3. Dividend Policy Theory

3. Dividend Policy Theory

1. Basics

   • What is the process of paying dividends?
     • Why pay dividend?
       • How pay dividends?
         • When?
           • Where?
           • Net profit rule
             • Only current or previous earnings
             • Capital impairment rule
               • No distrbution from capital reserves
               • Insolvency rule
                 • No distribution if firm bankrupt No distribution if debt covenants are breached
                 • Government regulation
                   • Loyds case
         • As residual
           • Dividend = delta earning + delta debt + earnings -investment
           • Expectation
             • High volatility in dividends
               • High growth companies pay small dividends
                 • Mature companies pay high dividends
           • Dividends are not volatile
       • 1. Perfect capital markets
         • Dividends does not matter
         • 2. Signal
           • Signal of future prospects Increasing dividends will increase value
           • 3. Agency conflicts
             • If there are agency conflicts, dividends will increase value, as the money does not get spoiled away. Increase dividends will increase value
             • 4. Tax disadvantages
               • If tax disadvantage of dividends, then decreasing dividends will increase value.
               • Dit = -0.003 + 0.033 EPS it + 0.84 Dit-1 + 0.017 TD - 0.003 TX
                 • TD = (1-m)/((1-s)(1-z)) m = tax on dividend z = tax in capital gains s = Tax credit TX = Tax exhaustion variable R^2 = 0.863
           • 1. Firms long term target dividend payout ratios
             • 2. Managers focus more on dividends changes than on absolute levels.
               • 3. Dividends follow shifts in long run, sustainable earnings
                 • 4. Managers are reluctant to make dividend changes that might have to be reversed.
           • High dividend is costly if not having cash flow to back it up.
             • Strong signal
               • Empiral evidence
         • Indifferent between dividends and capital gains
           • The cash flow does not change
     • Announcement data
       • Board declares dividend
       • Ex-dividend date
         • Buyers of stock after this date will not be entitled to dividend
         • Record date
           • Shareholders recorded by this date receive dividend
           • Payment date
             • Eligible shareholders receive dividend

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