Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Chapter Eighteen Dividends and Dividend Policy Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-1 Chapter Organisation 18.1 18.2 18.3 18.4 18.5 18.6 18.7 Cash Dividends and Dividend Payment Does Dividend Policy Matter? Real-world Factors Favouring a Low Payout Real-world Factors Favouring a High Payout A Resolution of Real-world Factors? Establishing a Dividend Policy Share Repurchase: An Alternative to Cash Dividends 18.8 Share Dividends and Share Splits 18.9 Employee Share Ownership Plans Summary and Conclusions Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-2 Chapter Objectives • Know the different forms of dividends and the appropriate dividend payment terminology. • Outline the arguments supporting the case for dividend irrelevance. • Discuss factors favouring a low or a high payout. • Explain the residual dividend policy. • Illustrate the situation of share repurchases vs paying a cash dividend. • Understand both bonus issues and share splits. • Outline the various employee share ownership plans. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-3 Types of Dividends • A dividend is a payment made out of a firm’s earnings to its owners (shareholders). • Dividends are usually paid in the form of cash. • Types of cash dividends include: – – – – regular cash dividends extra dividends special dividends liquidating dividends. • Share dividends are also paid, and share repurchases are a dividend alternative. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-4 Cash Dividends • Public companies commonly pay regular cash dividends twice a year – an interim dividend and a final dividend. • After a dividend is declared, it is distributed to all shareholders as of some specific date. • The amount of the cash dividend is expressed in terms of the dollars per share (dividends per share). • Dividends are also expressed as a percentage of the market price (dividend yield) or as a percentage of earnings per share (dividend payout). Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-5 Procedure for Dividend Payment Days Thursday, January 15 Wednesday, January 28 Friday, January 30 Monday, February 16 Declaration date Ex-dividend date Record date Payment date Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-6 Procedure for Dividend Payment • Declaration date: the board of directors declares a payment of dividends. • Ex-dividend date: if you buy the share on or after this date the seller is entitled to keep the dividend. Under ASX rules, shares are traded ex-dividend on and after the seventh business day before the record date. • Record date: declared dividends are distributable to shareholders of record on a specific date. • Payment date: the dividend cheques are mailed to shareholders of record. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-7 The Ex-date Price Drop Ex date -t . . . –2 –1 0 +1 +2 . . . t Price =$10 Price =$9 The share price will fall by the amount of the dividend on the ex date (Time 0). If the dividend is $1 per share, the price will be equal to $10 – 1 = $9 on the ex date. Before ex date (Time –1) Dividend = $0 Price = $10 On ex date (Time 0) Dividend = $1 Price = $9 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-8 Do Dividends Matter? • Yes – The value of a share is based on the present value of expected future dividends. – Dividends are paid in cash, and everybody likes cash. • No – The value of a share is not affected by a switch in dividend policy. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-9 Dividend Policy • Should the firm pay out cash now or invest the cash and pay it out later? • Dividend policy is the time pattern of dividend payout. In particular, should the firm pay out a large percentage of its earnings now or a small (or even zero) percentage? Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-10 Example― Does Dividend Policy Matter? Dividend policy versus cash dividends n An illustration of dividend irrelevance u Original dividends 0 1 2 $1000 $1000 If RE = 20%: P0 = $1000/1.2 + $1000/1.22 = $1527.78 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-11 Example― Does Dividend Policy Matter? (continued) Assume an additional $200 of dividends is offered, financed by an issue of debt or shares. New dividend plan: 0 1 2 $1000 $1000 +200 –240 $1200 $760 P0 = $1200/1.2 + $760/1.22 = $1 527.78 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-12 Dividend Policy Irrelevance • Any increase in dividends at one point is offset exactly by a decrease somewhere else. • An alternative explanation is home-made dividends. Individual investors can undo corporate dividend policy by reinvesting dividends or selling shares. • Companies may help with creating home-made dividends by offering shareholders automatic dividend reinvestment plans (ADPs or DRIPs). • However, we have so far ignored several real-world factors (e.g. taxes) that might influence our conclusions about dividend policy irrelevance. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-13 Dividend Imputation • The imputation system results in shareholders receiving a tax credit with their dividend for the tax actually paid by the company. • Imputation credits can be offset against income tax on the income of shareholders. • Franked dividends are dividends that are paid out of company profits on which tax has been levied. • Dividends are declared as ‘fully franked’, ‘partially franked’, or ‘unfranked’. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-14 Examples of Imputed Tax Credits Shareholders’ level of taxable income Marginal tax rate (1 July 2006) Corporate tax Dividend paid Taxpayer’s additional assessable income Tax on assessable income Credit for company tax Net credit (payment) Tax to be paid on dividends 6 001 to 25 000 15% 25 001 75 001 150000 to to + 75 000 150 000 30% 40% 45% $30 70 $30 70 $30 70 $30 70 $100 $15 30 $15 $100 $30 30 nil $100 $40 30 ($10) $100 $45 30 ($15) ($15) nil $10 $15 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-15 Dividends and the Real World A low payout is better if one considers: • Taxes: Optimal dividend policy is determined by various shareholder situations. Some shareholders prefer high franked dividends, others prefer the company to pay no dividend and retain the funds for reinvestment (tax on dividend income vs capital gains tax). • Flotation costs: Higher dividend payouts may require a new share issue, which could be expensive and decrease the value of the firm. • Dividend restrictions: Debt contracts might limit the percentage of income that can be paid out as dividends. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-16 Dividends and the Real World A high payout is better if one considers: • Desire for current income: Receiving large regular income payments instead of capital gains. • Uncertainty resolution: The ‘bird-in-hand’ story. • Tax benefits: There are some investors who do receive favourable tax treatment from holding high dividends (e.g. corporate investors). • Legal benefits: Superannuation and trust funds. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-17 Resolution of Real-world Factors • Recall: – Based on the home-made dividend argument, dividend policy is irrelevant. – Because of high taxation of some individual investors, a high-dividend policy may be best. – Because of new issue costs, a low-dividend policy is best. • Two important concepts related to dividends and dividend policy relevant at this point are the: – Information content of dividends – Clientele effect. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-18 Information Content of Dividends • Changes in dividends convey information – Dividend increases: Management believes it can be sustained Expectation of higher future dividends, increasing present value Signal of a healthy, growing firm – Dividend decreases: Management believes it can no longer sustain the current level of dividends Expectation of lower dividends indefinitely; decreasing present value Signal of a firm that is having financial difficulties • The information content makes it difficult to interpret the effect of the dividend policy of the firm Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-19 Clientele Effect • Shares attract particular groups based on dividend yield and the resulting tax effects. • Some investors prefer low dividend payouts and will buy shares in those companies that offer low dividend payouts. • Some investors prefer high dividend payouts and will buy shares in those companies that offer high dividend payouts. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-20 Residual Dividend Policy • Issue costs eliminate any indifference between financing by internal capital and new shares. • Dividends are paid only if profits are not completely used for investment purposes. • Desired debt-to-equity ratio is maintained. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-21 Example―Residual Dividend Policy • Each row in the table below represents a different level of investment. The firm’s desired debt-to-equity ratio is 0.50 (i.e. 1/3 debt and 2/3 equity). Row 1 2 3 4 5 6 (1) After-tax earnings 1 000 1 000 1 000 1 000 1 000 1 000 (2) New investment 3 000 2 000 1 500 1 000 500 0 (3) (4) (5) (6) Additional Retained Additional debt earnings shares Dividends 1 000 1 000 1 000 0 667 1 000 333 0 500 1 000 0 0 333 667 0 333 167 333 0 667 0 0 0 1 000 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-22 Relationship Between Dividends and Investment Dividends ($) 999 666 333 0 -333 0 500 1000 1500 2000 2500 3000 New investment ($) Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-23 Key Concepts in Dividend Policy • Dividend stability—dividends are only increased if the increase is believed to be sustainable. • Special dividends—‘one-off’’ extra dividends, clearly indicated as such. • Dividend reinvestment schemes—company reinvests individuals’ dividends into fully paid shares of the company. Avoids transactions costs (e.g. brokerage, stamp duty) and need for prospectus, and shares are usually offered at a discount. For tax purposes, a cash dividend is notionally paid with any franking credits. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-24 Australian Equity Raisings 2001 Source: Australian Stock Exchange Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-25 Share Repurchases • Company buys back its own shares. • Similar to a cash dividend in that it returns cash from the firm to the shareholders. • This is another argument for dividend policy irrelevance in the absence of taxes or other imperfections. • Subject to Corporations Act 2001 and ASX rules. • Generally companies are able to purchase 10 per cent of their ordinary shares in a 12-month period. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-26 Types of Buy-Back • Equal access purchase: – All shareholders are invited to sell to the company directly. • On-market purchase: – Purchase by a company of its own shares on the open market. • Employee share purchase: – Repurchase shares from employees that were issued under employee incentive scheme. • Selective purchase: – Repurchase of shares from specific shareholders. • Odd-lot purchase: – Repurchase of small parcels of shares. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-27 Example―Cash Dividend versus Share Repurchase Assume no taxes or other market imperfections. Consider a firm with 50,000 shares outstanding, net profit of $100,000 and the following balance sheet. Cash Other Assets Total $ 100 000 900 000 $1 000 000 $ 0 1 000 000 $1 000 000 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan Debt Equity Total 18-28 Example―Cash Dividend versus Share Repurchase (continued) • Price per share is $20 ($1 000 000/50 000). • EPS = $2.00 ($100 000/50 000). • PE ratio = 10 ($20/2). • The firm is considering either: – Paying a $1 per share cash dividend OR – Repurchasing 2500 shares at $20 a share. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-29 Example―Cash Dividend versus Share Repurchase (continued) Cash Dividend Option Cash $ Other Assets Total 50 000 900 000 $ 950 000 $ 0 Debt 950 000 Equity $ 950 000 Total Price per share is $19.00 ($950 000/50 000). EPS = $2.00 ($100 000/50 000). PE ratio = 9.50 ($19/2). Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-30 Cash Dividend versus Share Repurchase (continued) Share Repurchase Option Cash Other Assets Total $ 50 000 900 000 $ 950 000 $ 0 Debt 950 000 Equity $ 950 000 Total Price per share is $20.00 ($950 000/47 500). EPS = $2.105 ($100 000/47 500). PE ratio = 9.5 ($20/2.105). Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-31 Share Dividends and Splits • Bonus shares and share splits: – involve issuing new shares on a pro-rata basis to the current shareholders – do not change the firm’s assets, earnings, risk assumed and investors’ percentage of ownership in the company – increase the number of shares outstanding – reduce the value per share. • A common explanation is to adjust the share price to a ‘more desirable trading range’. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-32 Reverse Splits • The firm reduces the number of shares outstanding. • For example, in a one-for-three reverse split, each shareholder exchanges three old shares for one new share. • Reasoning: – reduction in transaction costs – increase in share marketability (trading range) – regain respectability. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-33 Employee Share Ownership Plans • Encourage the financial participation of employees in the company. Can involve: – – – – – – – fully paid shares partly paid shares special classes of shares options phantom or shadow shares employee share trusts tax exemptions. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-34 Summary and Conclusions • Dividend policy is irrelevant when there are no taxes and other imperfections because shareholders can effectively undo the firm’s dividend strategy. • New issue flotation costs and the demand of some shareholders for a high-dividend payout has led companies to develop dividend reinvestment plans. • The clientele effect suggests that firms should be reluctant to change dividend policy. • Dividend stability is usually viewed as highly desirable. • A share buy-back acts much like a cash dividend. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 4e, by Ross, Thompson, Christensen, Westerfield & Jordan 18-35