FIN-3403 Lecture Notes - Lecture 17: Dividend Policy, Treasury Stock, Retained Earnings
- Ways a Firm Can Use Cash
o Invest in new projects (reinvest in firm)
o Hoard cash for future use
o Pay out dividend to shareholders
o Repurchase shares from shareholders and hold as treasury stock
- Cash Dividend Measures
o Dividend Yield= D1/P0
o Dividend Payout Ratio= dividend per share/earnings per share = 1 - retention
ratio
- Cash Dividend Mechanics
o Declaration Date
o Ex-Dividend Date
o Date of Record
o Date of Payment
- Does Dividend Policy Matter?
o Need to determine if it has an impact on shareholder wealth (firm value)
o In a perfect economic world:
▪ Externally raised equity is a perfect substitute for retained earnings
• Capital gains returns are interchangeable with dividend returns
• No floatation costs or signaling problems associated with using
new equity
▪ Homemade Dividends
• Investors can sell shares to create an equivalent cash flow to
receiving the dividend stream they want
• If undesired dividends are received, investors can purchase more
stocks
o In a world with no market imperfections, dividend policy is irrelevant
- Here in the Real World
o Retained earnings are preferable to new external equity
o The hoeade aguet does’t appl due to diffeetial ta teatet of
dividends and capital gains
- The Clientele Effect
o Tue as log as the aket fo diided poli is i euiliiu
- Information Content of Dividends
o Share price reaction to the information contained in dividend changes (signaling)
o Result: managers may prefer to maintain a stable dividend policy
- Share Repurchase
o Company buying back outstanding shares of its common stock
o If there are no market imperfections, then stockholder wealth is unaffected by
the choice between share repurchases and cash dividends
o Here in the Real World
▪ Differential tax treatment of dividends versus capital gains
- Five Observations about Dividend Policy
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Document Summary
Invest in new projects (reinvest in firm: hoard cash for future use, pay out dividend to shareholders, repurchase shares from shareholders and hold as treasury stock. Cash dividend measures: dividend yield= d1/p0, dividend payout ratio= dividend per share/earnings per share = 1 - retention ratio. Cash dividend mechanics: declaration date, ex-dividend date, date of record, date of payment. Does dividend policy matter: need to determine if it has an impact on shareholder wealth (firm value) In a perfect economic world: externally raised equity is a perfect substitute for retained earnings, capital gains returns are interchangeable with dividend returns, no floatation costs or signaling problems associated with using new equity, homemade dividends. Investors can sell shares to create an equivalent cash flow to receiving the dividend stream they want. If undesired dividends are received, investors can purchase more stocks. In a world with no market imperfections, dividend policy is irrelevant.
