1. Dividend Policy

2. Should the firm pay out money to its shareholders? Source of capital: debt, preferred stocks, common stocks, and retained earnings. If we think dividend policy as an issue if capital structure policy, dividend policy is irrelevant.

3. Three issues 1.Describe various kinds of dividends and how dividends and how dividends are paid. 2.Discuss whether dividend policy matters 3.Strategies implement a dividend policy

4. Type of dividends 1.regular cash dividends (versus. stock dividends, stock repurchase) 2.extra dividends 3.special dividends 4.liquidating dividends

5. Dividend payment

6. Declaration date: to announce Ex-dividend date: four business days before the date of record. Date of record Effect of ex-dividend before ex-date, stock price is $10 is going to pay dividend of $1 per share →after ex-dividend date, stock price is about $9 We expect that the value of a share of stock will go down by about the dividend amount when the stock goes ex- dividend.

7. Whether dividend policy matters Dividend policy is the time pattern of dividend payment. Example Two-period, 100 shares, r=10%, ash flows for each period is $10,000. Case 1: dividends pay out per period are set equal to the cash flow of $10,000 the firm value=173.55*100=17,355

8. Alternatively, case 2 Want to pay $110 at period 1 Period 1 period 2 cash flow 10000 10000 dividends 11000 borrow 1000 -1100 11000 8900 ÷ 100 110 89, the same The value of the stock is not affected by the switch in dividend policy. Dividend policy makes no difference.

9. Homemade dividends Assuming the firm choose case 2 dividend policy, but a shareholder prefers 100 for each period. period 1 period 2 dividends 110 89 lending-10 11 net cash flow 100 100 Firm chooses case1, the shareholder prefers case 2 period 1 period 2 dividends 100 100 borrow 10 -11 net cash flow 110 89

10. Dividends are relevant Dividend policy is irrelevant. Dividend policy by itself can not raise the dividend at one date while keeps it the same at all other dates. Rather, dividend policy merely establishes the trade-off between dividends at one date and dividends at another date. → M&M Dividend Irrelevance Theory

11. Taxes: Tax Differential Theory Compare: –a: dividend income tax, –b: capital gain tax. If a>b, low dividend payout. For some corporate investors, they have 70% dividends tax-free, and Tax-exempt investors, like pension funds, they all require high dividends.

12. Gorden: Bird-in-the-hand theory Gorden argues that a high-dividend policy benefits stockholders because it resolves uncertainty. Forecasts of dividends to be received in the distant future have greater uncertainty than do forecasts of near-term dividends. Stock price should be low for those companies that pay small dividends now in order to remit, high, less certain dividends at later dates.

13. Two special issues 1.Information content of dividends: –The market's reaction to a change in corporate dividend pay out 2.The clientele effect: –Stock attracts particular groups based on dividend yield and the resulting tax effects.

14. Establish a dividend policy 1.Residual dividend policy –Policy under which a firm pays dividends only after meeting its investment needs while maintaining a desired debt/equity ratio. 2.Dividend stability 3.A compromise dividend policy *avoid cutting back positive NPV projects to pay a dividend *avoid dividends cutting *avoid the needs to sell equity to pay a dividend *maintain D/E ratio *maintain a target dividend payout ratio

15. Stock repurchase Stock Dividends and stock splits