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Payout Policy
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Corporate Finance Lecture Notes
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Payout Policy20 January 2020 14:13
Regular dividends
- Regular payments of cash to shareholders, normally six-monthly, or quarterly
in the USA
- Amount of next div is often announced with latest earnings
- Shareholders entitled to receive next div are all those on the register on day
before next ex-dividend date. On the ex-date, share price drops by the
amount of the div, net of income tax
- Companies are not obliged to pay dividends
- Dividends if paid are part of returns to shareholders on their investment.
They are not a cost to the company
Repurchases
- Discouraged in the USA until 1982. Legalised in UK in 1981. Restricted in
many other countries until 1990s or later
- Most listed companies seek shareholder approval in advance to repurchase
shares during year (in UK, up to 15% of shares in issue)
- Normal method is a programme of small open-market repurchases. There are
also:
○ Fixed-price tender offers (for amounts > 15%)
○ Dutch auctions
○ Repurchases negotiated with a particular shareholder
○ Accelerated share repurchases, in which an investment bank borrows
shares, sells them to the company, then closes its position afterwards
Difference between repurchases and regular dividends
1. Number of shares in issue is reduced in a repurchase
2. Repurchase (or repurchase programme) is a one-off event. There's no
commitment to repurchase in future.
3. Taxed as (potential) capital gains, not income
Special Dividends
- Simply a one-off extra dividend payment, to all shareholders, over and above
regular dividends
- Important in UK; much less so in USA
Theory Regarding Payouts
, regular dividends
- Important in UK; much less so in USA
Theory Regarding Payouts
Why might policy regarding dividend payout affect value? Main ideas:
1. Dividends are irrelevant (Modigliani and Miller)
a. Payout policy does not affect value
b. Assumes investment policy is unaffected
2. Personal taxes
a. Income tax is payable on dividends. Alternative is retention, which
implies capital gain, with capital gains tax. Or repurchase of shares.
b. Companies will choose the route that minimises tax
3. Agency perspective
a. Dividends and repurchases reduce free cash in the company, which
reduces potential agency costs. Dividend payment implies a
commitment to pay in future, so implies greater 'discipline' on
managers.
4. Information perspective
a. Payout policy provides information about current and future prospects.
b. Increase in div could imply higher future cash flows than previously
expected
c. Share repurchase could imply company believes its shares are
undervalued
d. Payout might be a costly signal that company is undervalued
5. Life-cycle theory (from agency considerations)
a. Young companies with many growth opportunities and no free cash
should not pay dividends. Mature companies with slower growth and
generating free cash flows, should pay dividends.
6. Catering theory
a. Certain retail and institutional investors have a demand for dividends.
The reasons are behavioural (psychological) and institutional.
Why repurchase?
1. Repurchases (and special dividends) are flexible
a. No commitment to keep paying
2. Management of earnings per share (EPS)
a. EPS = profit after tax/number of shares in issue
b. Repurchase will normally enhance EPS
c. Helps company reach an EPS target
d. Exercise of stock options dilutes EPS. Repurchases counteract this
e. Executives prefer repurchases if they are paid largely via stock options.
Dividends mechanically reduce the future growth of the share price
(bad for option holder), compared with retention or repurchase. (Until
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