1. The Dividend Decision Will it Affect shareholder Value?

2. copyright anbirts2 Agenda The Theoretical Positions -Dividend irrelevance -Dividend relevance -Leftists and rightists The Possible Policies Practical Issues

3. copyright anbirts3 Theoretical Discussion Irrelevance of Dividend Decision, the residual argument -Company X has net assets of £3,000,000 at day1 -1,000,000 shares issued, share price = £3-00 -Co X earns £ 300,000 in year -If no distribution net assets = £3,300,000 so share price £3-30 -If distributes, net assets £3,000,000 so share price £3-00 and each shareholder receives 30 pence div Shareholder total value £3-30 i.e. the same

4. copyright anbirts4 The Buts (Dividend Relevance) But what about shareholders that need income? - No problem, sell shares and manufacture a dividend But what about tax? But what about transaction costs? But what about behavioural finance, the information effect and the bird in the hand?

5. copyright anbirts5 Personal Tax Implications 1 Tax payer – 40% income tax 30% capital Gains tax Owns 100,000 (10%) shares of Co X Co X earnings £300,000 Shareholder Dividend 30,000 Tax at 40% 12,000 Net Receipt 18,000

6. copyright anbirts6 Personal Tax Implications 2 But if no dividend and needs income of £18,000 then Share value £3-30 Capital gain = 30 pence, tax at 30% = 9 pence per share Therefore sell 18,000/3.21 = 5607 shares 5607 x 3-30 = £18,503 5607 x 3-00 = £16,821 Capital Gain £ 1,682 Tax at 30% £ 504 Net receipt £17,999

7. copyright anbirts7 Personal Tax Implications 3 Net Result is to raise £17,999 but Shareholder still has 94,393 shares worth £3-30 each. Total value left £311,497 Original value £300,000 Difference £ 11,497 Income tax £ 12,000 Capital Gains tax £ 504 Difference £ 11,496

8. copyright anbirts8 Tax Effect Ex Dividend Day test Income Tax 40 % Capital Gains Tax 25 % Share Price at Yr start £1.00 Share Price ar Yr end £1.20 (cum div) Income Tax Payer Receives 20 pence dividend Tax 8 Net 12

9. copyright anbirts9 Tax Effect Ex Dividend Day Test Capital Gains Tax Payer would be willing to pay £1.04 at the start of the period to obtain the same result Start Price £1.04 End Price £1.20 Capital Gain 16 Tax @ 25 % 4 Net 12

10. copyright anbirts10 The Buts (part deux) Transaction costs Divisibility Flotation costs Dilution

11. copyright anbirts11 Leftists and Rightists Leftists. Apart from a residual dividend policy dividends are harmful. -costs of funding -tax Rightists. A high payout ratio is a good thing for information effects,clientele effects and psychology

12. copyright anbirts12 Middle of the Roaders Dividend policy does not matter except in so far as tax and transaction costs effect value

13. copyright anbirts13 Information Effect John Lintner (American Economic Review, May 1956) Firms have long run target dividend pay out ratios Focus is on changes rather than absolute levels Changes in dividend follow shifts in long run sustainable earnings (Healy and Palepu, J of Fin Ec 21, 1988) Managers are reluctant to reverse dividend decisions

14. copyright anbirts14 Clientele Effect Widows and orphans Legal restrictions/dividend paying shares Capital gains versus income Behavioural Effect Bird in the hand Dilution Management discipline

15. copyright anbirts15 Policies Argued that there is no right or wrong policy but -There should be one and -It should be consistent Possible policies are -Residual -Stable amount -Constant percentage -No dividend

16. copyright anbirts16 Practicalities 1 Financial - Liquidity/ cash flow - Debt repayment - Asset expansion - Profit growth - Stability of earnings - Access to capital markets

17. copyright anbirts17 Practicalities 2 Legal/ Technical - Restrictive loan agreements - Private limited Cos, only from realised profits

18. copyright anbirts18 Practicalities 3 -Timing Cum dividend – includes accrued dividend when the share is sold Ex dividend – excludes the dividend when the share is sold - Shareholder agreement at AGM Interim Final

19. copyright anbirts19 Other ways to return money to shareholders 1 –Bonus Issue (Scrip Issue) Example Bonus issue of 1share for every 4 owned 1 million new shares at 50p each (par) £000s Before Scrip After Net As 5,000 5,000 Called up Cap Ordinary shares 2,000 +500 2,500 P/L a/c 3,000 - 500 2,500 Shldrs Funds 5,000 5,000

20. copyright anbirts20 Other ways to return money to shareholders 2 Impact on share price Assume pre bonus share price 200p Individual holding of 1,000 shares = £2,000 Will receive 250 shares Therefore owns 1,250 shares worth £2,000 Therefore each share now worth 160p But may perform better Why therefore? – reduce market price, distribute reserves

21. copyright anbirts21 Other ways to return money to shareholders 3 Share buy backs How -by acquiring shares through the stock market -agreements with specific shareholders -tender offer

22. copyright anbirts22 Other ways to return money to shareholders 4 Why - Distribution of cash but no commitment - EPS will rise - Adjust capital base - Tighten control - Tax effect - No better use * Cancelled or held as Treasury Stock

23. copyright anbirts23 General Information Dividend Coverage Ratios Industry Ratio Construction 3 Chemicals 2 Engineering 2.25 Telecoms 1.5 Oil Exploration and 1 Production (From Peter Atrill original source, FT17-10- 98

24. copyright anbirts24 General Information Country Differences Dividend Payment, what it looks like! Dividend Reinvestment Plans