Week 11 - Payout Policy

Payout Policy

Topics Covered

• Facts About Payout
• Dividends or Repurchases?
• Dividend Clienteles
• Taxes and Payout Policy
• Payout Policy and the Life Cycle of the Firm

Payout Policy - Core Questions

• How much cash should a corporation distribute to its shareholders?
• How should this cash be distributed: through cash dividends or by repurchasing shares?

Methods of Cash Distribution

• Cash Dividend: Regular cash payments that tend to increase steadily with earnings. These are rarely cut back.
  • Managers are hesitant to increase dividends unless confident they can be maintained.
• Stock Repurchase (Share Buybacks): Provides shareholders with cash and offers more flexibility.
  • Often tax-advantaged.
  • Have grown significantly in the last 30 years and now rival dividends in importance in the U.S.

Stability of Dividends vs. Repurchases

• Dividends are generally more stable than repurchases.
• Repurchases experienced sharp cuts during the banking crisis of 2007-2009 and the COVID-19 pandemic.
• Dividends also decreased during these periods, but to a lesser extent than repurchases.
• Cash-rich corporations may undertake substantial repurchase programs while increasing dividends.
• A significant percentage of firms (40.1% from 2011-2020) do not pay dividends or repurchase shares.
  • These are often growth companies like Berkshire Hathaway, Alphabet, and Amazon.

U.S. Data 1985-2020 Showing Dividends and Stock Repurchases by Nonfinancial Companies

• Dividends and Stock Repurchases by Nonfinancial Companies in the United States

Dividend Terminology

• Cash Dividend: A payment/distribution of cash by a firm to its shareholders.
  • Regular cash dividends are typically paid each quarter or semi-annually.
  • May be supplemented by a one-off extra or special dividend.
• Declaration Date: The date the company announces the dividend.
  • In Australia, there are typically two announcements per year: Interim and Final.
• Ex-Dividend Date: The date determining which stockholder is entitled to the dividend payment.
  • Shares trade cum-dividend prior to this date.
  • Generally, the stock price falls by the amount of the dividend on the ex-dividend date.
• Record Date: The date on which the person who owns the stock (registered owner) receives the dividend.
• Payment Date: The date when dividend checks are mailed to shareholders.
• Dividend Reinvestment Plan (DRPs or DRIPs): Allows investors to reinvest their dividends in the company rather than receive cash.
  • Often, new shares are issued at a small discount (e.g., 5%) from the market price.

Additional Dividend Terminology

• Stock Dividend: Distribution of additional shares to a firm’s stockholders.
  • Example: A 5% stock dividend means a shareholder receives five extra shares for every 100 shares owned.
• Stock Splits: Issuance of additional shares to a firm’s stockholders, similar in effect to a stock dividend.
  • Both stock splits and stock dividends increase the number of shares outstanding but do not affect the company's assets, profits, or total value.
  • Consequently, both reduce the value per share.
• Stock Repurchase or Share Buy-back: The firm uses cash to repurchase shares instead of paying dividends.

Cash Dividend Procedure

• The firm’s board of directors declares the dividend.
• The dividend announcement specifies payment to all stockholders registered on a particular record date.
• Stocks are typically bought or sold with dividend (cum dividend) until two business days before the record date, after which they trade ex-dividend.
• Generally, the stock price decreases by the amount of the dividend on the ex-dividend date.
• Checks are mailed to shareholders on the payment date.

Cash Dividend Timeline

• Includes declaration date, ex-dividend date, record date, and payment date.
• The share price typically falls two trading days before the record date.
• The time between the declaration date and the payment date is about one month on average.
• Share trades cum-dividend until the ex-dividend date.

Ex-Div Price Drop

• If a stock closes cum-div at 10 and pays a 1 dividend, it may open ex-div at 9.
• The price drop ( 1 in this case) reflects the market value of the dividend.
• A very rough dividend valuation is indicated by this price drop.

Pfizer's First-Quarter Dividend for 2021

• Includes the declaration date (December 11, 2020), ex-dividend date (January 28, 2021), record date (January 29, 2021), and payment date (March 5, 2021).
• Pfizer declared a regular quarterly dividend of 0.39 per share.

How Firms Repurchase Stock

• Stock Repurchase: A firm buys back its own stock from shareholders.
• Four methods of stock repurchase:
  1. Buy shares on the market
  2. Tender offer to shareholders
  3. Dutch auction
  4. Private negotiation (Green Mail)

The Dividend Decision

• Most firms have longer-term target dividend payout ratios.
• Managers focus more on dividend changes than on absolute levels.
• Managers are reluctant to make dividend changes that might have to be reversed.
• To avoid the risk of reduction in payout, managers