Chapter 17: Debt and Payout Policy Flashcards Preview

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Flashcards in Chapter 17: Debt and Payout Policy Deck (16)
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1
Q

What is a cash dividend?

A

Payment of cash by the firm to its shareholders.

2
Q

What is an ex-dividend?

A

Without the dividend. Buyer of a stock after the ex-dividend dates does not receive the most recently declared dividend. Typically the price of the stock will fall by the amount of the dividend once it is ‘ex-dividend’.

3
Q

What are stock dividends and splits?

A

Distributions of additional shares to a firm’s stockholders. With dividends, there is a declaration of a percentage (say, 10%), so that you receive 1 new share for every 10 you own. With splits, one stock might be subdivided into two or three (or merged 2 for 1). The two are very similar – in both cases, s/h receive new shares for each one held. Neither of these instances impacts the company’s assets, profits or total value, but it does tend to result in a rise in the market price of the stock.

4
Q

What is a stock repurchase?

A

A firm distributes cash to s/h by repurchasing shares. There are 4 ways of doing this:

  1. open-market repurchase (via the secondary mkt)
  2. tender offer (will repurchase a certain number at a fixed price)
  3. auction - firm states a range of prices it is willing to pay, and s/h declare how much they are willing to accept
  4. direct negotiation - typically with one major s/h, ‘greenmail’ refers to an instance where this is done to resolve an issue with a hostile bidder/attempted takeover
5
Q

What is the information content of dividends?

A

Dividend increases convey managers’ confidence about future fut cash flow and earnings. Dividend cuts convey lack of confidence and therefore are bad news.

6
Q

How are dividends paid and how do companies decide how much to pay?

A

Most common is regular cash dividend, but sometimes companies pay a stock dividend. A firm is not free to pay dividends at will. For example, it may have accepted restrictions on dividends as a condition of borrowing money. Dividends do not go up and down with every change in the firm’s earnings. Instead, managers aim for smooth dividends and increase dividends gradually as earnings grow.

7
Q

How are repurchases used to distribute cash to s/h’s?

A

Corporations also distribute cash by repurchasing shares, but stock repurchases do not always replace dividends. Mature firms that pay dividends also repurchase shares. On the other hand, thousands of U.S. corporations pay no dividends at all. When they pay out cash, they do so exclusively through repurchases.

8
Q

What are dividend increases and repurchases usually good news for investors? Why are dividend cuts bad news?

A

Managers do not increase dividends unless they are confident that the firm will generate enough earnings to cover the payout. Therefore, the announcement of a dividend increase conveys the managers’ confidence to investors. Dividend cuts convey lack of confidence. Managers generally avoid them unless their firms are in trouble. This information content of dividends is the main reason that stock prices respond to dividend changes. Repurchase are usually also good news, company sees their own stock as a ‘good buy’. Cash payouts by dividends and repurchases can also assure investors who worry that managers might otherwise spend the money on empire-building and negative-NPV projects.

9
Q

Why would payout policy not affect firm value in an ideal world?

A

If the company’s investment policy and capital structure are held constant, then payout policy is a trade-off between cash dividens and the issue of repurchase of common stock. In an ideally simple and perfect world, the choice would have no effect on mkt val. An increa. cash dividend wld req more shares issued or fewer shares repurchased. The increas. cash in s/h’s wallets would be exactly offset by a lower share price. This is MM’s dividend-irrelevance proposition.

10
Q

What is MM’s dividend-irrelevance proposition?

A

The dividend irrelevance theory indicates that a company’s declaration and payment of dividends should have little to no impact on the stock price. If this theory holds true, it would mean that dividends do not add value to a company’s stock price.

What must hold true?
Efficient and complete capital mkt -
no taxes, no institutional constraints, no informational asymmetries, no transaction costs, complete contracting possibilities, and profit-maximising rational agents.

Yet studies show that stocks that do pay a dividend, like many blue-chip stocks, often increase in price by the amount of the dividend as the book closure date approaches. Although the dividend may not actually be paid until a few days after this date, given the logistics of processing such a large number of payments, the price of the stock usually drops again the amount of the dividend. Buyers after this date are no longer entitled to the dividend. These practical examples can conflict with the dividend irrelevance theory.

Analysts conduct valuation exercises to determine a stock’s intrinsic value. These often incorporate factors, such as dividend payments, along with financial performance, and qualitative measurements, including management quality, economic factors, and an understanding of the company’s position in the industry.

11
Q

How might differences in the tax treatment of dividends and capital gains affect payout policy?

A

The longer the wait before the sale of shares (at which point tax is owed), the lower the PV of the tax. Thus, capital gains have a tax advantage for investors. If dividend income is taxed more heavily than cap gains, investors should shun high-dividend stocks. In these cases, corporations should shift to repurchases.

12
Q

How does payout policy normally evolve over the life cycle of the firm?

A

Young, rapidly growing firms are usually raising cash from investors, not distributing it. Such firms rarely pay dividends, although they may repurchase from time to time. Mature firms that generate positive free cash flow make regular payouts, often by repurchases as well as dividends. Commitment to a regular dividend can reassure investors who worry about free-cash-flow problems (over-investment, inefficient operations).

13
Q

What is the fundamental difference between cash and stock dividends?

A

Cash dividends results in a reduction of aggregate firm value due to the disbursement of cash, while stock dividends or split result in no reduction of aggregate firm value, albeit with more or less shares outstanding.

However, cash dividends continue to be paid because it’s a market inefficiency that can change the marketability of shares, and because it’s a requirement of being listed on certain stock exchanges.

14
Q

What are the 4 important dates associated with dividend payments?

A

Declaration (aka Proposal) date: the Board of Directors declares a forthcoming dividend.
With-dividend date is the cut-off for determining dividend entitlement
– An investor who obtains the stock on day after with-dividend date (the ex-dividend date) – or afterwards (until Payment) is not entitled to receive the intended dividend
– Hence, ceteris paribus the value of ex-dividend stock is less than stock is less than that of with-dividend stock, by an amount corresponding to the present value of the dividend
- Record date: statement of firm’s listed shareholders who are listed shareholders who are eligible for a dividend
- Payment date: when cheques are mailed and brokerage accounts are credited.

15
Q

What is the agency problem that paying dividends can address?

A

Money might be spent on building a larger empire, rather than a profitable one.

16
Q

What is the problem that paying dividends might create?

A

If dividends are taxed more heavily than capital gains.