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Cash that is paid under the Payout Policy, Modigliani-Miller Dividend…
Cash that is paid under the Payout Policy
Paid As Dividends
Can be either Cash Dividend OR Stock Dividend
Firms have no obligation to issue dividends and are at the discretion of directors
Tend to be sticky: Shareholders expect company to pay dividends and overtime dividends tend to be smoothed relative to profits
Sticky because firms are reluctant to change dividends especially when earnings drop. Dividends tend to follow much smoother pattern than earnings.
Debt-holders may impose restrictions on dividends as covenants
New Dividend rule in Australia means that prior to issuing dividends a 'solvency test' rather than a traditional 'profit test' needs to be done.
Companies can issue either
Regular Dividends
Investors implicitly expect the company to maintain these dividends for the future.
Special Dividends
Special Dividends - Shareholders should not expect them to be repeated. This form of dividend payout is used when the dividend does not want to be sticky.
Measurements of Dividend Payout
DPS - Dividend per Dollar of Share
Dividend Yield - Dividend/Share Price
Dividend Payout - DPS/EPS
Imputation System
Franked dividends carry credits for tax paid by the company. Company tax paid by the company is credited back to the shareholders
Companies in New Zealand and Australia are able to distribute tax credits to ALL shareholders, but these can be Claimed by ONLY residents of Australia and New-Zealand.
Imputation credits cannot be used for Capital gains from retention of profits that arise in CGT. Therefore CGT is being subject to double taxation as imputation credits cannot be transfered to CG and only to fully franked dividends.
TV of money makes PV of CGT payable lower the longer the realisation of gains is delyaed. Investors will be able to realise the gains when their marginal tax rate is low.
Share Buyback/Repurchase
Legal requirements associated with buy back of up to 10% of their ordinary shares in 12 months - 10/12 Rule.
Different Types
Equal Access Buyback - Repurchase from all shareholders on a pro-rata basis
Selective Buyback - Repurchase from specific, limited number of shareholders (requires > 75% approval of non-selling shareholders)
On-market buyback - Repurchase through normal stock trading
Employee share scheme buyback
Reasons
Does not have to repeated and therefore more flexibility. Payment of dividend is a long term commitment and especially share decreases are unappreciated in the market.
Managers get call options on shares. By issuing dividends the share price will decrease and therefore to make it more valuable in the market shares are bough back instead of dividend payout.
Signalling and Undervaluation - Implies company shares are under-values and therefore shares are being bought to increase the price ( Share price protecting)
This is not a valid reason - To improve performance of EPS as the denominator decreases, EPS goes up artificially.
Tax treatment on Buy backs
Off Market Buyback - Transaction structured so that part of payment received treated as dividend for tax purposes. Incorporates features of a fully franked dividend and capital loss tax shield. Tax beneficial relative to dividends because they may provide franking credits and capital gains. Calculation separately done. Managers favor off-market buybacks to distribute franking credits when the buyback os larger and the firm is generating more CF.
On market Buyback - Cannot include dividend component and treated as proceeds from sale of shares. Therefore subject to CGT. Used when firm is undervalued.
Dividends vs. Stock Repurchases
• Dividends are paid by firms with higher permanent operating cash flows, while:
• Repurchases are used by firms with higher temporary, non-operating cash flows
• Firms repurchasing shares also have much more volatile cash flows and distributions because dividend payouts require consistent cash flows
• Firms repurchase stock following poor stock market performance and increase dividends following good performance
Modigliani-Miller Dividend Irrrelevance Theorem
Main Assumption: In a perfect capital market, the value of a firm is independent of its payout policy. Therefore Dividend Policy has no impact on shareholder wealth
Other Assumptions:
No tax differences to investors between dividends and Capital Gains
If companies pay out too much cash, they can issue new stock with no flotation costs or signalling consequences to replace this cash.
If companies pay too little dividends they do not use the excess cash for bad projects or acquisitions and the surplus will be used to repurchase the shares.
What the above essentially means is that dividend policy is a trade off between higher/lower dividends & issuing/replacing shares.
Implications about Dividends
If a firm's investment policies and hence cash flow do not change, the value of the firm cannot change as it changes dividends and the firm value only depends on Investment policy.
Paying dividends is a 0 NPV transaction, so the value of the firm cum dividend equals the value of the firm plus the value of the dividends.
In perfect capital markets, investors who want dividends can replicate dividends by selling their part of holdings in companies that do not pay dividends.
In perfect capital markets, investors who don't want dividends can replicate a no dividend stock by reinvesting their dividends.
M-M Homemade dividend
Since investors can replicate dividends by selling part of their holding in companies at no cost, investors will not be willing to pay a higher price for firms with higher dividend payout. Therefore dividend policy will have no impact on the value of the firm.
But why do companies want to pay dividends and factors that affect the dividend policy.
Resolution of uncertainty - Not a strong argument for a reason as to why a firm would pay dividend.
Issue and Transaction Costs
Information asymmetry and signalling
Agency costs and taxes
Explanation of these factors seperately done.