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CSUF FIN 320 - Dividend Policy and Internal Financing

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Chapter 13Dividend Policy and Internal FinancingChapter ObjectivesDividend PolicyDividend TradeoffsDoes Dividend Policy Affect Stock Price?View 1: Dividend Policy is IrrelevantPerfect Capital MarketsAdditional AssumptionsView 2: High Dividends Increase Stock ValueView 3: Low Dividends Increase Stock ValueExtensions of Dividend TheoryResidual Dividend TheoryClientele EffectInformation EffectAgency CostsExpectations TheoryDividend Theories: ConclusionsDividend ConsiderationsAlternative Dividend PoliciesDividend Payment ProceduresStock Dividends and Stock SplitsRationale for Stock Dividend or SplitStock RepurchasesRationale for Stock RepurchasesRepurchase ProcedureChapter 13Chapter 13Dividend Policy and Internal Dividend Policy and Internal FinancingFinancingChapter ObjectivesChapter ObjectivesTrade-offs between paying dividends and retaining profitsRelationship between a corporation’s dividend policy and the market price of its common stockPractical considerations important to dividend policyTypes of dividend policiesProcedures for dividend payoutNon cash dividendsStock repurchasesLow dividend payments and international capital budgeting opportunitiesDividend PolicyDividend PolicyTwo Key Elements:1. Dividend payout ratioamount of dividends paid relative to the company’s earnings2. Dividend stability over timeDividend TradeoffsDividend TradeoffsPaying large dividends means simultaneously deciding to retain little profits. Greater reliance on external financingPaying small dividends corresponds to high profit retention and less need for externally generated equity fundsDoes Dividend Policy Affect Does Dividend Policy Affect Stock Price?Stock Price?View 1: Dividend policy is irrelevantView 2: High dividends increase stock valueView 3: Low dividends increase stock priceView 1:View 1:Dividend Policy is Dividend Policy is IrrelevantIrrelevantAssumption: Investment and borrowing decisions will not be altered by the amount of any dividend paymentPerfect capitals markets are assumed to exist which means:Perfect Capital MarketsPerfect Capital MarketsInvestors can buy and sell stocks without incurring any transaction costs–Companies can issue stock without any cost–No corporate or personal taxes–Complete information is readily available–No conflicts on interest between management and stockholders–Financial distress and bankruptcy are nonexistentAdditional AssumptionsAdditional AssumptionsThere is no relationship between dividend policy and stock value. One dividend policy is as good as anotherInvestors are concerned only with total returns—they are indifferent whether these returns come from capital gains or dividend incomeView 2:View 2:High Dividends High Dividends Increase Stock ValueIncrease Stock ValueDividends are more predictable than capital gains—management can control dividends but can not dictate price of stock.Bird-in-the-hand theory: Dividends are more certain than capital gains.Trade-off of uncertain capital gains for a “safe” asset (a cash dividend)View 3:View 3:Low Dividends Low Dividends Increase Stock ValueIncrease Stock ValueTaxpayers seek to maximize after-tax return on investment relative to the risk assumed Minimize the effective tax rate on the income by deferring the payment of taxesStocks that allow tax deferral (low dividends-high capital gains) will possibly sell at a premium.Extensions of Dividend TheoryExtensions of Dividend TheoryResidual Dividend TheoryClientele EffectInformation EffectAgencyExpectations TheoryResidual Dividend TheoryResidual Dividend TheoryDividends paid only if profits are not completely used for investment purposes—only when there are “residual earnings” after the financing of new investments.Clientele EffectClientele EffectFirms draw a certain clientele given their stated dividend policy.The possibility that clienteles of investors exist might indicate that the dividend policy matters.Information EffectInformation EffectDividends are important as a communication tool about future earningsInformation asymmetry–Difference in accessibility to information between management and investors may result in a lower stock priceAgency CostsAgency CostsThe stock price of a company with investors who are separate from management may be less than the stock value of a closely held firm. The Potential difference in price is the cost of the conflict to the owners or agency costsA firm’s dividend policy may be perceived as a tool to minimize agency costsExpectations TheoryExpectations TheoryRegardless of the decision, how the market price responds to management’s actions is not determined entirely by the action itself; it is also affected by investors’ expectations about the ultimate decision to be made by management.If there is a difference between actual and expected dividends, stock price should changeDividend Theories: Dividend Theories: ConclusionsConclusionsAs a firm’s investment opportunities increase, the dividend payout ratio should decreaseDividend policy appears to be importantIf dividends influence stock price, this influence is based on investors desire to minimize and defer taxesManagement should avoid surprising investors when it comes to the firm’s dividends decisionDividend ConsiderationsDividend ConsiderationsLegal RestrictionsLiquidity PositionAbsence or lock of other sources of financingEarnings predictabilityOwnership ControlInflationAlternative Dividend PoliciesAlternative Dividend PoliciesConstant dividend payout ratio–Percentage of earnings paid out in dividends is held constant Stable Dollar Dividend per share–Policy maintains a relatively stable dollar dividend over time. The most common of the dividend policies Small, regular dividend plus a year-end extra–Pays a small, regular dollar dividend plus a year-end extra dividend in prosperous years.Dividend Payment ProceduresDividend Payment ProceduresDeclaration date–The date when the dividend is formally declared by the board of directorsDate of record–When the stock transfer books are to be closed– the person who owns the stock on this date receives the dividendPayment date–The date the company mails the dividend checkStock Dividends and Stock Stock Dividends and Stock SplitsSplitsBoth increase the number of shares outstanding.Stock


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