stocks basis EMBED Equation.3
Puts basis EMBED Equation.3
Note: Assume Susan still sells puts and that Bill and Joe exercise.
Bill = (9375*60 9375*28.23529 25,000*1.76471 50,000*2.5)* .05 = 6434
Note: basis on puts received from firm = $1.76, and on puts bought is $2.50 (what paid for them).
Susan = 50,000*(2.5 1.76471)*.15=5515
Joe = (625*60 625*28.23529 5000*1.76471)*.15 = 1654
Total = 13,603
Note: if all pursue best tax strategy, then Susan and Joe sell puts to Bill and Bill exercises all puts
=> total tax in this case is only $12,868 (lowest of all).
II. Dividend Theories
A. Dividend Irrelevance
Reason study => if figure out conditions where dividend policy doesn't matter, helps us figure out conditions that might make dividend policy matter.
1. Assumptions
a. Perfect Markets => no taxes, transaction costs, dominant investors, etc.
b. Homogeneous expectations => investors agree about future investments, cash flows, dividends, etc.
c. Investment optimally fixed
d. Any surplus cash (cash left after all positive NPV projects have been taken) has been paid out to S/H as dividend
2. Impact of increasing dividend
Assume pay out additional dividend = $100
a. Impact on firm
Note:
b. Impact on original stockholders
1)
2)
c. Conclusion =>
1)
2)
3)
B. Taxes
Key => In the U.S., capital gains are often taxed at a lower rate than ordinary income
Notes:
1) For 2003, dividends are also taxed at the same rate as capital gains
2) Even if dividends are taxed at same rate as capital gains, effective rate on dividends is higher since taxed in year paid rather than when sell stock.
1. Firms w/o excess cash
=> to increase dividends must:
a.
Ex.
Assume:
Tax rate for on ordinary income is 25%
Tax rate on capital gains is 15%
Tax rate on dividends is 15%
Firm pays extra dividend of $100
Result:
b.
Implication =>
2. Firms with Excess Cash
a.
=>
b.
=>
Ex.
Firm uses $100 to repurchase shares from S/H (Tender Offer)
Assume investors purchased shares for $75
Tax on distribution =
=> Net proceeds to S/H =
Problem: IRS has figured this out
=> can impose penalty on firm if can show firm is repurchasing shares only to avoid taxes
=> few firms have regular repurchases
c.
1)
Problem:
2)
Problem:
3)
Notes:
1]
2]
(1)
(2)
Conclusion:
3. Taxes, Dividends, and Required Returns
1)
2)
3)
Note: Doesn't imply that firm shouldn't pay dividend
=> stock price may fall even further w/ alternate uses of surplus cash.
C. Tax Arbitrage
1. Key =>
=>
=>
2. Result:
D. Signaling
1. Basic Idea
=>
1)
2)
3)
=>
2. Result:
At announcement of unexpected dividend increase
=>
=>
At announcement of unexpected dividend decrease
=>
=>
Note: Stock price increases at announcements of dividend increases doesn't imply that S/H prefer higher dividends for dividend's sake
=> stock reaction result of market's interpretation of the dividend increase as signal of management's optimism about the future.
E. Agency
1. Basic Idea
2. Result:
F. Stockholder/Bondholder Conflict
=> when pay a dividend, less cash remains with which B/H can be paid
=> S/H gain at expense of B/H
G. Clientele Effect
1. Key =>
=>
2. Rationale
1)
=>
=>
key =>
2)
=>
3)
4)
=>
H. Uncertainty resolution
1. Key Idea
=> dividend returns (determined by management) are less risky than capital gains (determined by the market)
=> by increasing dividends => decrease risk => increase value of firm
2. Problem
=> if investment & borrowing fixed => firm's CF unaffected by dividend policy => no change in risk of CF
=> have shifted risk from old S/H to new S/H by taking cash from new S/H & giving to old S/H
=> old S/H could have accomplished same thing by selling shares & holding the resulting cash
=> invalid argument
III. Evidence
1. Dividend announcements & stock prices
Note:
2. Unclear relationship between dividend yield & expected return
a. Brennan (70), Litzenberger & Ramaswamy (79 & 82) found a positive relationship between expected pre-tax returns and dividend yield
b. Black & Scholes (74), Miller & Scholes (82) found no relationship between expected pre-tax returns and dividend yield
c. Fama & French (92) found positive relationship between expected return and ratio of book to market for equity
=> high book to market are value stocks (vs. growth stocks) and tend to have higher dividend yields
=> concluded that any relationship between expected return and dividend yield is driven by the relationship between return and the book to market ratio
3. Stock price behavior on Ex-dividend date
=>
4. Overall conclusion =>
1)
2)
3)
4)
5)
6)
Dividends-PAGE4
Lecture Notes for Corporate Finance
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