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Session 08-09 - Dividend Policy & Firm Value
Session 08-09 - Dividend Policy & Firm Value
Manish Parmar
Key Concepts
Understand dividend types and how they
are paid
Understand the difference between cash
alternative to dividends
Understand the issues surrounding
Dividend payments can be made in either of the following ways:Cash Dividend - Payment of cash by the firm to its
shareholders. (Normally companies pay regular
dividend.
Dividend payments can be made in either of the following ways:Stock Dividend - Distribution of additional shares to
a firms Shareholders. (Bonus shares)
outstanding
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TABLE 1 Effect of Bonus Shares and Share Splits (I) Equity portion before the bonus issue:
Rs 30,00,000
7,50,000 62,50,000
Total equity
(II) Equity portion after the bonus issue (1 : 2 ratio): Equity share capital (45,000 shares of Rs 100 each) Share premium (45,000 shares Rs 25) Retained earnings (Rs 62,50,000 15,000 shares Rs 125) Total equity (III) Equity portion after the share splits (10 : 1 ratio): Equity share capital (3,00,000 shares of Rs 10 each) Share premium Retained earnings
1,00,00,000
Total equity
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1,00,00,000
Declaration Date ExCumdividend dividend Date Date Record Date Payment Date
Declaration Date: The Board of Directors declares a payment of dividends. Cum-Dividend Date: Buyer of stock still receives the dividend. Ex-Dividend Date: Seller of the stock retains the dividend. Record Date: The corporation prepares a list of all individuals believed to be stockholders as of 4 November.
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Price Behavior
In a perfect world, the stock price will fall by
-2
-1
+1
+2
$P
$P - div
The price drops Exby the amount of dividend Date the cash dividend. Assumptions: No tax on dividend payments
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is irrelevant.
Since investors do not need dividends to convert
shares to cash; they will not pay higher prices for firms with higher dividends.
In other words, dividend policy will have no impact
on the value of the firm because investors can create whatever income stream they prefer by using homemade dividends.
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Homemade Dividends
Bianchi Inc. is a $42 stock about to pay a $2 cash dividend. Bob Investor owns 80 shares and prefers a $3 dividend. Bobs homemade dividend strategy:
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dividend-irrelevance argument is: The investment policy of the firm is set ahead of time and is not altered by changes in dividend policy.
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Repurchase of Shares
In India, repurchase of shares is commonly known as
buyback of shares.
Instead of declaring cash dividends, firms can get rid
Concept Question
How does share buyback impact companies financial condition vis--vis paying cash dividends?
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Cash $150,000 Debt 0 Other Assets 850,000 Equity 1,000,000 Value of Firm 1,000,000 Value of Firm 1,000,000 Shares outstanding = 100,000
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Cash
Other Assets
$50,000
850,000
Debt
Equity
0
900,000
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Cash $50,000 Debt 0 Other Assets 850,000 Equity 900,000 Value of Firm 900,000 Value of Firm 900,000
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Concept Question
If the Board of directors hold ESOPS in the company and they are about to choose dividend vs buyback decision, what will they choose?
Let us have a re-look at the balance sheets we just saw!!
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Cash
Other Assets
$50,000
850,000
Debt
Equity
0
900,000
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Cash $50,000 Debt 0 Other Assets 850,000 Equity 900,000 Value of Firm 900,000 Value of Firm 900,000
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Cash
Other Assets
$50,000
850,000
Debt
Equity
0
900,000
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Cash $50,000 Debt 0 Other Assets 850,000 Equity 900,000 Value of Firm 900,000 Value of Firm 900,000
Shares outstanding= 90,000 Price pershare = $900,000 / 90,000 = $10
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buybacks.
E.g.
GESCO.
http://www.rediff.com/money/2001/jan/12inter.htm
Book Building process to buyback shares.
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shares
annually
with
board
resolution.
Regulation of buybacksContd
The shares bought should be extinguished &
physically destroyed.
A declaration of solvency has to be filed with
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months from 12. Minimum buy-back to be 50 per cent of the proposed size. 25 per cent of the amount earmarked for buyback to be kept in an escrow account Capital raising from equity markets to be prohibited for two years after a buy-back
* Will SEBI's proposals help in checking misuse of the share buy-back route by companies _ Business Today.pdf
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Cash: dividends
Taxes Gov.
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In a world of personal taxes, firms should not issue stock to pay a dividend.
Repurchase shares
Stock Type
Zero-to-Low payout (Prefer Capital gains) Low-to-Medium payout Medium payout High payout (Prefer Stable income) Once the clienteles have been satisfied, a corporation is unlikely to create value by changing its dividend policy.
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Dividends
Time
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dividend. Avoid issuing stock & debt to pay dividends. Consider share repurchase when there are few better uses for the cash.
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indentures.
Internal constraints; like liquidity problems.
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