Dividends policies
Essentials of Managerial Finance
SCOT T BESLEY, EUGENE F. BRIGHAM
14th edition
1
• We refer to the cash payments, or distributions, made to stockholders
from the firm’s earnings, whether those earnings were generated in
the current period or in previous periods, as dividends.
• a firm’s dividend policy involves the decision to pay out earnings or to
retain them for reinvestment in the firm.
• The optimal dividend policy for a firm strikes that balance between
current dividends and future growth that maximizes the price of the
stock.
2
How do dividend policy decisions
affect a firm’s stock price?
• there are those who suggest that dividend policy is irrelevant because
they argue a firm’s value should be determined by the basic earning
power and business risk of the firm, in which case value depends only
on the income (cash) produced, not on how the income is split between
dividends and retained earnings (and hence growth).
dividend irrelevance theory, would contend that investors care only
about the total returns they receive, not whether they receive those
returns in the form of dividends, capital gains, or both.
• Thus, if the dividend irrelevance theory is correct, there exists no
optimal dividend policy because dividend policy does not affect the
value of the firm.
3
• On the other hand, it is quite possible that investors prefer one
dividend policy more than another; if so, a firm’s dividend policy is
relevant.
1. investor prefers to receive dividends ‘‘today’’ because current
dividend payments are more certain than the future capital gains
that might result from investing retained earnings in growth
opportunities.
2. Another factor that might cause investors to prefer a particular
dividend policy is the tax effect of dividend receipts. Investors who
prefer to delay the impact of taxes would be willing to pay more for
low-payout companies than for otherwise similar high-payout
companies, and vice versa.
Those who believe the firm’s dividend policy is relevant are proponents
of the dividend relevance theory, which asserts that dividend policy
can affect the value of a firm through investors’ preferences. 4
• Information Content, or Signaling:
It is a well-known fact that corporations are extremely reluctant to cut
dividends and, therefore, managers do not raise dividends unless they
anticipate higher, or at least stable, earnings in the future to sustain the
higher dividends.
the stock price changes simply indicate that important information is
contained in dividend announcements. In effect, dividend
announcements provide investors with information previously known
only to management. This theory is referred to as the information
content, or signaling, hypothesis.
information content (signaling) hypothesis: The theory that investors
regard dividend changes as signals of management’s earnings forecasts
5
• Clientele Effect:
• It also has been shown that it is very possible that a firm sets a particular
dividend payout policy, which then attracts a clientele consisting of those
investors who like the firm’s dividend policy.
• For example, some stockholders, such as retired individuals, prefer
current income to future capital gains, so they want the firm to pay out a
higher percentage of its earnings.
• Other stockholders have no need for current investment income, so they
favor a low payout ratio.
• Consequently, we would expect the stock price of a firm to change if the
firm changes its dividend policy because investors will adjust their
portfolios to include firms with the desired dividend policy.
• clientele effect: The tendency of a firm to attract the type of investor who
likes its dividend policy.
6
• Free Cash Flow Hypothesis:
• According to the free cash flow hypothesis, the firm should distribute any
earnings that cannot be reinvested at a rate at least as great as the
investors’ required rate of return, rs—that is, payout, the free cash flows.
• Everything else equal, firms that retain free cash flows will have lower
values than firms that distribute free cash flows because the firms that
retain free cash flows actually decrease investors’ wealth by investing in
projects with IRR < rs.
• The free cash flow hypothesis might help to explain why investors react
differently to identical dividend changes made by similar firms. For
example, a firm’s stock price should not change dramatically if it reduces
its dividend for the purposes of investing in capital budgeting projects with
positive NPVs.
7
• On the other hand, a company that reduces its dividend simply to
increase free cash flows should experience a significant decline in the
market value of its stock because the dividend reduction is not in the
best interests of the stockholders - in this case, an agency problem
exists. Thus, the free cash flow hypothesis suggests that a firm’s
dividend policy can provide information about its behavior with
respect to wealth maximization.
• free cash flow hypothesis: All else equal, firms that pay dividends
from cash flows that cannot be reinvested in positive net present
value projects, which are termed free cash flows, have higher values
than firms that retain free cash flows.
8
Types of dividends in practice
1. Residual Dividend Policy:
Dividend policy is very much influenced by investment opportunities and by the
availability of funds with which to finance new investments.
a residual dividend policy, states that a firm should follow these steps when
deciding how much earnings should be paid out as dividends:
(1) determine the optimal capital budget for the year,
(2) determine the amount of capital needed to finance that budget,
(3) use retained earnings to supply the equity component to the extent possible.
(4) pay dividends only if more earnings are available than are needed to support
the optimal capital budget.
9
• The basis of the residual policy is the fact that investors prefer to have
the firm retain and reinvest earnings rather than pay them out in
dividends if the rate of return the firm can earn on reinvested
earnings exceeds the rate investors, on average, can themselves
obtain on other investments of comparable risk.
• according to the residual dividend policy, a firm that has to issue new
common stock to finance capital budgeting needs does not have
residual earnings, and dividends will be zero.
• following the residual dividend policy would be optimal only if
investors were not bothered by fluctuating dividends.
• if investors prefer stable, dependable dividends, rs would be higher
and the stock price lower if the firm followed the residual theory in a
strict sense rather than attempting to stabilize its dividends over time.
10
2. Stable, Predictable Dividends:
• In the past, many firms set a specific annual dollar dividend per share
and then maintained it, increasing the annual dividend only if it
seemed clear that future earnings would be sufficient to allow the
new dividend to be maintained. A corollary of that policy was this
rule: Never reduce the annual dividend.
• When the economy expands quickly, inflationary pressures plus
reinvested earnings generally tend to push earnings up, so many firms
that would otherwise follow the stable dollar dividend payment policy
switch to a ‘‘stable growth rate’’ policy.
• Here the firm sets a target growth rate for dividends and strives to
increase dividends by this amount each year.
• Management stopped increasing the dividend when earnings fell but
did not cut the dividend, even when earnings failed to cover it.
11
• There are two good reasons for paying stable, predictable dividends
rather than following the residual dividend policy.
• First, given the existence of the information content, or signaling,
idea, a fluctuating payment policy would lead to greater uncertainty,
hence to a higher rs and a lower stock price, than would exist under a
stable policy.
• Second, many stockholders use dividends for current consumption,
and they would be put into trouble and expense if they had to sell
part of their shares to obtain cash if the company cut the dividend.
• predictable dividends imply more certainty than variable dividends,
thus a lower rs and a higher firm value. So it is this dividend policy
that most firms favor.
12
3. Constant Payout Ratio:
• It would be possible for a firm to pay out a constant percentage of
earnings (dividends per share divided by earnings per share), but
because earnings surely will fluctuate, this policy would mean that the
dollar amount of dividends would vary.
• Therefore, with the constant payout ratio dividend policy, if earnings
fluctuate, investors would have had much greater uncertainty
concerning the expected dividends each year, and chances are rs also
would be greater; hence, its stock price would be lower.
4. Low Regular Dividend Plus Extras:
• A policy of paying a low regular dividend plus a year-end extra in good
years is a compromise between a stable dividend (or stable growth
rate) and a constant payout rate.
13
• Such a policy gives the firm flexibility, yet investors can count on
receiving at least a minimum dividend. Therefore, if a firm’s earnings
and cash flows are quite volatile, this policy might be its best choice.
The directors can set a relatively low regular dividend—low enough so
that it can be maintained even in low-profit years or in years when a
considerable amount of retained earnings is needed for investments
—and then supplement it with an extra dividend in years when excess
funds are available.
14
Payment procedures
• Oct. 17—Eastman Kodak Company’s board of directors today declared a semi-
annual cash dividend of 25 cents per share on the outstanding common stock of
the company. The 25-cent per share dividend declared today will be payable
December 14, 2006, to shareholders of record at the close of business on
November 1, 2006.
• The three dates included are important to current stockholders. These dates, as
well as the ex-dividend date, are defined as follows:
1. Declaration date.
On the declaration date, October 17, 2006, in Kodak’s case, the board of directors
meets and declares the regular dividend. For accounting purposes, the declared
dividend becomes a liability to the firm on the declaration date, and if a balance
sheet were constructed, the amount ($0.25 x the Number of shares outstanding)
would appear as a current liability, and retained earnings would be reduced by a
like amount. 15
2. Holder-of-record date.
At the close of business on the holder-of-record date or date of record,
the company closes its stock transfer books and produces a list of
shareholders as of that date. Thus, if Kodak was notified of the sale and
transfer of some stock before 5 p.m. on Wednesday, November 1, 2006,
then the new owner received the dividend. However, if notification was
received after November 2, the previous owner of the stock got the
dividend check because his or her name appeared on the company’s
ownership records
16
3. Ex-dividend date.
• The securities industry has set up a convention declaring that the right to the
dividend remains with the stock until two business days prior to the holder-of-
record date. This is to ensure the company is notified of the transfer in time to
record the new owner and thus pay the dividend to him or her. The date when
the right to receive the next dividend payment no longer goes with the stock—
that is, new purchasers will not receive the next dividend—is called the ex-
dividend date.
• In the case of Kodak, the ex-dividend date was Monday, October 30, 2006,
which is two business days before the holder-of-record date, Wednesday,
November 1, 2006. Therefore, any investor who purchased the stock on or
after that date did not receive the next dividend payment associated with the
stock. All else equal, then, we would expect that the price of Kodak’s stock
dropped on the ex-dividend date by approximately the amount of the
dividend.
17
4. . Payment date.
• Kodak paid the common stock dividends on Thursday, December 14,
2006—this is the payment date. Many firms now pay dividends
electronically.
18
dividend reinvestment plans (DRIPs)
• Most large companies offer dividend reinvestment plans (DRIPs),
whereby stockholders can automatically reinvest dividends they
receive in the stock of the paying corporation.
• There are two types of DRIPs (referred to as ‘‘drips’’):
• (1) plans that involve only ‘‘old’’ stock that already is outstanding and traded
in the financial markets and
• (2) plans that involve newly issued stock.
• In either case, the stockholder must pay income taxes on the amount
of the dividends even though stock rather than cash is received.
19
• Under the ‘‘old-stock’’ type of plan, the stockholder chooses between
receiving dividend checks or having the company use the dividends to
buy more stock in the corporation. If the stockholder elects
reinvestment, a bank, acting as a trustee, takes the total funds available
for reinvestment, purchases the corporation’s stock on the open market,
and allocates the shares purchased to the participating stockholders’
accounts on a pro-rata basis.
• The ‘‘new-stock’’ type of DRIP provides for dividends to be invested in
newly issued stock; hence, these plans raise new capital for the firm.
Companies use such plans to raise substantial amounts of new equity
capital. No fees are charged to stockholders, and many companies offer
stock at a discount of 5 percent below the actual market price. The
companies absorb these costs as a trade-off against the flotation costs
that would have been incurred had they sold stock through investment
bankers rather than through the dividend reinvestment plans.
20
Factors influence dividends policy
A. Constraints on dividend payments. The amount of dividends a firm
can pay might be limited due to
(1) debt contract restrictions, which often stipulate that no dividends
can be paid unless certain financial measures exceed stated minimums;
(2) the fact that dividend payments cannot exceed the balance sheet
item ‘‘retained earnings’’ (this is known as the impairment of capital
rule, which is designed to protect creditors by prohibiting the company
from distributing assets to stockholders before debt holders are paid);
(3) cash availability because cash dividends can be paid only with cash;
21
B. Investment opportunities. Firms that have large numbers of
acceptable capital budgeting projects generally have low dividend
payout ratios and vice versa.
C. Alternative sources of capital. When a firm needs to finance a given
level of investments and flotation costs are high, the cost of
external equity, re, will be well above the cost of internal equity, rs,
making it better to set a low payout ratio and to finance by retaining
earnings rather than through the sale of new common stock.
D. Ownership dilution. If management is concerned about maintaining
control, it might be reluctant to sell new stock; hence, the company
might retain more earnings than it otherwise would.
22
E. Effects of dividend policy on rs.
Effects of dividend policy on rs. The effects of dividend policy on rs
might be considered in terms of four factors:
1. (a) stockholders’ desire for current versus future income,
2. (b) the perceived riskiness of dividends versus capital gains,
3. (c) the tax advantage of capital gains over most dividends, and
4. (d) the information content of dividends (signaling). Because we
discussed each of these factors earlier, we need only note here that
the importance of each factor in terms of its effect on rs varies from
firm to firm, depending on the makeup of its current and possible
future stockholders.
23
Stock dividends and stock splits
توزيعات أرباح األسهم وتجزءة األسهم
:Stock Splits • تجزءة االسهم
• An action was taken by a firm to:
1. increase the number of shares outstanding
2. Decreasing the par value per share.
3. and thus decrease the per-share price of the stock.
4. Decreasing the earnings and dividends per share
Each shareholder will have more shares, but each share will be worth less.
Stock splits can be of any size—for example, the stock could be split 2-for-1, 3-for-
1, 11.2-for-1, or in any other way
• A stock split is generally used after a sharp price rise to achieve a significant price
drop. 24
مثال توضيحي على تجزءة السهم
• لدينا المعلومات التالية عن شركة البنك العربي كما يلي :
عدد االسهم 20مليون سهم
200مليون دينار رأس المال اسهم عادية
القيمة االسمية للسهم الواحد 10دينار
100مليون عالوة االصدار
دينار
400مليون االرباح المحتجزة
دينار
700مليون مجموع حقوق الملكية
دينار
280دينار سعر السهم في السوق
ك تجزءة السهم بنسبة ، 1 – 10ماذا يحصل على بنود الميزانية اعاله ؟ وكم تتأثر ثرو
25
مثال توضيحي على تجزءة السهم
رأس المال ومجموع حقوق الملكية بقيا ثابتين
كل سccccهم تجccccزاء الى 10اسccccهم
وبالتccالي عccدد االسccهم في السccوق عدد االسهم 200مليون
تضcccاعف 10مcccرات ليصcccبح 200 مليون 200 القيمة االسمية سهم رأس المال اسهم عادية
دينار للسهم
مليcون سcهم ( 20مليcون ) x 10 الواحد 1دينار
وبالمقابcل انخفضcت القيمcة االسcمية مليون 100 االصدار عالوة
للسcccهم الواحcccد عشcccرة اضcccعاف مليوندينار
400 االرباح المحتجزة
لتصcبح دينcار واحcد ( ، ) 10 / 10امcا دينار
مليون 700 مجموع حقوق الملكية
بالنسcبة الى السcعر السcوقي للسcهم
دينار
فإنccه انخفض بمقccدار مضccاعف 10 دينار 28 سعر السهم في السوق
مcccرات ليصcccبح 28دينcccار للسcccهم
الواحد ( ) 10 / 280
26
على فرض ان احد المساهمين كان يملك 1000سهم
من اسهم البنك العربي ماذا حصل لثروة هذا المساهم؟
نالحظ ان
ثروة بعد قبل
المساهم التجزءة
10000 التجزءة
1000 عدد
لم تتغير االسهم
وبقيت 28 280 سعر
ثابتة السهم
280000 280000 ثروة المساهم
27
على فرض ان صافي ربح البنك كان 100مليون
دينار ،ما هي التغيرات التي تطراء على ربحية السهم
؟ PEومضاعف سعر السهم EPSالواحد
بعد قبل
التجزءة
28 التجزءة
280 سعر
انخفضت 0.5 5 السهم
EPS
بقيت 56 56 PE
ثابتة
28
:Stock Dividends • االسهم المجانية
• Stock dividends are similar to stock splits in that they ‘‘divide the pie into
smaller slices’’ without affecting the fundamental position of the current
stockholders. On a 5 percent stock dividend, the holder of 100 shares
would receive an additional five shares (without cost); on a 20 percent
stock dividend, the same holder would receive 20 new shares; and so on.
Again, the total number of shares is increased, so earnings, dividends, and
price per share all decline
• Stock splits generally are used after a sharp price run-up to produce a large
price reduction. Stock dividends typically are used on a regular annual
basis to keep the stock price more or less constrained. For example, if a
firm’s earnings and dividends were growing at about 10 percent per year,
its stock price would tend to go up at about that same rate, and it would
soon be outside the desired trading range. A 10 percent annual stock
dividend would maintain the stock price within the optimal trading range.
29
Balance Sheetتأثيرات الميزانية العمومية
Effects
• With a stock dividend, the par value is not reduced, but an accounting entry is
made transferring funds from the retained earnings account to the common
stock and paid-in capital accounts. The transfer from retained earnings is
calculated as follows
• Porter has 5 million shares outstanding, and they sell for $80 each, so a 20
percent stock dividend would require the transfer of $80 million: Dollars
transferred (5,000,000.00$ * 20% * 80$ = 80,000,000.00$)As shown in the table,
$1 million of this $80 million is added to the common stock account and $79
million is added to the additional paid-in capital account. The retained earnings
account is reduced from $285 million to $205 million.7 30
Porter Electronic Controls Inc.: Stockholders’
Equity Accounts, Pro Forma, December 31, 2009 ($
millions, except per share values)
1. Before a Stock Split or Stock Dividend
• Common stock (5 million shares outstanding, $1 par) $ 5.0
• Additional paid-in capital 10.0
• Retained earnings 285.0
• Total common stockholders’ equity
$300.0
• Book value per share ¼ $300/5 $ 60.0
31
2. After a Two-for-One Stock Split
• Common stock (10 million shares outstanding, $0.50 par) $ 5.0
• Additional paid-in capital 10.0
• Retained earnings 285.0
• Total common stockholders’ equity $300.0
• Book value per share = $300/10 $ 30.0
32
3. After a 20 Percent Stock Dividend
• Common stock (6 million shares outstanding, $1 par)a $ 6.0
• Additional paid-in capital 89.0
• Retained earnings 205.0
• Total common stockholders’ equity
$300.0
• Book value per share = $300/6 $ 50.0
33
مثال توضيحي على اسهم المنحة
• لدينا المعلومات التالية عن شركة البنك العربي كما يلي :
عدد االسهم 20مليون سهم
200مليون رأس المال اسهم عادية
القيمة االسمية للسهم الواحد 10دينار
دينار
100مليون عالوة االصدار
دينار
400مليون االرباح المحتجزة
دينار
700مليون مجموع حقوق الملكية
دينار
280دينار سعر السهم في السوق
اذا قرر البنك توزيع اسهم مجانية على المساهمين بنسبة ، %5ماذا يحصل على بنود
الميزانية اعاله ؟ وكم تتأثر ثروة المالكين؟
34
مثال توضيحي على اسهم المنحة
• اوال :نحسب عدد االسهم المنوي توزيعها كالتالي :
عدد االسهم العادية Xنسبة التوزيعات لالسهم
مليون سهم = مليون 5% X 20
سهم • ثانيا :نحسب القيمة النقدية للتوزيعات كالتالي :
السعر السوقي للسهم Xعدد االسهم الموزعة
دينار = 280مليون دينار X 280مليون سهم
• ثالثا :توزيع القيمة النقدية للتوزيعات على رأس المال وعالوة االصدار
كما يلي :
35
مثال توضيحي على اسهم المنحة
عدد االسهم الجديد 21
20مليون +مليون سهم جديد
سهم
للسهم الواحد 10دينار القيمةمليون
االسمية
عدد االسهم 20مليون سهم
21مليون سهم X 10 210مليون 200مليون دينار رأس المال اسهم عادية
دينار القيمة االسمية للسهم الواحد 10دينار
100مليون 270 +مليون 370مليون 100مليون عالوة االصدار
400مليون – 280مليون دينار
120مليون دينار
400مليون االرباح المحتجزة
دينار دينار
700مليون مجموع حقوق الملكية
700مليون
دينار دينار
بقيت ثابتة 280دينار سعر السهم في السوق
اذا قرر البنك توزيع اسهم مجانية على المساهمين بنسبة ، %5ماذا يحصل على بنود
الميزانية اعاله ؟ وكم تتأثر ثروة المالكين؟
36
على فرض ان صافي ربح البنك كان 100مليون
دينار ،ما هي التغيرات التي تطراء على ربحية السهم
؟ PEومضاعف سعر السهم EPSالواحد
بعد قبل
التوزيع
م21 التوزيع
م20 عدد
انخفضت 4.76 5 االسهم
EPS
انخفض 266.67 280 سعر
56 56 السهم
بقيت PE
ثابتة
37
على فرض ان احد المساهمين كان يملك 1000سهم
من اسهم البنك العربي ماذا حصل لثروة هذا المساهم؟
نالحظ ان
ثروة بعد قبل
المساهم التوزيع
1050 التوزيع
1000 عدد
لم تتغير االسهم
وبقيت 266.67 280 سعر
ثابتة 280000 280000 السهم
ثروة المساهم
38
التجزءة العكسية للسهم
Reversal Stock Split
• Reverse splits, which reduce the shares outstanding, can also be used. For instance, a
company whose stock sells for $5 might employ a 1-for-5 reverse split, exchanging one new
share for five old ones and raising the value of the shares to about $25, which is within the
optimal range.
• It is a process that results in reducing the number of shares traded in the financial market
without affecting the company’s capital so that each shareholder becomes the owner of a
smaller number of shares, but with the following modifications:
1. Increasing the nominal value of the share.
2. An increase in the market price per share.
3. Reducing the number of shares for each shareholder.
• In this case, the company's assets, profits, degree of risk, total property rights, and
shareholders' wealth are also not affected by this process.
• The main objective of this process is to increase the share price in the market in order to
reduce the trading of the company's shares by a smaller number of shareholders. 39
مثال توضيحي على التجزءة العكسية لالسهم
• لدينا المعلومات التالية عن شركة الكيماويات كما يلي :
عدد االسهم 10مليون سهم
10مليون رأس المال اسهم عادية
القيمة االسمية للسهم الواحد 1ديناردينار
500الف عالوة االصدار
دينار
500الف االرباح المحتجزة
دينارمليون
11 مجموع حقوق الملكية
دينار
0.5دينار سعر السهم في السوق
اذا قررت الشركة عمل تجزءة عكسية لالسهم بنسبة ، 1 – 2ماذا يحصل
على بنود الميزانية اعاله ؟ وكم تتأثر ثروة المالكين؟
40
مثال توضيحي على تجزءة السهم العكسية
رأس المال ومجموع حقوق الملكية بقيا ثابتين
كل سcccهمين اصcccبحوا سcccهما واحcccدا
وبالتcccالي فcccإن عcccدد االسcccهم في عدد االسهم الجديد 5مليون
السcccوق انخفض ليصcccبح 5مليcccون 10مليون دينار سهمرأس المال اسهم عادية
القيمة االسمية للسهم
سcهم ( 10مليcون ) 2 /وبالمقابcل الواحد 2دينار
ارتفعت القيمcccة االسcccمية للسcccهم 500الف دينار عالوة االصدار
الواحcد لتصcبح دينcاران ( ، ) X 2 1 500الف دينار االرباح المحتجزة
امccا بالنسccبة الى السccعر السccوقي
11مليون دينار مجموع حقوق الملكية
للسcهم فإنcه ارتفcع بمقcدار الضcعف
ليصcبح 1دينcار للسcهم الواحcد ( 0.5 1دينار سعر السهم في السوق
)X 2
41
على فرض ان احد المساهمين كان يملك 10000سهم
من اسهم الشركة ماذا حصل لثروة هذا المساهم؟
نالحظ ان
ثروة بعد التجزءة قبل التجزءة
المساهم العكسية
5000 العكسية
10000 عدد
لم تتغير االسهم
وبقيت 1 0.5 سعر
ثابتة 5000 5000 السهم
ثروة المساهم
42
على فرض ان صافي ربح الشركة كان مليون دينار ،ما
EPSهي التغيرات التي تطراء على ربحية السهم الواحد
؟ PEومضاعف سعر السهم
بعد التجزءة قبل التجزءة
العكسية
1 العكسية
0.5 سعر
ارتفعت 0.2 0.10 السهم
EPS
بقيت 5 5 PE
ثابتة
43
The end
44