Dividend Policy

11/19/07

Learning Objectives

Factors that influence dividend policy How dividends are paid Major dividend theories Alternatives to cash dividends Stock Dividends Stock Splits Stock Repurchases

Factors that affect Dividend Policy

Company projects low growth, has excess funds, may = large dividends (PG & E) Management expects high growth, high need for cash; may = high retained earnings and low or no dividends (high tech firms) Stockholders preferences Capital gains vs ordinary income

Factors that affect dividend policy

Restrictions on dividend payments Bond indenture agreements Lack of retained earnings Availability of cash

Dividend Payment Procedures

On August 25, 2002 Southside Bankshares announced a quarterly dividend of $1 per share to be paid to shareholders of record September 9, 2002. Dividend will be paid on Sept. 15, 2002 Each dividend must be declared (approved) by the Board of Directors. This is usually done at the quarterly Board meetings.

Dividend Payment Procedures

On August 25, 2002 Southside Bankshares announced a quarterly dividend of $1 per share for shareholders of record as of Sept. 9, 2002, and payable to shareholders on Sept. 15, 2002
25 August 31 1 5 9 September 15

Declaration Date

Date that dividend is announced by the Board of Directors. A dividend payable is recorded on the books. Debit retained earnings
6

Dividend Payment Procedures

On August 25, 2002 Southside Bankshares announced a quarterly dividend of $1 per share for share holders of record as of September 9, 2002, and to be paid on September 15, 2002
25 August 31 1 5 9 September 15

Declaration Date

Date of Record All owners of record will receive the dividend.

7

Dividend Payment Procedures

On August 25, 2002 Southside Bankshares announced a quarterly dividend of $1 per share for shareholders of record September 9, 2002, and to be paid on September 15, 2002
25 August 31 1 7 9 15

September

Ex-Dividend Date Declaration Date Date of Record

To allow time for the official list of stockholders to be updated, stockholders must buy stock before the ex-dividend date which is 2 business days prior to date of record.

Dividend Payment Procedures

On August 25, 2002 Southside Bankshares announced a quarterly dividend of $1 per share for shareholders of record September 9, 2002, and to be paid on September 15, 2002
25 August 31 1 7 9 15

September

Ex-Dividend Date Declaration Date Date of Record Payment Date

Date that the dividend is paid out in cash to the stockholders.

9

Dividend determination methods

Dividend Rate. Most companies use a fixed dollar amount per share. This amount is determined by the Board of Directors Dividends tend to stay the same or increase slightly each year; shows stability, positive future Decreases in dividends can severely impact the stock price
10

Leading Dividend Theories

Clientele Dividend Theory Some investors, such as elderly people on fixed incomes, tend to prefer to receive dividend income. Others, such as young investors often prefer growth, and tend to like their income in the form of capital gains rather than as dividend income.
11

Alternatives to Cash Dividends

Stock Dividends Existing shareholders receive additional shares of stock instead of cash dividends Stock dividends represent a distribution of stock of less than 25% of total shares outstanding Done usually if the firm wants to conserve cash The number of shares is expressed as a percentage of current stock holdings.

e.g. if there is a 10% stock dividend, you would receive one additional share for every 10 that you currently own.
12

Stock Dividend

A stock dividend is recorded at the current market price of the stock For example, if the market price of the stock is $21, and the par value of the stock is $1, then stock dividend of 20,000 shares would be recorded as: Retained Earnings 420,000 Common Stock (at $1 par) 20,000 Capital in excess of par 400,000
13

Stock Dividends Impact on Balance Sheet (Market price $21 per share)
BEFORE 10% Stock DIVIDEND Common Stock (200,000 shares, $1 par) Capital in Excess of Par Retained Earnings TOTAL COMMON STOCK EQUITY $200,000 $1,800,000 $10,000,000 $12,000,000

AFTER 10% STOCK DIVIDEND (Stock price = $21) Common Stock (220,000 shares, $1 par) Capital in Excess of Par Retained Earnings TOTAL COMMON STOCK EQUITY $220,000 $2,200,000 $9,580,000 $12,000,000
14

Alternatives to Cash Dividends

Stock Splits If total shares will increase by more than 25%, the company will usually declare a stock split. Expressed as a ratio to original shares. e.g. a 2-1 split means that each investor will end up with twice as many shares as they had prior to the split.
Link to Reuters
15

Stock split

Typically signals good news, in that the company expects to grow and increase stock price Keeps stock price affordable for the greatest number of potential investors Gives something of value to the shareholder without using up cash Has no impact on the capital structure of the company
16

Stock Splits Impact on Balance Sheet

BEFORE SPLIT

Common Stock (200,000 shares, $1 par) $200,000 Capital in Excess of Par $1,800,000 Retained Earnings $10,000,000 TOTAL COMMON STOCK EQUITY $12,000,000 AFTER THE 2 to 1 STOCK SPLIT
Common Stock (400,000 shares, $.50 par) $200,000 Capital in Excess of Par $1,800,000 Retained Earnings $10,000,000 TOTAL COMMON STOCK EQUITY $12,000,000
17

Impact of Stock Splits and Dividends on Stock Price

The book argues that no significant economic event has taken place and that the price of the stock will drop in proportion to the size of the increase in shares I disagree. Stock splits especially are an indication that the company believes the stock price will continue to grow. As a result, shareholder wealth typically increases as the result of a split
18

Impact of Stock Split on Shareholder

Before Split 100 shares x $10 = $1,000 value After 2 for 1 Split Per book argument (no increase in value) 200 shares x $5 = $1,000 value Investor positive reaction (value increases to $11.00 per share prior to split) 200 shares x $5.50 = $1,100 value
19

Stock Repurchases

A firm buys back its own stock on the open market A very common occurrence recently By reducing the number of shares outstanding, earnings per share are increased Rather than payout a dividend, which would have immediate tax consequences for the investor, a stock repurchase increases the share price Stock repurchase reverses the impact of dilution
20

Stock Repurchase Effect

Serves as a perfect replacement for a dividend payment to shareholders Example: stock worth $60 per share pays $4 dividend. Shareholder has a Stock worth $60 and must pay tax on the $4 dividend If dividend money used to repurchase stock instead, shareholder ends up with stock worth $64 with no immediate recognition of income
21