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Pradeepta Sethi
TAPMI

Our voyage

Dividend
decision

Working
capital

Long
term
financing

Dividend decision

What is dividend?

What are the forms of distributions?

Why do firms pay dividend?

How do firms decide how much to pay in


dividends?

Why do investors pay attention to


dividends?

Dividend

A payment made by
a company to its
shareholders,
usually as a
distribution of
profits.

Dividend payments

Cash dividend

Stock repurchase

Firm buys back stock from its shareholders

Stock dividend

Payment of cash by the firm to the shareholders

Distribution of
stockholders

additional

shares

to

firms

Stock splits

Issue of additional shares to firms stockholders

Dividend process

Dividend declaration date

Ex-Dividend date

At this point of time investors must have bought the


stock to receive the dividend

Record date

The date on which the board of directors declares


the dividend that will be paid

Makes up a list of shareholders till date. These


shareholders will receive dividend.

Payment date

Dividend got credited in the account.

ONGC Dividend
November
28, 2014

December
16, 2014

ONGC
declares
dividend
of Rs 5.00 per
share

Shares start to
trade exdividend

Declaration
date

Ex-dividend
date

December 17,
2014
Dividend will be
paid
to shareholders
registered
on this date

Record
date

December 15, 2014

Rs. 343.00

December 16, 2014

Rs. 335.00

December 17, 2014

Rs. 343.00

2/3 weeks
after record
date
Dividend
checks
mailed
to shareholders

Payment
date

Measures of dividend policy

Dividend yield = Dividends per share/Price


per share

Measures the return that an investor can


make from dividends alone

Becomes part of the expected return on the


investment

Expected return on stock = Dividend yield


+ Price appreciation

Invest in stocks with high dividend yields.

Dividend Yield
30

25
20
15
10
5
0

2010

2011

2012

2013

Bajaj Auto Ltd.

Cipla Ltd.

Infosys Ltd.

Mahindra & Mahindra Ltd.

Maruti Suzuki India Ltd.

Tata Steel Ltd.

Source: CMIE Prowess

2014

Dividend payout ratio

Dividend payout ratio = Dividends/Earnings

Measures the % of earnings that the company pay


in dividends
Payout ratio > 100% = firms paid more dividend
than their earnings.
Payout ratio tends to follow the life cycle of the firm.
If the net income is negative, the payout ratio cannot
be computed.

Retention ratio= (1- payout ratio)

Used in valuation as a way of estimating dividends


in future periods.

Dividend payout ratios


Payout ratios
300
250
200

150
100
50
0

2010

2011

2012

2013

Bajaj Auto Ltd.

Cipla Ltd.

Infosys Ltd.

Mahindra & Mahindra Ltd.

Maruti Suzuki India Ltd.

Tata Steel Ltd.

Source: CMIE Prowess

2014

Dividend changes

Dividends are sticky.


Dividends follow a smoother path than earnings.
Vary across countries.
Dividend changes
40000
30000
20000
10000
0
2010

2011

2012

2013

Bajaj Auto Ltd.

Cipla Ltd.

Infosys Ltd.

Mahindra & Mahindra Ltd.

Maruti Suzuki India Ltd.

Tata Steel Ltd.

2014

Investors preferences

Investors preferences for returns in the


form of dividend yields versus capital
gains.

the dividend irrelevance theory

the dividend preference theory

the tax effect theory

Do investors prefer high or


low payouts?

Dividends are irrelevant: Investors dont


care about payout.

Bird-in-the-hand: Investors prefer a high


payout.

Tax preference: Investors prefer a low


payout, hence growth.

Dividend Irrelevance Theory


Miller and Modigliani (1961)

Under the assumption of

No tax, No transaction cost

Dividends that a firm pays do not affect the


value of its shares or return to the investors.

Choice between a stock that pays dividend


and a stock that pays no dividend is similar.

What a firm pays in dividends is irrelevant


and that stockholders are indifferent about
receiving dividends.

Dividend preference theory


Gordon (1963), Linter(1962)

The Bird-in-the-Hand Fallacy


Investors prefer dividends to capital gains
because dividends are certain, whereas
capital gains are uncertain.
Risk-averse investors will therefore prefer
dividend.
Possibility of agency cost leads to similar
conclusion.
High payouts reduce the risk of agency costs.

Tax effect theory

Dividends are taxed more highly than capital


gains.

Investors might require a higher pre-tax rate of


return to induce them to buy dividend-paying
stocks

The time value of money means that a dollar of


taxes paid in the future has a lower effective cost
than a dollar paid today.

If a stock is held until the shareholder dies, then


no capital gains tax is due at all.

Taxes dividend policy


Returns to shareholders taxed twice

Clientele effect

Despite the tax disadvantages of dividends,


some different groups, or clienteles, of
stockholders prefer different dividend
payout policies.

On the other hand, stockholders in their


peak
earning
years
might
prefer
reinvestment, because they have less need
for current investment income.

Clientele effect

Therefore, investors who want current


investment income should own shares in
highdividend payout firms, while investors
with no need for current investment income
should own shares in lowdividend payout
firms.

This clustering of stockholders in companies


with dividend policies that match their
preferences in called the clientele effect.

Consequences of clientele effect

Firms get the investors they deserve, because the


dividend
policy
of
a
firm
attracts investors who like it.

Firms
will
have
a
difficult
changing an established dividend policy.

Provides an alternative argument


irrelevance of dividend policy.

If investors migrate to firms that pay the dividends


that most closely match their needs no firms
value should be affected by its dividend policy.

time
for

the

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