1. DIVIDENDS © 2000 South-Western College Publishing
Chapter 13
DIVIDENDS
© 2000 South-Western College Publishing

2. DIVIDENDS AS A BASIS FOR VALUE
Pricing Models-
Stock prices depended entirely on expected future dividends
The Individual Perspective
where P0 = today's stock price
Di = the dividend in the ith year
Pn = the selling price of the stock in the nth year
k = the expected return on equity.
The Whole Market View
TM 13-1

3. THE DIVIDEND DECISION Three Theories: Dividends Are Discretionary
Earnings can be paid out as dividends or retained for reinvestment
in the business.
Both Options Benefit Stockholders
Dividend - Immediate Cash - Current Income
Retained Earnings - Growth - Deferred Benefit
The Dividend Decision Is A Trade-off.
THE DIVIDEND CONTROVERSY
Whether Paying Dividends or Paying Larger Rather Than Smaller Dividends, Has a Positive, Negative, or Neutral Effect on Stock Price
Three Theories:
TM Slide 1 of 3

4. I. DIVIDEND IRRELEVANCE
PVs Offset in Valuation Model
Tailoring the Cash Flow Stream
Sell off Shares to Maintain Current Income
Works in Perfectly Efficient Capital Markets
Problems: Transaction Costs, Income Taxes
TM Slide 2 of 3

5. II. DIVIDEND PREFERENCE
Argument Is Based On The Uncertainty Of The Future.
(Not a time value of money argument.)
Bird in the Hand Theory
Logical flaw: Why Invest In the Firm In The First Place?
III. DIVIDEND AVERSION
Based On Taxes: Capital Gains vs Ordinary Income
OTHER CONCEPTS
The Clientele Effect
The Residual Dividend Theory
The Signaling Effect of Dividends
The Expectations Theory
Prefer Not to Pay Dividends
No Flotation Costs On Retained Earnings
TM Slide 3 of 3
The View from Within the Company

6. CONCLUSION
No one knows with certainty whether paying more or less in dividends increases or decreases stock prices
Opinions:
Practitioners - positive effect
Scholars - it can't be proven
The majority of U.S. companies pay dividends
On average about 50% of earnings
TM 13- 3

7. LEGAL AND CONTRACTUAL RESTRICTIONS ON DIVIDENDS
Legal Restrictions
Capital Impairment Rule
Dividends can't be paid out of capital, they
must come from retained earnings.
Can't Pay Dividends If Insolvent
Protects creditors in bankruptcy proceedings.
TM Slide 1 of 2

8. Contractual Restrictions
Debt Contracts
Restrict Behavior of the Borrowing Company
Covenants - Loans
Conserve cash and maintain conservative business practices.
May restrict or prohibit the payment of common stock
dividends under certain conditions.
Preferred Stock
Cumulative Feature - no common stock dividends until
preferred dividends are caught up cumulatively.
TM Slide 2 of 2

9. DIVIDEND POLICY Payout Ratio
The rationale under which a firm determines
what it will pay in dividends.
Amount paid and the pattern over time.
DEFINITIONS
Payout Ratio
Payout Ratio =
TM Slide 1 of 2

10. Stability - Constancy Over Time COMMON DIVIDEND POLICIES
A stable dividend is constant, but is usually increased occasionally.
- Nondecreasing -
A dividend with a stable growth rate increases by a more or less
constant percentage.
Signaling effect Keep Dividends From Going Down
Stable dividend Goes up or flattens, but doesn't decline
COMMON DIVIDEND POLICIES
The Target Payout Ratio
Stable Dividend Per Share
A Small Regular Dividend With A Year End Extra If Earnings Permit
TM Slide 2 of 2

11. THE MECHANICS OF DIVIDEND PAYMENTS
Four key dates
Declaration Date: Board of Directors Authorizes Dividend
Date of Record: Dividend payable to owners of record as of the date of record.
The Payment Date: Check is mailed.
The Ex-dividend Date: Purchase cutoff for receiving dividend - Four business days before date of record
TM Slide 1 of 2

12. EXAMPLE DIVIDEND REINVESTMENT PLANS
Declaration Date of Payment
Date Record Date
April May June 1
Ex-Dividend
Date
May 8
The dividend declared on April 27 is payable on June 1 to owners of record as of May 12. However, to be an owner of record by May 12, an investor must have purchased shares by May 7.
Figure The Dividend Declaration and Payment Process
DIVIDEND REINVESTMENT PLANS
Avoids brokerage fees for stockholder and can avoid
flotation costs for company.
Reinvested Dividend is Taxable
TM Slide 2 of 2

13. STOCK SPLITS AND DIVIDENDS
Increase the count of shares in the hands of stockholders with no other real effect
Stock Splits
Issues new shares in numbers proportionate to those already outstanding
Stock Dividends
When new shares are less than or equal to twenty percent of the original
number of shares
RATIONALE FOR SPLITS AND DIVIDENDS
The Trading Range Argument for Splits
Signaling - Giving Something That Doesn't Cost Anything
The Effect on Value
Logically - No Effect
However, a sentiment exists that something is gained, probably because
stock splits and dividends generally occur when prices are rising
TM 13-7

14. ACCOUNTING TREATMENT OF STOCK SPLITS AND DIVIDENDS
Stockholder's Equity
Eagle, Inc.
Common Stock (2 million shrs outstdg, $3 par)... $6,000,000
Paid in Excess ,000,000
Retained Earnings ,000,000
Total Common Equity $12,000,000
Book Value per share $6.00
Table 13-1
TM Slide 1 of 3

15. After a Two-for-One Stock Split
Stockholder's Equity
After a Two-for-One Stock Split
Eagle, Inc.
Common Stock (4 million shrs outstdg, $1.50 par)...$6,000,000
Paid in Excess ,000,000
Retained Earnings ,000,000
Total Common Equity $12,000,000
Book Value per share $3.00
Table 13-2
TM 13-8 Slide 2 of 3

16. Stockholder's Equity After a 10% Stock Dividend (at market price of $10)
Eagle, Inc.
Common Stock (2.2 million shrs outstdg, $3 par)...$6,600,000
Paid in Excess ,400,000
Retained Earnings ,000,000
Total Common Equity $12,000,000
Book Value per share $5.45
Table TM Slide 3 of 3

17. STOCK REPURCHASE An Alternative To A Dividend
Increases the value of the remaining shares
The Opportunistic Repurchase
Takes advantage of a temporarily depressed price
To Dispose Of Excess Cash
Better tax treatment possible for shareholders than a special dividend
To Restructure Capital
Borrow to retire equity and change debt-equity mix
Methods of Repurchasing Shares
Open Market
Tender Offer
Negotiated Deal
TM 13-11