Chapter 16 Payout Policy.ppt

Chapter 16: Payout Policy Many companies pay a regular cash dividend. Public companies often pay quarterly. Sometimes firms will throw in an extra cash dividend. The extreme case would be a liquidating dividend. Often companies will declare stock dividends. No cash leaves the firm. The firm increases the number of shares outstanding. Some companies declare a dividend in kind. Wrigley’s Gum sends around a box of chewing gum. Dundee Crematoria offers shareholders discounted cremations. Standard Method of Cash Dividend Payment Procedure for Cash Dividend Payment Price Behavior around the Ex-Dividend Date In a perfect world, the stock price will fall by the amount of the dividend on the ex-dividend date. The Benchmark Case: An Illustration of the Irrelevance of Dividend Policy A compelling case can be made that dividend policy is irrelevant. Since investors do not need dividends to convert shares to cash they will not pay higher prices for firms with higher dividend payouts. Under some important assumption, MM (1961) proved that dividend policy is irrelevant. The assumptions are No taxes. No transaction costs. Perfect capital market (symmetric information, no agency problems, other) The Benchmark Case: An Illustration of the Irrelevance of Dividend Policy (example 1) York Corporation , an all-equity firm At date 0, the managers are able to forecast cash flows perfectly. The firm will receive a cashflow of $10,000 at date 0 and $10,000 at date 1 The firm will dissolve at date 1.(end its life) The firm has no additional positive NPV projects An Illustration of the Irrelevance of Dividend Policy (example 1) I ) Current Policy:Dividends set equal to cashflow Dividends (Div.) at each date = $10000 The firm value will be : An Illustration of the Irrelevance of Dividend Policy (example 1) Assume 1,000 shares are outstanding, then, price just before dividend is paid is An Illustration of the Irrelevance of Dividend Policy (example 1) I I) Alternative Policy: I