Dividends: Key Concepts and Regulations

Dividends

Dividends Defined

  • The board of directors determines the dividend amount per share and the payment date.
  • Cum-Dividend: Just before the ex-dividend date, the stock trades "cum-dividend" meaning the buyer is entitled to the dividend.

Key Dates

  • Declaration Date: Board authorizes dividend; the firm is legally obligated to pay.
  • Record Date: Firm pays the dividend to shareholders recorded on this date.
  • Ex-Dividend Date: Because share registration takes 3 business days, shareholders purchasing stock at least 3 days before the record date receive the dividend.
  • Payable Date: Date the firm pays the dividend.

Timeline for Dividends

  • Board decision and announcement
  • Cum Dividend
  • Ex Dividend (Two days prior to record date)
  • Record date
  • Payment date

Accounting Impact of Dividends

  • Question: If Todos pays $200K in dividends, what's the balance sheet impact?
  • Answer: $200K decrease in both assets and shareholder equity.

Declaration of Dividends

  • The board may authorize dividends subject to restrictions in the articles of incorporation and limitations.
  • Shareholders cannot force directors to declare dividends.
  • Directors have wide discretion under the business judgment rule.

Revocation of Dividends

  • Generally, a declared cash dividend cannot be revoked.
  • Declaration creates a debt against the corporation, giving shareholders creditor rights.
  • Exception: A dividend may be revoked if the declaration or payment would be illegal.

Propriety of Distribution

  • State corporate codes limit directors’ discretion to protect creditors.
  • Prevents troubled companies from issuing large dividends that would otherwise be available to pay corporate debts.

Tests for Propriety of Distributions

  • Traditional Approach
  • Modern Approach

Traditional Approach

  • Distributions can be paid from:
    • Retained Earnings
    • Stated Capital
  • Stated Capital: Par value of par issuance plus amount allocated to stated capital on no-par issuance.

Modern Approach: Florida Test

  • No distribution if, after giving it effect:
    • Cash-Flow Insolvency: Corporation cannot pay debts as they become due.
    • Balance-Sheet Insolvency: Corporation’s total assets are less than its total liabilities.

Cash-Flow Insolvency Example

  • Firm Non−Cash Assets+Cash=Short−Term Liabilities+Long−Term LiabilitiesFirm\ Non-Cash \ Assets + Cash = Short-Term \ Liabilities + Long-Term \ Liabilities
  • $500K + $100K = $300K + $200K
  • The firm is cash-flow insolvent because Cash (100K100K) < Short-Term Liabilities (300K300K).
  • The firm lacks sufficient liquid assets.
  • The firm is balance-sheet solvent because Total Assets (600K600K) > Total Liabilities (500K500K).

Balance Sheet Insolvency Example

  • Firm Non−Cash Assets+Cash=Short−Term Liabilities+Long−Term LiabilitiesFirm\ Non-Cash \ Assets + Cash = Short-Term \ Liabilities + Long-Term \ Liabilities
  • $200K + $300K = $100K + $500K
  • The firm is balance-sheet insolvent because Total Assets (500K500K) < Total Liabilities (600K600K).
  • The firm is cash-flow solvent because Cash (300K300K) > Short-Term Liabilities (100K100K).
  • The firm has sufficient liquid assets.

Liability for Improper Dividends: Board of Directors

  • Directors willfully or negligently voting to declare improper dividends are personally liable to the corporation for the amount paid improperly.

Liability for Improper Dividends: Shareholders

  • Any dividend paid while the corporation is insolvent is a fraudulent conveyance.
  • Shareholders are directly liable to corporate creditors for the dividend amount, whether they knew of the insolvency or not.
  • Personal liability for contribution to a director may exist if the shareholder received the dividend knowing it was improper.

Dividend Terminology

  • Common Stock
  • Preferred Stock
  • Preferred Participating Stock
  • Preferred Cumulative Stock

Hypo Facts

  • Todos has two classes of stock: Class 1 and Class 2.
  • Class 2 is preferred stock and receives 2 per share before Class 1 common stock.
  • There are 10,000outstandingsharesofClass1andoutstanding shares of Class 1 and2,000 shares of Class 2.

Preferred Stock Question 1

  • Scenario: Directors declare a total dividend of only 4,000.
  • Answer: Only Class 2 receives the dividend, equal to 4,000((2 x 2,000).
  • Class 1 shares receive nothing.

Preferred Stock Question 2

  • Scenario: Directors declare a 40,000 dividend.
  • Answer: Class 2 receives 4,000((2 x 2,000).
  • The remaining 36,000ispaidtotheis paid to the10,000 shares of Class 1 common stock.
  • Class 2’s preference is to priority, not the amount of payment.

Preferred Participating Stock

  • Scenario: Directors declare a 40,000 dividend, and the preferred stock is participating.
  • Answer: Class 2 receives 4,000((2 x 2,000).
  • The remaining 36,000ispaidtotheis paid to the10,000sharesofClass1commonstockandtheshares of Class 1 common stock and the2,000 shares of Class 2 preferred stock.

Preferred Cumulative Stock

  • Scenario: Directors declare a 40,000 dividend.
  • 2,000sharesofClass2cumulativepreferredstockwithashares of Class 2 cumulative preferred stock with a2 preference (but not participating).
  • 10,000 shares of Class 1 common stock.
  • Directors have not declared a dividend in the last 3 years.
  • What is the dividend payout?

Preferred Cumulative Stock Answer

  • The firm owes preferred shareholders 2foreachoftheprevious3yearsandfor each of the previous 3 years and2forthisyear(totalfor this year (total8pershareorper share or16,000 total).
  • This sum is paid first because cumulative dividends must be paid before any dividend on common stock.
  • This leaves 24,000tobedistributedamongcommonshares(forto be distributed among common shares (for2.40$$ per share).