BUS 650 Week 5 Discussions

Chapter 10

Dividend Policy: Distributions to Shareholders

Associated Press

Learning Objectives

A�er studying this chapter, you should be able to:

Describe the characteris�cs of common cash dividends. Explain how dividend policy func�ons in perfect capital markets. Show how imperfec�ons in capital markets impact dividend policy. Summarize how dividend policy is put into prac�ce.

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Ch. 10 Introduction

Our study of the capital budge�ng process in Chapters 6, 7, and 8 covered the NPV criterion for iden�fying projects expected to increase corporate shareholders' wealth.

In Chapter 9, we analyzed the considera�ons managers should make when selec�ng the mix of debt and equity used to finance investment projects. Again, this analysis was presented within the framework of maximizing shareholders' wealth. In this chapter, we discuss dividend policy, or the distribu�on of residual cash to shareholders, an act upon which shareholders' wealth ul�mately depends. Figure 10.1 depicts where the dividend decision occurs in terms of the financial balance sheet's model of business ac�vity.

To understand the importance of dividends, let's consider the fundamental equa�on for value:

This equa�on expresses value as the sum of future cash flows, discounted at a risk-adjusted required return. This formula may be applied to stocks by recognizing that the cash flows distributed to shareholders come in the form of dividends.

Now, suppose a fic��ous stock included in its corporate charter an iron-clad, irrevocable promise never to pay a dividend to stockholders. What would be the value of a share of this stock? According to Equa�on (10.2), the value would be zero. Despite the firm's profitability, it would be forced by its own charter to retain all residual cash flows, never distribu�ng funds to shareholders. Because the present value of an infinite stream of zeros is zero, such a firm would be worthless to shareholders. For those who argue that money could s�ll be made via price apprecia�on, consider who would be willing to purchase a valueless stock (especially at a higher price). Such an investment strategy is known as the "next-bigger-fool" strategy. It will eventually break down when there are no buyers willing to make a bad investment, leaving the shareholder with a worthless security.

Yet, you may be aware of firms that pay no dividends and sell for rela�vely high prices. For example, Apple (Ticker: AAPL) quit paying dividends in 1995. In 2012, the company's share price was a whopping $585.00, and investors must have an�cipated the reins�tu�on of dividend payments. It turns out they were right. In March 2012, Apple announced a $2.65 dividend and the repurchase of $10 billion of stock.

This discussion points out two important facts about dividend policy: First, dividends are essen�al to stock value, and second, large future dividends may occur even if current dividends are small or nonexistent.

In our assessment of dividend policy in this chapter, we will assume that the firm has iden�fied its investment projects and established its mix of debt and equity financing. Thus, capital budge�ng is done, capital structure has been targeted, and we may isolate the dividend decision. Because we know our target capital structure, we also know how much equity financing is needed to fund the firm's promising investment projects. This will allow us to focus more closely on the distribu�on of residual cash to shareholders.

Before we dive into our analysis of dividend policy, we will quickly examine two basic types of dividends: regular and special dividends. Following this discussion, we will return to the format used to analyze capital structure, first exploring dividend policy analysis within a perfect capital market. A�er we have established how the process func�ons in this ideal environment, we will once again introduce market imperfec�ons. Finally, we will look at dividend policy in prac�ce.

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As this graph shows, Procter & Gamble has an almost uninterrupted history of dividend increases.

10.1 Overview of Cash Dividends

Corporate law gives the firm's board of directors the authority to declare dividends. This is generally done at quarterly board mee�ngs, with large corpora�ons usually paying dividends four �mes a year. Regular dividends are generally paid on approximately the same dates year a�er year. Most U.S. firms that pay dividends follow the constant dollar dividend policy, in which the company pays the same dollar amount every year unless the dividend increases. This policy represents an implicit promise to shareholders to con�nue paying dividends, year a�er year, at or above the current regular dividend level. Over �me, companies following the constant dollar policy will have a dividend payout that follows a stair-step pa�ern, which can be observed in Figure 10.2. The graph shows Procter & Gamble's (Ticker: PG) quarterly dividend history from 1970 to 2012. As you can see, only in Q1 of 1983 did the amount of the dividend fall, but since then it has steadily increased.

Figure 10.2: Procter & Gamble's quarterly dividend history: 1970–2012

Based on data from Yahoo Finance: h�p://finance.yahoo.com/q/hp? a=06&b=1&c=1985&d=09&e=8&f=2012&g=v&s=pg&ql=1 (h�p://finance.yahoo.com/q/hp? a=06&b=1&c=1985&d=09&e=8&f=2012&g=v&s=pg&ql=1)

Although not a legally enforceable guarantee, a firm declaring a $0.50 regular dividend in the current year is promising its shareholders that it can maintain the regular dividend at or above that level in the future. Regular dividends, therefore, are a quasi-fixed cost. They are fixed in that, like interest payments, they represent an obliga�on of the corpora�on. They are quasi in that, unlike interest payments, there is no legal contract that forces the firm to make payment. If the firm chooses not to make an interest payment, it is an act of default, whereas choosing to forego an expected regular dividend payment is not. However, there is a penalty associated with the inability to maintain a regular dividend at its expected level: the ire of investors. This disappointment is o�en reflected in declining of share prices.

Special dividends, on the other hand, carry no implicit promise. Boards declaring a special dividend are careful to designate it as such. A special dividend might be caused by a special cash flow–genera�ng event. For instance, corpora�ons that have sold a division may find themselves with a large excess cash flow on hand. They could declare a special dividend to put this excess cash in the hands of their stockholders. Some�mes a special dividend is part of a recapitaliza�on plan. For example, Domino's Pizza issued a $13.50 per share special dividend a�er comple�ng a $1.85 billion debt issue in 2012 (PR Newswire, 2012). The distribu�on was designated a special dividend to ensure that investors would not expect the same windfall the following year.

Now that we have briefly overviewed cash dividends, we can move on to learning how they are distributed in perfect and imperfect markets.

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10.2 Dividend Policy in Perfect Capital Markets

Like capital structure, dividend policy is also irrelevant to shareholders in perfect capital markets. A firm is equally valuable whether it pays all of its residual cash to shareholders (a 100% payout), or retains all of its cash flow (a 100% reten�on, or plowback, rate). Regardless of a firm's dividend policy, shareholders' wealth remains unchanged in this environment. This irrelevance can be a�ributed to the perfect market assump�ons discussed in Chapter 9:

1. Perfect markets are fric�onless, so corpora�ons may raise new capital without incurring transac�on costs. Individuals may also buy (or sell) securi�es without commissions or tax ramifica�ons.

2. Perfect markets lack informa�on asymmetry. 3. Perfect markets are strong-form efficient; therefore, security prices accurately reflect value, and agency problems do not exist.

Now, let's analyze dividend irrelevance within this ideal context.

Imagine a corpora�on with 1,000 shares of stock issued and outstanding. The corpora�on has two assets: $100,000 in cash and an iden�fied, proprietary project. This project will cost the firm an ini�al investment of $100,000 and has a net present value of $20,000. The corpora�on has no debt in its capital structure, and management has decided to finance the project with 100% equity. Because the firm operates in perfect financial markets, the stock's price will accurately reflect its value.

Let's consider two alterna�ves for funding the project. First, the firm could retain all of its cash and fund the total cost of the project with internal equity. In this case, the firm's current dividend would be zero because all cash has been retained and reinvested in the project. The second alterna�ve is to distribute all the cash as dividends to current shareholders and sell new stock to raise the equity needed to finance the project. In this case, the firm would pay a dividend of $100 per share and use external equity to fund the project.

Irrelevance predicts that either dividend policy results in the same shareholder wealth. We examine the zero dividend scenario first. If all $100,000 is invested in the project, which has a $20,000 NPV, then the stock's price will be $120. To see this, recall the formula for net present value:

Recognizing that the sum of discounted future cash flows equals value, we can subs�tute value for this term in Equa�on (10.3).

In efficient markets, value equals price. We know NPV is $20,000 and the project costs $100,000, so we can make further subs�tu�ons and solve for the stock's price.

Thus, with 1,000 shares outstanding, the price per share is $120 per share ($120,000/1,000 shares).

Now, let's examine the funding plan that includes a dividend. The company distributes $100,000 cash to its shareholders, resul�ng in a $100 per share dividend ($100,000/1,000 shares), and then raises $100,000 by selling addi�onal stock. Thus, each current shareholder would have $100 in the bank (from the dividend) and a share of stock valued at $20. By distribu�ng all of its cash, the corpora�on is le� with only one asset—the right to pursue the $20,000 NPV project. To raise the $100,000 needed to finance the project, the corpora�on sells 5,000 shares of new stock to the public for $20 per share, the same rate as currently outstanding stock. Both the new and old stockholders have iden�cal rights represen�ng iden�cal claims. The firm now has 6,000 shares, with a total value of $120,000. Ul�mately, the strategy of paying a dividend and raising investment funds by selling stock results in present shareholder wealth of $120 ($100 in cash and a share of stock worth $20)—the same value as the first dividend policy.

Table 10.1 summarizes this result for the two dividend strategies.

Table 10.1: Two dividend strategies compared

Firm paying no dividend Firm paying $100,000 in dividends

Total value $120,000 $120,000

Number of shares 1,000 6,000

Value per share $120 $20

Wealth of "old" shareholders

Number of shares 1,000 1,000

Value of shares $120,000 $20,000

Cash dividend received 0 $100,000

Total wealth $120,000 $120,000

As you can see in the table, neither the value of the firm nor the wealth of the shareholders has changed. The old shareholders who received the dividend simply converted a por�on of their wealth from common stock to cash. Shareholders can reallocate their wealth easily by selling shares at $120 to raise cash (in the case of no dividend) or by using cash to buy shares at $20 (in the case of dividend). Ul�mately, both policies result in iden�cal wealth for exis�ng stockholders, illustra�ng that dividend policy is irrelevant to shareholder wealth within the environment of perfect capital markets.

You may object to this conclusion. You may know of individuals who prefer high-dividend-paying securi�es because they depend on income from their personal investments to meet living expenses. Re�rees, for example, o�en require regular investment income to supplement Social Security payments. Recall, however, that in perfect capitalProcessing math: 0%

Many re�rees supplement their fixed incomes with investments. What are the benefits and risks of this prac�ce?

Associated Press

markets there are no transac�on costs. Re�rees needing current income can, in such markets, manufacture homemade dividends by selling some propor�on of their shares. Consider an individual who owns 60 shares of stock worth $7,200 in the firm that elected the no dividend op�on. If this individual needs $6,000 to pay a hospital bill, he could simply sell 50 shares of stock for $120 each, raising $6,000 in cash. He would s�ll own 10 shares of stock worth $1,200. Had the firm paid a $100 per share dividend and dropped each share's value to $20, the investor would collect $6,000 in total dividends, pay his hospital bill, and s�ll have $1,200 worth of stock in his por�olio. Either way, his total remaining wealth a�er paying his hospital bill is $1,200.

You might assume that investors would prefer a high-payout policy over a homemade dividend. If there is a large clientele with such a preference, the demand for high-payout stocks would drive up their prices. However, in a perfect market, investors with zero dividend policies can simply sell shares of stock to generate cash without transac�on costs. They won't pay a premium for stock with characteris�cs they can duplicate for free; therefore, in perfect markets homemade dividends can subs�tute for dividends generated by the firm.

What of investors who prefer to keep their funds invested in the firm's stock rather than saved in a bank account? Wouldn't these investors pay a premium to invest with firms that adopt a low payout of cash? Again, the answer is no. Consider the 100% payout policy. An investor with 60 shares of stock in such a firm would receive dividends totaling $6,000 and would own 60 shares of $20 stock for a total wealth of $7,200. If the investor wished to maintain her total investment in the firm, she could purchase 300 shares of the newly issued stock for $20 per share. Her total wealth consists of investment in the firm equal to $7,200, and she would own 360 shares (6% of the firm's equity). Note that this is the same posi�on she would be in had the firm chosen to retain all the cash: There would be 1,000 shares outstanding, she would own 60 (6% of the total) and her investment would be worth $7,200. Again, dividend policy is irrelevant because investors can construct their own dividend policies independent of that adopted by the firm.

Both of the aforemen�oned scenarios break down once we introduce imperfec�on into the market. If we allow transac�on costs (e.g., brokerage commissions) to enter these examples, then selling shares to construct a homemade dividend becomes costly and reduces the shareholder's wealth. Clearly, it would be economically preferable for such an individual to invest in a corpora�on adop�ng a higher payout. Thus, just as capital structure irrelevance disappears when perfect market assump�ons are relaxed, a breakdown of irrelevance also occurs in dividend policy. We will now relax the perfect market assump�on to examine dividend policy in a context that more closely resembles the real world.

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Stocks with different dividend prices are like buying chocolate and vanilla ice cream; some people prefer one over the other. What other examples of comparisons can you think of?

Ingram Publishing/SuperStock

10.3 Dividend Policy in Imperfect Capital Markets

Once transac�on costs enter our example, individuals are no longer neutral regarding dividend policy. Those who need steady income from their investments (e.g., re�rees) are likely to prefer stocks that pay rela�vely higher dividends, also known as income stocks. Construc�ng their own homemade dividends would incur brokerage commissions, effec�vely lowering their wealth.

Similarly, investors who wish to keep their savings fully invested in stocks may prefer firms that pay li�le or no dividends. There are firms with numerous promising projects that con�nually reinvest all their residual cash into posi�ve NPV investments; these firms are known as growth companies. As their assets grow, the claims on the assets gain in value, causing price apprecia�on or capital gains. Younger investors, saving for re�rement, o�en prefer to invest in the securi�es of such firms. These investors would rather not receive large dividends and then use this cash to buy more of the company's stock because of the brokerage commission they would have to pay on these transac�ons.

Market Frictions and Dividend Policy: Transaction Costs and Taxes

The existence of two dividend clienteles does not necessarily mean that dividend policy affects firm value. Dividend policy remains irrelevant as long as there are enough high-dividend income and growth stocks to sa�sfy demand for each. Compare this situa�on to buying ice cream. Some people prefer chocolate, and others choose vanilla. The price of both flavors will be equal so long as there is no shortage of one flavor. The same holds true for stocks with different dividend policies: Adop�ng a high or low payout does not lead to an increase in value, as long as demand for such issues is sa�sfied. Thus, irrelevance s�ll persists. We saw this in 2012; as yields on government bonds approached zero, there s�ll wasn't enough excess demand for high dividend paying stocks to shi� prices (Jakab, 2012).

In our example from Sec�on 10.1, the firm adop�ng a high-dividend payout sought outside equity to fund its investment in the posi�ve NPV project. This capital was raised by selling new equity, which was done in a fric�onless, perfect capital market. However, when firms issue and sell securi�es, they generally hire investment bankers to assist them in marke�ng the issue. Investment bankers charge fees for their services, known as flota�on costs. These costs represent a leakage of cash from the firm, lowering its value. Recall in our perfect markets example that the firm funding the project by foregoing dividend payments incurred no fees. With flota�on or brokerage costs associated with other forms of raising capital, investors are no longer indifferent to dividend policy. Because of transac�on costs involved in raising equity capital, firms should first fund all posi�ve NPV projects with opera�ng cash flows and then determine the dividend policy regarding the le�over cash. This strategy is known as a residual dividend policy; funds le� over a�er making all profitable investments are distributed to investors.

Taxes represent an important fric�on in capital markets. Individuals in high personal-tax brackets o�en prefer investments whose returns come in the form of price apprecia�on (capital gains) rather than current income. To convince yourself of this, try the following �me value problem: Suppose you are in the 50% tax bracket and invest $1,000 for 10 years in an investment that returns 10% per year before taxes. Now try two different scenarios. In the first, imagine that you must pay taxes at the end of each year at the 50% tax rate. In the second case, suppose your investment compounds tax-free for 10 years and then you must pay a 50% tax on your total gain. In which case will you be be�er off?

Paying taxes each year at a 50% rate effec�vely lowers your annual return from 10% to 5%. The a�er-tax value of your 10-year, $1,000 investment is found by using the future value of a single cash flow formula from Chapter 3:

FV = $1,000(1.05)10 = $1,628.89

The tax-deferral feature of capital gains allows the investment to compound at 10% for 10 years; then 50% taxes are assessed against the gain:

FV (before taxes) =$1,000(1.10)10 = $2,593.74

In this second scenario, you see a capital gain of $1,593.74 on your original investment. The taxes on the gain must be paid ($1,593.75 × 0.50 = $796.87), leaving you with $1,796.87 a�er tax. The deferral feature of capital gains results in $167.98 greater wealth.

The a�rac�veness of capital gains for this highly taxed individual lies in its tax-deferral feature. Dividends are taxed in the year they are paid, whereas capital gains are not recognized for tax purposes un�l the security is sold at its appreciated value. In 2012, the capital gain has an even greater advantage because it is taxed at a maximum rate of 15%, rather than the ordinary income maximum rate of 35%. Nevertheless, the benefit of tax-deferred compounding exists regardless of the rates.

Taxes and Investment Income

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Investment income may come in the form of interest, dividends, or reselling at a profit. Typical investments include stocks, bonds, or mutual funds. Why should a financial manager consider tax rates when choosing dividend policies?

Many investors pay li�le or no taxes on their investment income. Investors such as low-income re�rees, college endowments, and pension plans pay no taxes on current income and may be indifferent between capital gains and dividends. Does the existence of tax clientele necessarily lead to a prescribed dividend policy that will op�mize the value of the firm? The answer is no. It is the ice cream story once more—as long as demand for firms with a par�cular dividend policy does not outstrip supply, investors will be unwilling to pay a premium price based on the firm's dividend strategy.

Transac�on costs, therefore, lead to one breakdown of the irrelevance proposi�on: The costs associated with raising external equity should be avoided if possible. Thus, market fric�ons lead us toward a residual dividend policy.

Capital Gains Controversy

A par�cular type of capital gain received significant publicity in the early 2000s. Private equity managers were having a considerable por�on of their income taxed as carried interest, qualifying them for the 15% long-term capital gain rate. This became a conten�ous poli�cal issue, promp�ng legisla�on aimed at preven�ng the low rate from being applicable to high income. Master investor Warren Buffet even got involved when he admi�ed in 2011 that he paid only 17.4% in income taxes, which was less than his secretary's rate of more than 30% (Buffet, 2011). He argued that the rich shouldn't pay a lower tax rate than middle-income ci�zens, and his admission helped mo�vate proposed legisla�on aimed at "limi�ng the degree to which the most well-off can take advantage of tax expenditures and preferen�al rates on certain income" (Na�onal Economic Council, 2012, p. 2). This legisla�on, known as "The Buffe� Rule" was a hotly-debated topic in the 2012 presiden�al elec�ons.

Cri�cal Thinking Ques�on

1. Do you think that wealthy individuals should be allowed to pay a lower tax rate using the capital gains rate? Why or why not?

Information Asymmetry and Dividend Policy: Signaling and Agency Costs

Dropping perfect market assump�on reintroduces asymmetry between the informa�on available to company insiders and outsiders. Like the signaling feature of debt, dividend policy also allows insiders to give a credible signal to outsiders regarding the firms' prospects.

Let's examine the signaling effect within the context of the quasi-fixed nature of regular dividends. Recall from Chapter 9 that a firm's management can signal higher expected cash flows by taking on a greater propor�on of debt. The signal is credible because of the penalty associated with false signaling—a higher likelihood of bankruptcy. Similarly, for firms using a constant dollar dividend policy, declaring a higher regular dividend signals to investors that the board, under advisement of management, believes the corpora�on can maintain its dividend at the new level indefinitely into the future. If management expects a firm's cash flows to be higher in the future, they may signal to outsiders the improved prospects by increasing the regular dividend.

If management increases the regular dividend without expec�ng be�er prospects, then they have sent a false signal. There is some likelihood of the firm not being able to meet its new, higher dividend payment. If the company performs poorly, managers may have to lower the dividend. Shareholders respond nega�vely to dividend decreases by lowering their share valua�ons. Some�mes the response is drama�c enough to cost managers their jobs. This penalty for false signaling lends credibility to a dividend increase.

Other policies do not share the constant dollar policy's signal reliability. If the company follows a different type of dividend policy—such as a pure residual dividend policy or a payout ra�o target policy—then investors cannot infer a signal from a dividend increase. Under the pure residual policy, dividends go up and down as earnings and investment need changes. With a target payout ra�o policy, a dividend increase follows higher earnings, but there is no assurance from managers that earnings will con�nue to be high, so there is no signal. Investors prefer the constant dollar policy because it allows managers to reliably signal a company's future prospects.

A second outcome of introducing informa�on asymmetry into our economic environment is the poten�al for agency problems. In Chapter 9, we introduced the agency cost of free cash flow argument, which predicts that firms o�en waste money when cash on hand is in excess of that needed to fund all posi�ve NPV projects. The poten�al for agency costs does not go unno�ced by investors. They see the poten�al for waste within firms that produce cash flows in excess of their internal needs, yet fail to pay outProcessing math: 0%

this cash to residual claimants. In order to lower the poten�al for waste, firms should pay dividends at the highest possible level without limi�ng the cash needed to fund an�cipated promising investment projects.

Now that we have examined how market inefficiencies affect dividend policy, we can more thoroughly examine the process in ac�on.

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10.4 Dividend Policy in Practice

Three proposi�ons that are at odds with dividend irrelevance have been presented:

1. The residual dividend policy prescribes funding all posi�ve NPV projects first and then determining the dividend payment. 2. Signaling with dividends prescribes paying regular dividends at a level that can be maintained by the firm. 3. The agency costs of free cash flow policy prescribe paying the highest possible dividend a�er funding all posi�ve NPV projects.

Taken together, these three proposi�ons suggest that managers take the following ac�ons when implemen�ng dividend policy:

Step 1. Forecast the cash needed to fund the firm's investment projects for several years in the future.

Step 2. Forecast the residual cash flows the firm will generate for several years in the future.

Step 3. Using the informa�on from steps 1 and 2, subtract the cash needed for investment projects each year from the cash flows an�cipated that year in order to determine each year's free cash flow. This effec�vely implements the residual dividend policy's recommenda�ons.

Step 4. Taking into account the variability of the year-to-year expected free cash flow, establish a maintainable regular dividend, thereby implemen�ng the recommenda�ons of the signaling hypothesis.

Step 5. Large free cash flows le� in a par�cular year a�er the payment of a regular dividend and not needed to fund future investment projects should be disgorged. This can be accomplished by se�ng the regular dividend at its highest maintainable level or by using a special dividend, thereby implemen�ng the recommenda�ons of the agency costs of free cash flow argument.

Table 10.2 applies these recommenda�ons to a hypothe�cal firm. The company portrayed follows a constant dollar dividend policy but supplements the regular dividend with a special dividend a�er Year 3, when cash flow genera�on is high.

Table 10.2: Implemen�ng dividend policy for a hypothe�cal firm (100,000 shares outstanding)

Dividend policy implementa�on Year 1 Year 2 Year 3 Year 4

Step 1. Forecast residual cash needed to fund the firm's investments for several years. $200,000 $300,000 $100,000 $250,000

Step 2. Forecast residual cash flows produced by the firm. $350,000 $400,000 $450,000 $400,000

Step 3. Subtract cash flows needed from those produced. $150,000 $100,000 $350,000 $150,000

Step 4. Establish a maintainable regular dividend. $125,000 $125,000 $150,000 $150,000

Price per share $1.25/share $1.25/share $1.50/share $1.50/share

Step 5. Pay out large sums of residual cash using a special dividend.

A�er-dividend residual cash flow $25,000a 0 $200,000 0

Special dividend $200,000

Price per share $2.00/share

aCarried over to Year 2 to fund maintainable regular dividend of $1.25/share.

Note that certain predic�ons are possible when we consider firms' applica�on of these steps in the real world. For example, we can expect that firms in high-growth industries, where new and promising projects abound, will adopt a low (or zero) dividend payout. On the other hand, firms in mature industries would have a higher dividend payout ra�o. Table 10.3 compares the average dividend payout ra�o for 15 diverse industries. No�ce how widely payout ra�os can vary from one category to the next.

Table 10.3: Payout ra�os for selected industries, 1999–2012

Industry name Average payout ra�o Average # of firms

Adver�sing 26.32% 33

Aerospace/Defense 25.49% 64

Apparel 20.12% 56

Biotechnology 5.88% 104

Computer So�ware & Services 14.55% 365

Computer & Peripherals 12.24% 139

Electric U�li�es 54.89% 71Processing math: 0%

Electronics 9.22% 171

Internet 0.67% 268

Medical Services 4.24% 177

Paper & Forest Products 47.41% 42

Petroleum (Integrated) 33.59% 31

Tobacco 53.63% 12

Water U�lity 88.03% 15

Wireless Networking 4.31% 66

Source: h�p://pages.stern.nyu.edu/~adamodar/ (h�p://pages.stern.nyu.edu/~adamodar/)

As predicted, the industries with the most growth (Internet, Medical Services, Wireless Networking, Biotechnology, and Electronics) have the lowest payout ra�os. We expect firms in these industries to need significant investment funds, so they would retain and reinvest any cash flow generated. More mature firms, and those with li�le need for constant compe��ve innova�on (Tobacco, Electric and Water U�li�es), have the highest payout ra�os.

Expectations and Dividend Policy

Another predic�on we can make is that firms lowering their regular dividend will experience a fall in stock prices when the announcement is made. One might also an�cipate that corpora�ons announcing an increase in their regular dividend will see their share value increase. These predic�ons are based on the signaling effect of the dividend announcement. If the change in the regular dividend signals new informa�on to the market, an impact on price will be forthcoming as investors evaluate the content of the signal. However, we must keep in mind that investors may have already formed expecta�ons about future dividends when they value stocks. In some cases, the market is expec�ng a firm to lower its dividend, perhaps because of recent and ongoing difficul�es. If a firm subsequently lowers its dividend, but by less than the amount expected, the market may actually perceive this as good news (posi�ve signal) that circumstances are be�er than investors originally thought. On the other hand, a corpora�on raising its dividend less than expected could find that share prices decline due to investors' disappointment in the rela�vely low increase. Therefore, the wealth effect (share price change) of a dividend change is a func�on of the actual change versus the expected change. In other words, it's the unexpected part of the dividend announcement that has an impact on value.

An erra�c pa�ern of paying dividends could be full of unexpected changes that surprise investors. Managers seek to avoid irregularity by se�ng a regular dividend at a reasonable maintainable rate. Many managers also avoid issuing regular dividend increases in large, randomly occurring jumps. Rather, they tend to adopt a smooth stream of steadily but moderately increasing dividend payments. Such a stream can absorb the shock of earnings reversals that occur from �me to �me. This type of payment schedule is known as smooth-stream dividend strategy and can be viewed as an a�empt to minimize dividend disappointments. An example of the smooth-stream dividend strategy in prac�ce is shown for Hershey in Table 10.4.

Table 10.4: Hershey's annual dividend, EPS, and payout ra�o, 1990–2011 (adjusted for stock splits)

Year Dividend EPS Payout ra�o

1990 0.25 0.55 45.4%

1991 0.24 0.61 38.5%

1992 0.26 0.68 38.1%

1993 0.29 0.72 39.9%

1994 0.31 0.76 41.1%

1995 0.34 0.85 40.5%

1996 0.38 1.00 38.0%

1997 0.42 1.12 37.7%

1998 0.46 1.15 40.2%

1999 0.50 1.05 47.8%

2000 0.54 1.18 45.8%

2001 0.58 0.72 81.0%

2002 0.63 1.42 44.4%

2003 0.72 1.70 42.5%

2004 0.84 2.25 37.1%

2005 0.93 1.99 46.7%

2006 1.03 2.34 44.0%Processing math: 0%

The dividend payment process has four key dates: (1) announcement date, (2) ex-dividend date, (3) date of record, and (4) payment date.

2007 1.14 0.93 122.2%

2008 1.19 1.36 87.6%

2009 1.19 1.90 62.7%

2010 1.28 2.21 57.9%

2011 1.38 2.74 50.4%

Based on data from Yahoo Finance: h�p://finance.yahoo.com/q/hp?s=HSY&a=06&b=1&c=1985&d=09&e=8&f=2012&g=v (h�p://finance.yahoo.com/q/hp?s=HSY&a=06&b=1&c=1985&d=09&e=8&f=2012&g=v)

No�ce that even though Hershey's dividends increase smoothly, the dividend payout ra�o (Dividends/EPS) is somewhat erra�c, ranging from 38% to 122%. We must also point out that firms are so reluctant to reduce dividends—due to the nega�ve response from investors—they may con�nue to pay dividends even if they exceed current earnings. This was the case in 2007 for Hershey.

The Process of Paying Dividends

When a corporate board declares payment of dividends, the announcement includes a date of record. On that date, the corpora�on reviews its stock transfer books to determine who owns shares and is en�tled to the dividend proceeds. The dividend announcement also specifies a dividend payment date. This date is a few weeks a�er the date of record, the payment delay being necessary to allow paperwork and check wri�ng to be completed.

The date of record is preceded by the ex-dividend date. Only investors who purchase a share of stock prior to the ex-dividend date are en�tled to the dividend. For example, when shares are bought a few days a�er the ex-dividend date, the old owner will receive the dividend payment, even though the stock has changed hands. Brokerage firms specify an ex-dividend date in order to assure investors that their names will appear as stockholders on the corporate books by the date of record. Because it normally takes a few days to se�le a stock purchase or sale, the ex-dividend date precedes the date of record by about two business days.

Figure 10.3 illustrates a dividend payment �me line. Point A is the April 1 announcement of a dividend payable on May 19. Point C is the date of record, May 5, and Point B is the ex-dividend date, May 1. The dividend checks are mailed on the payment date of May 19.

Figure 10.3: Dividend payment �meline

In the �meline, anyone holding stock by the ex-dividend date will receive the May 19 dividend check, even if they subsequently sell their shares. Those who buy the stock on or a�er May 1 will receive no dividend because the transac�on occurred a�er the date-of-record deadline. This means that if you bought shares on May 2, you would not be en�tled to a dividend, whereas had you purchased shares two days earlier, you would receive the dividend check. This may seem unfair un�l you realize that, theore�cally, the stock's price drops on the ex-dividend date by the amount of the dividend. Thus, by purchasing the stock on May 2, you pay less than if had you purchased the stock two days earlier. Those who sell their shares on May 2 will receive their dividend for stock they no longer own, but they receive less on the sale of their stock than they would have had they sold earlier and foregone the right to collect the dividend. In this way, the dividend payment system works out fairly for all par�es.

In the previous paragraph we said "theore�cally, the stock's price drops on the ex-dividend date by the amount of the dividend." In reality, a company's stock price may not drop by the exact dividend amount following the ex-dividend date, due to the new informa�on con�nually fed into the market. The stock price could actually rise if, for example, the firm announced an oil discovery a�er the close of trading the previous day. This posi�ve news would more than offset the decline caused by the stock going ex- dividend. Even if there is no new informa�on arriving in the market place that day, the price drop on the ex-dividend rate may be smaller than the dividend per share. This is because investors, on average, need to pay tax on a dividend, so the drop will approximately equal (Dividend) × (1 – t), where t is the average tax rate.

Stock Repurchases

Firms considering issuing a special dividend will o�en opt for a stock repurchase instead. Similar to the dividend, the repurchase distributes excess cash to exis�ng shareholders, lowering the poten�al for agency costs. Once stock is repurchased, it becomes known as treasury stock. Treasury stock is held by the corpora�on and may be reissued to the public without going through the costly registra�on requirements associated with issuing completely new shares. Many firms also use treasury stock to fund execu�ve bonuses and employee re�rement plans. For this reason, some firms repurchase stock to provide them with shares to fund such programs. Some�mes companies choose to re�re the stock, permanently reducing the number of shares outstanding. Stock repurchases can also be used as a takeover defense when a large block of stock is repurchased at a premium from a poten�al acquirer. These targeted repurchases, called greenmail transac�ons, were used in the 1980s but are uncommon now.

We will discuss three methods for accomplishing share repurchases: open market purchases, fixed-price tender offers, and Dutch Auc�ons.

In an open market purchase, the corpora�on buys its own stock in the secondary market, but must publicly announce in advance their inten�on to repurchase shares. In June 2012, the clothing company Guess announced in a press release that it would "repurchase, from �me-to-�me and as market and business condi�ons warrant, up to $500 million of its common stock" (Guess, 2012). This announcement is typical of open market share buyback programs, with no definite period or price range specified.

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During the crash of 1987 the United States Securi�es and Exchange Commission announced it would make it easier for companies to buy back their stocks. Dozens of companies jumped at the chance and the Dow began to rise. Why do you think some companies chose to repurchase shares, while others did not?

Guess is just one company that decided to repurchase its own stock in the secondary market. Do you think it is fair for companies to do this?

PR Newswire/Associated Press

When the share price drops, the company could become a buyer, and other investors never know if they are selling to the company or other outside investors. Also, there is no assurance that the repurchase plan will ever be completed. In fact, there is evidence that companies actually purchase only about 78% of the announced target number of shares (Stephens & Weisbach, 1998). In the two weeks a�er the stock market crash of 1987, about 600 companies (9.3% of all listed companies in the U.S.) announced open market repurchase programs. Over the following five months, only about 40% of those firms decreased their shares outstanding, while one- third actually saw an increase (Ne�er & Mitchell, 1989).

A Crisis Is Averted

Share repurchases are some�mes interpreted as posi�ve signals that the firm's stock is undervalued. The reasoning behind this signal follows: Managers are looking for posi�ve NPV projects, or projects whose costs are less than their value. With their superior informa�on, managers who choose to repurchase shares send a signal that they consider the firm's stock to be priced below value, and view the purchase as a posi�ve NPV investment. Knowing that repurchases might be viewed as a signal of the firm's value, what prevents managers from abusing repurchases for corporate gain? There are rules that prevent companies from using open market repurchases to manipulate share prices. For example, the maximum amount of stock that can be bought on a single day is 5% of the average trading volume for the previous month. Addi�onally, all shares purchased by a firm on a single day must be purchased through a single brokerage firm. (Share buybacks by corporate issuers are governed by the Securi�es Exchange Act of 1934 under Rule 10b-18, �tled Purchases of Certain Equity Securi�es by the Issuer and Others.)

As opposed to an open market purchase, a tender offer is a formal offer to buy all shares tendered, up to a given total. Firms generally use the tender offer method when repurchasing a large number of shares. The repurchase price (or bid price) is explicitly stated in the tender offer announcement and exceeds the current market price. Thus, the term bid premium is used to describe the percentage by which the tender offer price exceeds the share's market price as of the date of the offer's announcement. Typical bid premiums are 15% to 20% above the preannouncement share price. There is no obliga�on on the part of the stockholder to tender their shares; if they wish, they can con�nue to hold them. If more shares are tendered than the number sought by the firm, the tender offer is oversubscribed, and the corpora�on has the op�on of purchasing some or all of the excess shares.

Finally, a Dutch Auc�on repurchase allows the firm to set a price range it will consider for the shares. Shareholders submit offers with the number of shares they wish to sell at a price within the specified range. When the auc�on period ends, the company looks at all the offers and creates a supply curve. It then chooses the lowest price that allows it to repurchase the desired number of shares and pays everyone who submi�ed an offer at or below that price. Let's consider an example. Company A wants to repurchase 1 million shares for a price between $25 and $30 per share. Table 10.5 shows the range of bids submi�ed by investors, with the number of bids submi�ed in the le� column, and the price per share for those bids in the middle column. The right column totals up the number of shares, star�ng at the lowest number and working up to the 1,000,000 goal (similar to what the firm managers will do). The company will reach its target number of shares once it purchases those through the $27.75 price. Therefore the firm will offer this price to all investors submi�ng offers at or below $27.75, no ma�er what their actual offer was.

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Stock repurchases via Dutch Auc�on are different than purchasing shares through the secondary market in that there is more flexibility in the share price. What are some other differences?

Associated Press

Table 10.5: A Dutch Auc�on example

Number of shares Price per share Total number of shares (1,000,000 goal)

150,000 $26.00 150,000

250,000 $27.00 400,000

350,000 $27.25 750,000

200,000 $27.50 950,000

50,000 $27.75 1,000,000

150,000 $28.00 1,150,000

On June 28, 2012, AOL (the old America On-Line), announced a Dutch Auc�on repurchase. The press release gave the following details: the repurchase was to distribute the proceeds from the sale of AOL patents to Microso�. Shareholders had un�l August 2, 2012, to submit their offer to tender shares at a price between $27 and $30 per share. AOL allocated $400 million for the repurchase, but reserved the right to terminate or extend the repurchase (AOL.com, 2012).

A major func�on of stock repurchases is to lower the number of outstanding shares. In this respect they differ from special dividends. Because there are fewer outstanding shares, future regular dividends may increase a�er a repurchase. For example, if a corpora�on forecasts that $1,000,000 is available for regular dividends each year for the foreseeable future and has 1,000,000 shares outstanding, then the firm could maintain a $1 per share annual dividend. Let's assume the firm has sufficient addi�onal free cash to either pay a special dividend or repurchase 200,000 shares. If the firm pays a special dividend with this cash, it will con�nue to pay the $1 per share dividend. On the other hand, if the excess cash is used to repurchase shares, then only 800,000 shares will be outstanding, and the corpora�on could theore�cally pay a $1.25 per share regular dividend ($1,000,000 distributed among 800,000 shares).

Increasing the dividend level through the reduc�on of shares means that remaining shares increase in value. Investors, realizing this, will demand a higher price for tendering, leading to the bid premium referred to earlier. Although it might appear that repurchasing shares will increase shareholder wealth more than a special dividend, this is not necessarily the case. Note that the share repurchase alterna�ve from the previous paragraph increases the dividend by 25%, from $1 to $1.25. The special dividend alterna�ve distributes cash, enabling individual investors to use these funds to buy addi�onal shares. With the special dividend alterna�ve, shareholders in this example have the op�on of increasing their holdings by 25% if they reinvest the disbursement to buy stock in the corpora�on. In theory, shareholders' wealth would be iden�cal under either

the special dividend or the share repurchase alterna�ve.

Even though shareholder wealth might be theore�cally equal in either alterna�ve, in reality this is not the case. We overlooked taxes in this argument. Dividends are taxed as regular income, but share repurchases may be taxed as capital gains. This creates a tax advantage to the repurchase alterna�ve, pu�ng more cash in the pockets of stockholders, making it preferable to the dividend op�on. However, when repurchases are made through a tender offer, the firm incurs considerable transac�on costs, which tend to offset some of the tax advantages. Tender offer repurchases are therefore generally reserved for instances where the firm intends to buy back a substan�al amount of stock, and transac�on costs can be spread across numerous shares with minimal impact on shareholders' wealth.

Stock Dividends and Stock Splits

In Sec�on 10.1, we discussed two kinds of cash dividends: regular and special. Here, we will cover a different type of dividend: the stock dividend. A stock dividend is the payment of addi�onal stock to shareholders; they change the number of shares of stock that are outstanding, but do not increase the cash flows paid to investors. Let's look at an example. Assume a company issues a 10% stock dividend, en�tling the holder of 100 shares of stock to 10 addi�onal shares (new total of 110 shares). Note that if this company had 2,000 shares outstanding prior to the stock dividend, it would have 2,200 shares outstanding a�er the stock dividend—a 10% increase overall. The stockholder's 100 shares represented a 5% ownership interest in the firm's equity before the dividend, and the 110 shares represents 5% of the equity a�er the stock dividend. Thus, the shareholder's propor�onal claim on the firm's cash flows remains unchanged at 5%.

A stock split increases the number of shares outstanding by replacing old shares with new shares on a propor�onal basis. A firm offering a two-for-one split doubles the number of shares outstanding, doubling each individual's shareholdings. Like a stock dividend, a split does not change a shareholder's ownership interest in the firm. Our example firm, with 2,000 shares before a two-for-one split, would have 4,000 shares outstanding a�er the split. An owner of 100 shares would end up with 200 shares, both of which represent 5% of the firm's equity.

If we think of shares of stock as coins, stock dividends and stock splits are like changing how we count our coins. Before a split let's say we have four dimes. A�er a two-for- one split, we have eight nickels, and our value remains unchanged. Another way of viewing this is to realize that the value of stock is grounded in its claim on le�-hand-side cash flow–producing assets. All splits and stock dividends do is change the units in which we count the claims, not the value of the le�-hand-side assets. Thus, if you own claims totaling 5% of the total le�-hand-side value, it is immaterial whether that 5% is counted as 110 shares, 100 shares, or 200 shares; the value is the same. On the other hand, if accompanying the split is a signal of increased le�-hand-side value, then an increase in shareholder wealth may occur.

O�en with a split, dividends effec�vely increase. In a two-for-one split, a stock that paid a $3 per share dividend prior to the split would be expected to pay a dividend of $1.50 a�er the split. However, should the firm announce that the dividend following the split was going to be $1.75 per share, it has revealed some posi�ve informa�on about the value of the stock. In this case, stock selling for $40 prior to the two-for-one split may jus�fiably sell for more than $20 a�erward. Of course, the same informa�on

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could arguably be conveyed by not spli�ng the stock and simply raising the dividend from $3 to $3.50 per share. Splits, in this case, can be seen as a device used to draw more a�en�on to the posi�ve dividend news.

We have described splits that increase the number of shares and reduce share price, but it can happen the other way. A reverse split represents a propor�onal reduc�on in shares that leaves ownership interests and value unchanged. If we go back to the idea of exchanging coins, reverse splits are like moving from nickels to dimes. Reserve splits reduce the number of shares outstanding and subsequently increase the price per share. For example, a company could offer one share for every two shares tendered, reducing shares outstanding by 50%. Some�mes reverse splits are used to consolidate control of a company. If a company carries out a reverse split where one share is issued for every 500 tendered, investors with fewer than 500 shares will be paid in cash, and their shares will be added to the company's Treasury Stock. The result is that only large shareholders will remain as owners of the company.

Stock dividends and splits are so alike that a rule has been adopted to dis�nguish them: If the number of shares outstanding changes by more than 25%, the change is termed a stock split. Ac�on involving a change of less than 25% is termed a stock dividend.)

Field Trip: Stock Splits

Learn more about upcoming stock splits here: h�p://biz.yahoo.com/c/s.html (h�p://biz.yahoo.com/c/s.html)

Pick one of the be�er-known firms announcing a split and find its website using a search engine. The corpora�on's site should include informa�on about the upcoming split.

Record the firm's name, its web address, the split terms, and the date. Then read the ra�onale given for the split.

Reflec�on Ques�ons

1. What reason does the company give for spli�ng its stock? 2. How do you think the split will impact the post-split value of shares?

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Ch. 10 Conclusion

Like the capital structure decision, iden�fying a firm's op�mal dividend policy can be a challenging task. No formula exists to provide the answer, nor is there general agreement on the wisdom of a par�cular strategy. Managers can feel confident in their decision if they take a few careful and far-sighted considera�ons when forecas�ng: Minimize transac�on costs, limit poten�al agency problems, and aim to meet the expecta�ons of investors. Most firms, in fact, follow a pa�ern of slow but steady dividend growth, supplemented by an occasional special dividend.

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Ch. 10 Learning Resources

Key Ideas

When capital markets are perfect, dividend policy is irrelevant. When a corpora�on raises its regular dividend, the increase carries with it the implicit promise that the new level of payment can be maintained. The decision to increase a regular dividend is a signal that the firm can support a higher payment level. Dividend payments tend to lower a corpora�on's free cash flow and may, therefore, lower agency costs. Many firms a�empt to manage investors' expecta�ons by adop�ng a smooth stream dividend strategy. An alterna�ve to paying a special dividend is to repurchase shares. Stock dividends and stock splits change the number of shares of stock that are outstanding but do not increase the cash flows that are paid to investors.

Key Equa�ons

Cri�cal Thinking Ques�ons

1. Investors and stock analysts are forward-looking. They are concerned with expected future dividends when es�ma�ng value. There are occasions when these analysts see a firm's problems even before management faces up to the difficul�es. Explain why a stock's price might increase when the firm announces it is lowering its dividend and will use the retained cash to retool an inefficient factory.

2. Suppose Bioenergy, Inc. has a market value of $50,000,000 and is 100% equity financed. Its market value per share is $25 because there are 2,000,000 shares outstanding. The firm pays no dividend. At the last shareholders' mee�ng, there were complaints about the no-dividend policy. As a director of Bioenergy, what factors should you consider as you contemplate ini�a�ng a dividend? [Hint: Discuss why you should analyze (a) the current and expected level of cash flows, (b) the cash needed to fund expected posi�ve NPV investment opportuni�es, (c) the variability of expected cash flows, (d) other means of financing investment projects and the costs associated with using other sources of capital, and (e) if there have been some wasted funds expended in the firm in the past.]

3. On Thursday, May 3, the board of directors of ACME, Inc. declares a $1.50 per share dividend, payable on Thursday, May 31 to the shareholders of record as of Thursday, May 17. When is the ex-dividend date? Do you think it is a good idea to buy the stock on May 8 and sell it on May 15? Why or why not?

4. Dividend reinvestment plans (DRPs) are in place at many large corpora�ons. DRPs allow stockholders to have their dividends automa�cally reinvested in the company's stock. Stockholders avoid brokerage commissions by par�cipa�ng in DRPs, and at �mes the firm sells the stock to plan par�cipants at a light (3–5%) discount from the current market price. What clientele do you think might find this feature a�rac�ve?

5. What kind of dividend policy would you expect growth companies to have? Why? 6. One mo�ve for stock splits is the trading range hypothesis. The argument says that stocks with high prices tend not to be bought by many small investors. Thus, lowering the

price per share by way of a stock split makes the stock more a�rac�ve to the low-price clientele. More demand for the stock should increase equity's value. Do you think this is true? Why or why not?

Key Terms

Click on each key term to see the defini�on.

bid premium (h�p://content.thuzelearning.com/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/fro

The percentage by which the tender offer price exceeds the share's market price as of the date of the offer's announcement. Typical bid premiums are 15% to 20% above the preannouncement share price.

constant dollar dividend policy (h�p://content.thuzelearning.com/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/fro

A dividend policy where the company pays the same dollar amount every year unless the dividend increases. A company that follows this policy has made an implicit promise to con�nue to pay dividends, year a�er year, at or above the current regular dividend level.

date of record (h�p://content.thuzelearning.com/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/fro

The date the corpora�on uses to determine who owns shares and is en�tled to the dividend proceeds.

SLIDE 1 OF 3

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dividend payment date (h�p://content.thuzelearning.com/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/fro

This date is a few weeks a�er the date of record, the payment delay being necessary to allow paperwork and check wri�ng to be completed.

dividend policy (h�p://content.thuzelearning.com/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/fro

The distribu�on of residual cash to shareholders.

ex-dividend date (h�p://content.thuzelearning.com/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/fro

The date on or a�er which a security begins trading without the dividend included in the contract price.

growth companies (h�p://content.thuzelearning.com/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/fro

Firms with numerous projects that con�nually reinvest their residual cash into posi�ve NPV investments.

income stocks (h�p://content.thuzelearning.com/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/fro

Stocks that pay a rela�vely high dividend.

open market purchases (h�p://content.thuzelearning.com/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/fro

When a corpora�on buys its own stock in the secondary market just as any other investor. The firm must publicly announce its inten�on to repurchase shares in advance.

oversubscribed (h�p://content.thuzelearning.com/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/fro

During a tender offer, each stockholder may elect to tender shares or con�nue to hold the shares. When more shares are tendered than the number sought by the firm, it has the op�on of purchasing some or all of the excess shares tendered.

payout ra�o (h�p://content.thuzelearning.com/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/fro

Target policy where a percent of earnings is distributed as dividends.

reverse split (h�p://content.thuzelearning.com/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/fro

A propor�onal reduc�on in shares that leaves ownership interests and value unchanged.

regular dividends (h�p://content.thuzelearning.com/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/fro

A dividend on common stock that is intended to be paid periodically in equal amounts over the course of a year, typically quarterly.

residual dividend policy (h�p://content.thuzelearning.com/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/fro

Dividend policy that distributes any remaining funds to investors a�er making all profitable investments first.

special dividends (h�p://content.thuzelearning.com/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/fro

A higher than usual payout to stockholders in a company as a share of company profits (may not be con�nued).

stock dividend (h�p://content.thuzelearning.com/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/fro

The payment per share that a corpora�on distributes to its stockholders as the return on their investment.

stock repurchase (h�p://content.thuzelearning.com/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/fro

A firm's repurchase of outstanding shares of its common stock.

stock split (h�p://content.thuzelearning.com/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/fro

An increase in the number of shares outstanding by replacing old shares with new shares on a propor�onal basis.

tender offer (h�p://content.thuzelearning.com/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/froProcessing math: 0%

An acquisi�on bid made directly to shareholders and not needing the approval of the target company's management.

treasury stock (h�p://content.thuzelearning.com/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/front_ma�er/books/AUBUS650.13.1/sec�ons/fro

Treasury stock is held by the corpora�on and may be reissued to the public without going through the costly registra�on requirements that issuing completely new shares entails.

Web Resources

Many investors rely on a company's dividend yield as a guide to selec�ng stocks. To learn more about how the "dogs" are selected, go to: h�p://www.dogso�hedow.com (h�p://www.dogso�hedow.com)

The Stock Center at Market Edge is a good source of dividend informa�on: h�p://www.marketedge.com/ (h�p://www.marketedge.com/)

An excellent website about corporate finance and valua�on has been created by NYU finance professor Aswath Damodaran: h�p://pages.stern.nyu.edu/~adamodar/ (h�p://pages.stern.nyu.edu/~adamodar/)

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