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Session 8 Dividend Decision

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Shahil Gupta
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15 views30 pages

Session 8 Dividend Decision

Uploaded by

Shahil Gupta
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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DIVIDEND POLICY

QUESTIONS??
• Whether dividend decisions are important?
• How it impact the firm value?
• What are existing theories on dividend policy?
• When a firm should pay dividends?
D I V I D E N D PAY M E N T
CHRONOLOGY
Commonly, the amount of the
cash dividend is expressed in
terms of dollars per share
(dividends per share).
Also expressed as a percentage
of the market price (the dividend
yield) or as a percentage of net
income or earnings per share
(the dividend payout).
EXAMPLES
2 0 2 3 D I V I D E N D PAY M E N T S
BUYBACKS IN INDIA
TYPES OF BUYBACKS
TRENDS

NSE Firms
2019 2020
No Dividend 165 229
Paid 1294 1230
% Not paid 12.75% 18.62%
THEORIES: DIVIDEND POLICY
• Walter Model
• Gordon model
• MM Theory
WA LT E R ’ S M O D E L
• Assumptions
EXAMPLE
I M P L I C AT I O N S
GORDON MODEL
• Assumptions
MODEL
EXAMPLE
I M P L I C AT I O N S
M M " D I V I D E N D I R R E L E VA N C E "
THEOREM
• Miller and Modigliani (MM, 1961) have advanced the view that the value of a firm
depends solely on its earnings power and is not influenced by the manner in which its
earnings are split between dividends and retained earnings.
MM THEORY
• The substance of MM argument may be stated as follows:
• If a company retains earnings instead of giving it out as dividends, the shareholders
enjoy capital appreciation equal to the amount of earnings retained.
• If it distributes earnings by way of dividends instead of retaining it, the shareholders
enjoy dividends equal in value to the amount by which his capital would have
appreciated had the company chosen to retain its earnings.
• Hence, the division of earnings between dividends and retained earnings is irrelevant
from the point of view of the shareholders.
MM: PROOF
• MM begin with the simple valuation model:

where n is the number of outstanding equity shares at time 0, nP0 is the total market value of
outstanding equity shares at time 0, nD1 is the total dividends in year 1 payable on equity shares
outstanding at time 0, m is the number of equity shares issued at time 1 at price P1 (the prevailing
market price at time 1), (n + m)P1 is the total market value of all outstanding equity shares at time 1,
mP1 is the market value of shares issued at time 1, and ρ is the discount rate.
CONTINUE….
• What is the total amount of new equity stock issued at time 1, mP1 equal to?

• where I is the total investment at the end of year 1, and X is the total net profit of the firm for
year 1.

• As D1 is not found in this equation and as {n + m)P1, l1 X1 and ρ are independent of D1, MM
reach the conclusion that the value of the firm does not depend on its dividend decision.
EXAMPLE
I F D I V I D E N D S A R E PA I D
R E A L W O R L D FA C TO R S
FAV O U R I N G :

Low Payout High Payout

• TAXES • DESIRE FOR CURRENT INCOME

• FLOTATION COSTS • TAX AND OTHER BENEFITS FROM


HIGH DIVIDENDS
I N F O R M AT I O N C O N T E N T O F
DIVIDENDS
• Dividend Decision are signals-
• The reaction can be attributed to changes in the expected amount of future
dividends, not necessarily a change in dividend payout policy. This reaction is called
the information content effect of the dividend. The fact that dividend changes convey
information about the firm to the market makes it difficult to interpret the effect of the
dividend policy of the firm.
THE CLIENTELE EFFECT
• Some groups (wealthy individuals, for example) have an incentive to pursue low-payout
(or zero-payout) stocks. Other groups (corporations, for example) have an incentive to
pursue high-payout stocks. Companies with high payouts will attract one group, and low-
payout companies will attract another. These different groups are called clienteles.
• The clientele effect argument states that different groups of investors desire different
levels of dividends. When a firm chooses a particular dividend policy, the only effect is to
attract a particular clientele. If a firm changes its dividend policy, then it attracts a different
clientele.
STOCK REPURCHASES: AN
A LT E R N AT I V E T O C A S H D I V I D E N D S
• The purchase, by a corporation, of its own shares of stock; also known as a buyback.
SHARE REPURCHASES
• Three ways-
1. First, open market purchases, the firm does not reveal itself as the buyer. The seller
does not know whether the shares were sold back to the firm or sold to another
investor.
2. Second, tender offer. Here, the firm announces to all of its stockholders that it is willing
to buy a fixed number of shares at a specific price.
3. Finally, firms may repurchase shares from specific individual stockholders. This
procedure has been called a targeted repurchase.
REAL WORLD CASE
STOCK DIVIDENDS AND STOCK SPLITS

• Stock dividend: A payment made by a firm to its owners in the form of stock, diluting the
value of each share outstanding. Commonly expressed as a percentage; for example, a
20 percent stock dividend means that a shareholder receives one new share for every
five currently owned (a 20 percent increase). the total number of shares outstanding rises
by 20 percent.
• Stock split: An increase in a firm’s shares outstanding without any change in owners’
equity, expressed as a ratio. For example, in a three-for-one stock split, each old share is
split into three new shares. When a split is declared, each share is split up to create
additional shares.
SUMMARY

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