Measures of Dividend Policy

Dividend Payout:
measures the percentage of earnings that the company
pays in dividends
Dividends / Earnings

Dividend Yield :
measures the return that an investor can make from
dividends alone
=Dividends / Stock Price

Three Schools Of Thought On

Dividends
1.

If
(a) there are no tax disadvantages associated with dividends
(b) companies can issue stock, at no cost, to raise equity,
whenever needed

Dividends do not matter, and dividend policy does

not affect value.
2. If dividends have a tax disadvantage
Dividends are bad, and increasing dividends will
reduce value
3. If stockholders like dividends, or dividends operate as a
signal of future prospects,
Dividends are good, and increasing dividends will
increase value

A clientele based explanation

Basis: Investors may form clienteles based upon their tax
brackets.
Investors in high tax brackets may invest in stocks which do
not pay dividends
those in low tax brackets may invest in dividend paying stocks.

Evidence: A study of 914 investors' portfolios was carried

out to see if their portfolio positions were affected by their
tax brackets. The study found that
Older investors were more likely to hold high dividend stocks
Poorer investors tended to hold high dividend stocks

Results from Regression: Clientele

Effect

Determinants of Dividend Policy

Investment Opportunities:
More investment opportunities - > Lower dividends

Stability in earnings:
More stable earnings -> Higher Dividends

Alternative sources of capital:

More alternative sources -> Higher Dividends

Constraints:
More constraints imposed by bondholders and lenders -> Lower
Dividends

Signaling Incentives:
More options to supply information to financial markets - Lower
need to pay dividends as signal

Stockholder characteristics:
Older, poorer stockholders -> Higher dividends

Other payoutsStock Dividends

and stock splits
Not a true dividend: not paid in cash
Increases the number of outstanding shares
Stock dividend: 20% --20% increase in # shares
Stock splits: 3-for-2 split = 50% stock dividend

Popular trading range:

Stocks are usually traded by a unit of 100 shares
(round lot)
When the price of stock is too high, investors may
be short of money to buy the stock lots.
=> Dividing stocks to smaller units which trade at a
lower price.

Minicase Electronic Timing, Inc

Linear Technology div policy

Basic description: Exhibit 1
Dividend policy: exhibit 3
1986: first IPO
1992 starting paying dividends: increasing the div by
about 0.01$ per share each year
2002: significant drop in sales: -47% in sales, - 54% in
profit
2003: an other increase in dividend to 33.1% of payout
ratio.

Historical payout policy

Analyzing Exhibit 3
How does dividend change?
How does repurchase change?
Has the firm a long-run target payout ratio? (analyzing
exhibit 2)
Linking with the findings of Lintner, how do you
interpret the variation of the payout ratio?

Funding requirement
Do you think whether a payout ratio of 33.1% presents
any problems for Linear?
Analyzing Exhibit 2, what is the trend of change of net
income, operating cash flow, relative to sales?
How about the pre-capital expenditure cash flow as
compared to the capital expenditure?
Look at the cash balance in 2003, what do you think
the cash position of Linear?

Funding requirements
Exhibit TN-1:
Both Net income in % sales and cash flow in % of sales
remains stable, even if the sales dropped by 47% in 2002
The pre-capital expenditure cash flow ranged from 4-19
times capital expenditures.
Large cash balance in 2003: 1.57billion or 16.2% of its
market value.
=> Linear is able to pay a dividend of 33% pre-investment
cash flow while still meeting its investment needs.

Should Linear return cash to its

shareholders?
Taxes:
look at Exhibit 7, what do you infer about the dividend
return and capital gain in the presence of corporate
and personal taxes?

Should Linear return cash to its

shareholders?
Agency: investment opportunity of Linear
Read the 4th paragraph in page 3. What do you infer in
respect to the business plan of Linear?
Has the manager incentive to work for the maximum
value of the firm? (compensation plan for the CEO, ref
ex.6)
What do you infer the cost of carrying cash inside the
company?

How should Linear return cash to

its shareholders?
Consider the various theories that make the dividend
policy relevant. What do you think the pricing
behavior for a $ 1 dividend?
On the announcement day
On the ex-div day?
Table

How should Linear return cash to

its shareholders?
EPS effects:
Back to the MM world, what are the different effects on
stock price and the EPS under the following payout
policy? (data from Ex-2)
Retain all cash
Repurchase stock
Pay dividend

Table

How should Linear return cash to

its shareholders?
Taxes:
What is the price behavior on the announcement day
and the ex-dividend day?

If dividends result in higher taxes,

why do firms pay dividends?
Signaling:
Analyze Ex-3, what is the market price responds to the
dividend increase?
Asquith and Mullins (JoB) find that the reaction of stock
price is about 5%.
Table

If dividends result in higher taxes,

why do firms pay dividends?
Agency:
What is the signal conveyed about the agency relation
inside the company?
With the executive stock options, what do you think the
managers incentive in paying dividend?
Compute the loss of the CEO if it exercise its stock
option after ex-div date (Ex-6)

If dividends result in higher taxes,

why do firms pay dividends?
Clientele effect:
From a tax rate clientele, who prefers the dividends to
capital gain?
From a transaction cost clientele, small investors prefer
what kind of payout policy?
Read the 2nd paragraph in p. 3, which kind of clienteles
does Linear try to attract?
Read the description of Janus Capital (5-6 paragraph). How
does this owner like Linears dividend policy?
(Table)

Other determinants?market
conditions
Dividend policy changes
Early 1960s, most listed firms paid a div
1999, fewer than 21% firms paid
2002-03, div initiates again and increased slightly. (ex-9b)

What account for the change over time?

Change in taxes? Ex-7
Changes in the investment opportunity? Ex 9
Changes in the distribution of firms? In response to the
scandals at Enron, Worldcom, etc?

What should Paul Coghlan

recommend to the board?
A better way? Div/ stock repurchase
Ability to return cash?
What happened?
In the end, Linear increased it dividend by $0.01 per
share.
The stock price rose by 8.7% on a day.