Dividends and Other

Payouts

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19.1 Different Types of Payouts

• Many companies pay a regular cash dividend.

– Public companies often pay quarterly.
– Sometimes firms will pay an extra cash dividend.
– The extreme case would be a liquidating dividend.
• Companies will often declare stock dividends.
– No cash leaves the firm.
– The firm increases the number of shares outstanding.
• Some companies declare a dividend in kind.
– Wrigley’s Gum sends a box of chewing gum.
• Other companies use stock buybacks.
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19.3 The Irrelevance of Dividend Policy
• A compelling case can be made that dividend
policy 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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 Dividends and Investment Policy
• Firms should never forgo positive NPV projects
to increase a dividend (or to pay a dividend for
the first time).
• Recall that one of the assumptions underlying
the 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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19.4 Repurchase of Stock
• Instead of declaring cash dividends, firms can
rid themselves of excess cash through buying
shares of their own stock.
• Recently, share repurchase has become an
important way of distributing earnings to
shareholders.

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 Share Repurchase
• Flexibility for shareholders
• Keeps stock price higher
– Good for insiders who hold stock options
• As an investment of the firm (undervaluation)
• Tax benefits

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 Firms without Sufficient Cash

The direct costs of

Investment Bankers
stock issuance will
add to this effect.

Cash: stock issue

Stock
Firm
Holders
Cash: dividends

Taxes
In a world of personal taxes,
firms should not issue stock to
Gov.
pay a dividend.
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 Firms with Sufficient Cash

• The above argument does not necessarily apply

to firms with excess cash.
• Consider a firm that has $1 million in cash after
selecting all available positive NPV projects.
– Select additional capital budgeting projects (by
assumption, these are negative NPV).
– Acquire other companies
– Purchase financial assets
– Repurchase shares

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 19.6 Real-World Factors Favoring High
Dividends
• Desire for Current Income
• Behavioral Finance
– It forces investors to be disciplined.
• Agency Costs
– High dividends reduce free cash flow.

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19.8 What We Know and Do Not Know
• Corporations “smooth” dividends.
• Fewer companies are paying dividends.
• Dividends provide information to the market.
• Firms should follow a sensible policy:
– Do not forgo positive NPV projects just to pay a
dividend.
– Avoid issuing stock to pay dividends.
– Consider share repurchase when there are few
better uses for the cash.

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 19.10 Stock Dividends
• Pay additional shares of stock instead of cash
• Increases the number of outstanding shares
• Small stock dividend
– Less than 20 to 25%
– If you own 100 shares and the company declared
a 10% stock dividend, you would receive an
additional 10 shares.
• Large stock dividend – more than 20 to 25%

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 Stock Splits
• Stock splits – essentially the same as a stock
dividend except it is expressed as a ratio
– For example, a 2 for 1 stock split is the same as a
100% stock dividend.
• Stock price is reduced when the stock splits.
• Common explanation for split is to return
price to a “more desirable trading range.”

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