Measures of Dividend Policy Dividend Payout:

measures the percentage of earnings that the company pays in dividends

Dividends / Earnings Dividends / Earnings

Dividend Yield :

measures the return that an investor can make from dividends alone

=Dividends / Stock Price

Three Schools Of Thought On

Dividends1. If

(a) there are no tax disadvantages associated with dividends(b) companies can issue stock, at no cost, to raise equity,

whenever needed

Dividends do not matter, and dividend policy does Dividends do not matter, and dividend policy does not affect value.

2. If dividends have a tax disadvantageDividends are bad, and increasing dividends will reduce value

3. If stockholders like dividends, or dividends operate as a signal of future prospects,Dividends are good, and increasing dividends will increase value

A clientele based explanation Basis: Investors may form clienteles based upon their tax

brackets.

Investors in high tax brackets may invest in stocks which do not pay dividends not pay dividends

those in low tax brackets may invest in dividend paying stocks.

Evidence: A study of 914 investors' portfolios was carried out to see if their portfolio positions were affected by their tax brackets. The study found that

Older investors were more likely to hold high dividend stocks

Poorer investors tended to hold high dividend stocks

Results from Regression: Clientele

Effect

Determinants of Dividend Policy Investment Opportunities:

More investment opportunities - > Lower dividends

Stability in earnings: More stable earnings -> Higher Dividends

Alternative sources of capital: Alternative sources of capital: More alternative sources -> Higher Dividends

Constraints: More constraints imposed by bondholders and lenders -> Lower

Dividends

Signaling Incentives: More options to supply information to financial markets - Lower

need to pay dividends as signal

Stockholder characteristics: Older, poorer stockholders -> Higher dividends

Other payoutsStock Dividends

and stock splits Not a true dividend: not paid in cash Increases the number of outstanding shares

Stock dividend: 20% --20% increase in # shares Stock splits: 3-for-2 split = 50% stock dividend Stock splits: 3-for-2 split = 50% stock dividend

Popular trading range: Stocks are usually traded by a unit of 100 shares

(round lot) When the price of stock is too high, investors may

be short of money to buy the stock lots. => Dividing stocks to smaller units which trade at a

lower price.

Minicase Electronic Timing, Inc

Linear Technology div policy Basic description: Exhibit 1

Dividend policy: exhibit 3

1986: first IPO

1992 starting paying dividends: increasing the div by 1992 starting paying dividends: increasing the div by about 0.01$ per share each year

2002: significant drop in sales: -47% in sales, - 54% in profit

2003: an other increase in dividend to 33.1% of payout ratio.

Historical payout policy Analyzing Exhibit 3

How does dividend change?

How does repurchase change?

Has the firm a long-run target payout ratio? (analyzing Has the firm a long-run target payout ratio? (analyzing exhibit 2)

Linking with the findings of Lintner, how do you interpret the variation of the payout ratio?

Funding requirement Do you think whether a payout ratio of 33.1% presents

any problems for Linear?

Analyzing Exhibit 2, what is the trend of change of net Analyzing Exhibit 2, what is the trend of change of net income, operating cash flow, relative to sales?

How about the pre-capital expenditure cash flow as compared to the capital expenditure?

Look at the cash balance in 2003, what do you think the cash position of Linear?

Funding requirements Exhibit TN-1:

Both Net income in % sales and cash flow in % of sales remains stable, even if the sales dropped by 47% in 2002

The pre-capital expenditure cash flow ranged from 4-19 The pre-capital expenditure cash flow ranged from 4-19 times capital expenditures.

Large cash balance in 2003: 1.57billion or 16.2% of its market value.

=> Linear is able to pay a dividend of 33% pre-investment cash flow while still meeting its investment needs.

Should Linear return cash to its

shareholders? Taxes:

look at Exhibit 7, what do you infer about the dividend return and capital gain in the presence of corporate and personal taxes?and personal taxes?

Should Linear return cash to its

shareholders?Agency: investment opportunity of Linear

Read the 4th paragraph in page 3. What do you infer in respect to the business plan of Linear?

Has the manager incentive to work for the maximum Has the manager incentive to work for the maximum value of the firm? (compensation plan for the CEO, ref ex.6)

What do you infer the cost of carrying cash inside the company?

How should Linear return cash to

its shareholders? Consider the various theories that make the dividend

policy relevant. What do you think the pricing behavior for a $ 1 dividend?

On the announcement day On the announcement day

On the ex-div day?

Table

How should Linear return cash to

its shareholders? EPS effects:

Back to the MM world, what are the different effects on stock price and the EPS under the following payout policy? (data from Ex-2)policy? (data from Ex-2)

Retain all cash

Repurchase stock

Pay dividend

Table

How should Linear return cash to

its shareholders? Taxes:

What is the price behavior on the announcement day and the ex-dividend day?

If dividends result in higher taxes,

why do firms pay dividends? Signaling:

Analyze Ex-3, what is the market price responds to the dividend increase?

Asquith and Mullins (JoB) find that the reaction of stock Asquith and Mullins (JoB) find that the reaction of stock price is about 5%.

Table

If dividends result in higher taxes,

why do firms pay dividends? Agency:

What is the signal conveyed about the agency relation inside the company?

With the executive stock options, what do you think the With the executive stock options, what do you think the managers incentive in paying dividend?

Compute the loss of the CEO if it exercise its stock option after ex-div date (Ex-6)

If dividends result in higher taxes,

why do firms pay dividends? Clientele effect:

From a tax rate clientele, who prefers the dividends to capital gain?

From a transaction cost clientele, small investors prefer what kind of payout policy?From a transaction cost clientele, small investors prefer what kind of payout policy?

Read the 2nd paragraph in p. 3, which kind of clienteles does Linear try to attract?

Read the description of Janus Capital (5-6 paragraph). How does this owner like Linears dividend policy?

(Table)

Other determinants?market

conditions Dividend policy changes

Early 1960s, most listed firms paid a div

1999, fewer than 21% firms paid

2002-03, div initiates again and increased slightly. (ex-9b) 2002-03, div initiates again and increased slightly. (ex-9b)

What account for the change over time?

Change in taxes? Ex-7

Changes in the investment opportunity? Ex 9

Changes in the distribution of firms? In response to the scandals at Enron, Worldcom, etc?

What should Paul Coghlan

recommend to the board? A better way? Div/ stock repurchase

Ability to return cash?

What happened? What happened?

In the end, Linear increased it dividend by $0.01 per share.

The stock price rose by 8.7% on a day.