ࡱ> bOcdOh+'0x   ( 4 @ LX`hpDividend Policy:divighongndhonNormald ArthurWarga13hMicrosoft Word 8.0@@yqb@]b@V;:.0Microsoft Office0Templates<@,@:i+00/C՜.+,D՜.+,< hp|  UWM$  Dividend Policy: Title 6> _PID_GUIDAN{0AEB25E1-CDF8-11CF-833B-444553540000}Templates<@,@:i+00/CCHAPTER 14. DIVIDEND CONTROVERSY How dividends are paid out. Dividend policy is defined as the tradeoff between retaining earnings on the one hand and paying out cash on the other hand. You can't pay out your "par" capital as a dividend... ( State law protects the firm's creditors (i.e., bondholders) from paying excessive dividend. [Extreme case : selling all the assets and payout all the proceeds as a dividend] Paying a dividend reduces the amount of R/E. Many firms have automatic dividend reinvestment plan (so call DRIP), under which the new shares are issued at a 5% discount from the market price. ( It saves the underwriting costs of a regular share issue. Share repurchases as an alternative to dividends... ( Happens when cash resources have generally outrun good capital investment opportunities. [i.e., a firm has accumulated large amounts of unwanted cash] ( Happens when the firm wants to change the capital strucuture by replacing equity with debt. Major methods of repurchases Acquisition in the open market By a general tender offer to shareholders. By direct negotiations with a major shareholder. [ i.e., Greenmail : Shares are repurchased by the target of the takeover at a price which makes the hostile bidder happy to agree to leave the target alone] ( Deprive the shareholders of the value. How firms decide on dividend payments. S @ E@  @D@ RU@  r # 49@ Lintner's finding on dividends : Firms have long-run target dividend payout ratios Changes much more important than levels Transitory earnings don't lead to dividend changes Managers are reluctant to reverse a recent change in dividends Partial adjustment model : Explained in the Text book in page 421. The Information Contents of the Dividend Dividend increases are good news ( signal managerial optimism. Dividend increases usually lead to stock price increases ( That is not because dividend increases create value but because they signal future prosperity. Dividend Controversy 1. Right wing: increasing payouts raise value 2. Middle of the road: who cares about dividend policy? 3. Left wing: increasing payouts lowers value RETE@URRENTLY @% DENSED @'U IMENTS @ TION@ )F!  AING@L @w#pt4 @LY @ED@RS Franco Modigliani and Merton Miller [MM Model] Assets Liabilities + Net Worth  Cash $1,000 $0 Debt Fixed Assets $9,000 $10,000 + NPV Equity Inv. Oppor. NPV  Total $10,000 + NPV $10,000 + NPV Suppose you payout $1,000 dividend, financed by issuing stock... You haven't changed the assets of the company--it still has the same cash, fixed assets, and investment opportunities; hence it still has the same total value. If the NEW stockholders pay a fair price, they have stock worth the $1,000 they paid for it after the issue. Hence OLD stockholders must have stock worth $9,000 + NPV. ( Old shareholders have received a $1000 cash dividend and incurred a $1000 capital loss. ( Thus dividend policy doesn't matter [i.e., doesn't affect the value of the firm] The crucial assumption in the proof above is that the new shares are sold at a fair price. ( The shares sold to raise $1000 must actually be worth $1000. ( In other words, we assumed efficient capital markets. ATE @S @O @RATULATE @ ESSIONAL @JECTURE@ UGATE @ NCTION@ 2NECT#@ THE RIGHT WING: Dividends carry information that the firm truly is healthy Investors don't fully trust managers to handle the firm's free cash flow--but here dividend policy has an impact because it eliminates negative NPV investments. THE LEFT WING: ( Effects of a shift in dividend policy when dividends are taxed more heavily than capital gains. [ The high payout stock must sell at a lower price in order to provide the same after-tax return ] No-Dividend Firm High-Dividend Firm Next Year's Price $112.50 $102.50 Dividend $0 $10.00 Total Pretax Payoff $112.50 $112.50 Today's Stock Price $100 $96.67 Captal Gain $12.50 $5.83 B4 Tax Rate of Ret. $12.5/100x100=12.5% $5.83/96.67x100=16.4% Tax on Div.(50%) $0 $5.00 Tax on C.Gain (20%) $2.50 $1.17 After-Tax Income $10.00 $9.66 After-Tax R.of Ret. $10/100 x 100=10% $9.66/96.67 x 100=10% Moral: Cut your dividends and expropriate a piece of the government's share of the corporation by playing the angles of the tax system. But the tax reform act of 1986 equalized the tax rates (now only a small gap exists). MIDDLE OF THE ROAD If companies could increase their value by increasing dividends, wouldn't they have done so already? Perhaps dividends are where they are because they are where constrained-cash-flow advantages exactly offset tax arbitrage. 8:::> > >>>>>>>>>>??? ? ?&?(?BGGGGHMMMMPUUVV0W2WXWZWZ__``2a4aaaaaddddffDhFhHhJhjjHmJmLmoooo5CJOJQJ5CJCJH* jCJ0JmH0J j0JU5CJ CJOJQJCJGBDF~~XZ \  I z  B C D 8 & F & F$BDF~~XZ \  I z  B C D E l m HJhtvJABCDYZdf KLZCD$&r dD E l m HJhtvJABCDYZd & F & Fdf KLZCD$&r .Hq?bV X !!!!.Hq?bV X !!!!!B!D!"" &P/ =!"#$% Suggested Homework Problems Quiz 2, 3 and 4 on page 440 Question 7 on page 442 Question 18 on page 444 Suggested Homework Problems Quiz 2, 3 and 4 on page 440 Question 7 on page 442 Question 18 on page 444 !!B!D!""$8&8(8d8888:::B:z:::>> >F>~>>>>&`#$ & F8:::> > >>>>>>>>>>??? ? ?&?(?BGGGGHMMMMPUUVV0W2WXWZWZ__``2a4aaaaaddddffDhFhHhJhjjHmJmLmoooossss5CJOJQJ5CJCJH* jCJ0JmH0J j0JU5CJ CJOJQJCJK6 Suggested Homework Problems Quiz 2, 3 and 4 on page 440 Question 7 on page 442 Question 18 on page 444 PAGE 1 PAGE 1 CHAPTER 16 >>> ?"?$?&?(?B*BtBB(CrCCDDEEFGGGH*H8 & F 8 & F & F & F&`#$h*HtHH(IrIIJJKKLMMMP*PtPP(QrQQRRSSTU & F8 & F 8 & F & F8POLICY Reasons for Information or Signalling Hypothesis No Profitable use for internally generated funds. Firm believe that stock is undervalued. Mixed results (positive or negative) Dividend or Personal Taxation Hypothesis In order to let the S/Holders benefit from the preferential tax treatment of repurchases relative to dividend. Leverage Hypothesis. -Tax subsidy connected with the deductibility of interest payments. This subsidy is passed on to the shareholders. Bondholder Expropriation Hypothesis. Repurchase reduces the assets of the firm and therefore the value of the claims of the bondholders. This plausibility of this hypothesis is weakened by the existence of the law and by the bond covenants. ( Procedure for Dividend Payment [Page 461, Figure 18.1] Declaration date Ex-Dividend date : traded ex-dividend on and after 2nd business day before record date. Record Date Payment Date (page 481. 18.9)828. Dividend Policy UU V,VVVWXWZWZ*ZtZZ([r[[\\]]^__ `,`8 & F 8 & F & F & F & F h8POLICY Reasons for Information or Signalling Hypothesis No Profitable use for internally generated funds. Firm believe that stock is undervalued. Mixed results (positive or negative) Dividend or Personal Taxation Hypothesis In order to let the S/Holders benefit from the preferential tax treatment of repurchases relative to dividend. Leverage Hypothesis. -Tax subsidy connected with the deductibility of interest payments. This subsidy is passed on to the shareholders. Bondholder Expropriation Hypothesis. Repurchase reduces the assets of the firm and therefore the value of the claims of the bondholders. This plausibility of this hypothesis is weakened by the existence of the law and by the bond covenants. ( Procedure for Dividend Payment [Page 461, Figure 18.1] Declaration date Ex-Dividend date : traded ex-dividend on and after 2nd business day before record date. Record Date Payment Date (page 481. 18.9)8 ( Clientele Effect : Individual with different tax brackets and Corporation. 48. Dividend Policy noor:rVrssss & F ,```a2aaaaddf,h0h4hHhJhl0lmFmHmJmLmnnn & F  & F & F & F hn the Gordon s model. . rate of 4 [Bird-in-the-hand Theory][MM dividend theory-Homemade div][Tax Preference Theory]MIDDLE OF THE ROAD : The firm value is determined by its basic earning power [or by the income produced by its assets], not by how this income is split between dividends and R/E. Homemade dividends. Ex.) if a firm does not pay dividends, a S/Holders who wants a 5% dividend can  create it by selling 5% of his stock. Homemade dividends. Investors value a dollar of expected dividends more highly than a dollar of expected capitepurchase reduces the assets of the firm and therefore the value of the claims of the bondholders. This plausibility of this hypothesis is weakened by the existence of the law and by the bond covenants. (page 481. 18.9)828. Dividend Policy 8POLICY Reasons for Information or Signalling Hypothesis No Profitable use for internally generated funds. Firm believe that stock is undervalued. Mixed results (positive or negative) Dividend or Personal Taxation Hypothesis In order to let the S/Holders benefit from the preferential tax treatment of repurchases relative to dividend. Leverage Hypothesis. -Tax subsidy connected with the deductibility of interest payments. This subsidy is passed on to the shareholders. Bondholder Expropriation Hypothesis. Ral gains because the dividend yield component is less risky than the  g component in the Gordon s model. . rate of X : $96.67(102.5-X)on C.Gain (20%) $2.50 $(102.5-X)*0.2(10)*0.5+(102.5-X)*0.8[ (10)*0.5+(102.5-X)*0.8] / X 3 noo & F [$@$NormalmH <A@<Default Paragraph Font6%@6Envelope ReturnCJ, @,Footer  !&)@& Page Number,@",Header  !m8;<Tl<|Ev>?Y~&C:;t+ , ^ A B m H I Y *fCE2`6ABCNjkn                        18.5 a. $15 18.5 b. $4613.38 18.7 a. $16.2 18.7 b. He can invest the dividends into the Gibson stock. Dividends that he gets = $600. Expected share price after dividend = (0.6+15)/1=$15.5. # of shares he needs to buy = 600/15.6=38. 1 20dDividend Policy:ghong ArthurWarga [$@$NormalmH <A@<Default Paragraph Font6%6Envelope ReturnCJ, @,Footer  !&)@& Page Number,",Header  ! 8;<Tl<|Ev>?Y~&C:;tBF~XZ\ ^     E l vxDYZ`c$  !!!B!"(8*885 jCJOJQJ5CJOJQJ6CJjCJUmH5CJ jCJ CJOJQJ5CJCJ5CJL+ , ^ A B m H I Y *fCE2`                            @@@@@@ 55588oD d!>*HU,`no ',18"Unknownghong ArthurWarga 8!!8@0(  B S  ?mhr P V w ~ V^:@aj6kn _e?Cv{    U ] 6knghong%C:\DOS\AutoRecovery save of ch_16.asdghong%C:\DOS\AutoRecovery save of ch_16.asd ArthurWarga2C:\windows\TEMP\AutoRecovery save of ch_16_div.asd ArthurWargaC:\0_6335\ch_16_div.doc ArthurWargaC:\0_6335\ch_16_div.doc ArthurWargaC:\0_6335\ch_16_div.doc ArthurWargaC:\0_6335\ch_16_div.doc ArthurWargaC:\0_6335\ch_16_div.doc ArthurWargaC:\0_6335\ch_16_div.doc ArthurWargaC:\0_6335\ch_16_div.doc H F2h ւ!P wrF2rclF2u9_5X >3oF2)5r ( vo(-88o(.88o(-o(-o(-88o(.hho(.o(-0o(.o(. h )5r( vP u9>3o_5XH wrrcl @ЯHC$Eƀb'[Bird-in-the-hand Theory][MM dividend theory][Tax Preference Theory]2 [Bird-in-the-hand Theory][MM dividend theory-Homemade div][Tax Preference Theory] Investors value a dollar of expected dividends more highly than a dollar of expected capital gains because the dividend yield component is less risky than the  g component i          [$@$NormalmH <A@<Default Paragraph Font6%@6Envelope ReturnCJ, @,Footer  !&)@& Page Number,@",Header  !8;<Tl<|Ev>?Y~&C            @@@@@@ 55588sD d!>*HU,`ns ',18"Unknownghong ArthurWarga 8!!8@0(  B S  ? hr P V w ~ V^:@aj  _e?Cv{    U ]  8POLICY Reasons for Information or Signalling Hypothesis No Profitable use for internally generated funds. Firm believe that stock is undervalued. Mixed results (positive or negative) Dividend or Personal Taxation Hypothesis In order to let the S/Holders benefit from the preferential tax treatment of repurchases relative to dividend. Leverage Hypothesis. -Tax subsidy connected with the deductibility of interest payments. This subsidy is passed on to the shareholders. Bondholder Expropriation Hypothesis. R epurchase reduces the assets of the firm and therefore the value of the claims of the bondholders. This plausibility of this hypothesis is weakened by the existence of the law and by the bond covenants. (page 481. 18.9)828. Dividend Policy  & F2 ?<<<<8<<<<C$Eƀb' & FC$ & F?C$Eƀb'< & F2 ?ghong%C:\DOS\AutoRecovery save of ch_16.asd ArthurWarga2C:\windows\TEMP\AutoRecovery save of ch_16_div.asd ArthurWargaC:\0_6335\ch_16_div.doc ArthurWargaC:\0_6335\ch_16_div.doc ArthurWargaC:\0_6335\ch_16_div.doc ArthurWargaC:\0_6335\chĠ & F?$d%d&d'd4 =>?AMXY}~%&QBCn:;<[st *  = > ?  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