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Dividend Policies

Objectives:
By the end of this topic the students should
comprehend the following:
Types of dividends
Factors affecting dividend policies
Residual Dividend policies
Dividend theories
Dividend controversy

Types of dividends

Cash dividends
Regular dividends
Special dividends
Liquidating dividends
Stock dividends
Stock splits
Share repurchase

Types of dividends

Does stock splits and
stock dividends affect the
price of shares?

Types of dividends
What does academic research have to say about this
 Stock prices tend to rise after a stock split or stock
dividends
 Price increase appear to be because stock splits are
taken as a positive signal from management about
future earnings
 If a report of good earnings does not follow a stock
split, prices tend to revert to original (split-adjusted)
levels
 Stock splits and dividends tend to reduce liquidity due
to higher percentage brokerage fees on lower-priced
stocks

Factors affecting dividend policies

Signaling effect
Taxation of dividends
Clientele effect
Restrictions on dividend payments:
The impairment of capital rule
Debt covenants
Cash flow
Industry life cycle

Factors affecting dividend policies

Flotation costs on new issues versus costs of
retained earnings
Shareholder preferences for current versus
capital gains

Share repurchase
Share repurchases as an alternative to dividends
...
[i
...
, a firm has
accumulated large amounts of unwanted cash]
Happens when the firm wants to change the capital
structure by replacing equity with debt
...

• By direct negotiations with a major shareholder
...

 Firm believe that stock is undervalued
...


Share repurchase
Reasons for repurchases
• Leverage Hypothesis
...
This subsidy is passed on to the
shareholders
...

 Repurchase reduces the assets of the firm and
therefore the value of the claims of the bondholders
...


Residual Dividend Policy

Dividends are based on earnings less funds
the firm retains to finance the equity portion
of its capital budget
...


Residual Dividend Policy
Example
An analysts gathered the following information
about a company’s investment plan:
• Capital Budget of Sh
...
4 million
If the company follows a residual dividend policy,
calculate the dividend payout ratio for this year?

Residual Dividend Policy
Class Exercise
A company has declared net income of Sh
...
2 million

8%

B

Sh
...
6 million

15%

D

Sh
...
The cost of
capital is 12%
...
On the one hand, theory tells us that dividends are
irrelevant both in the absence of taxes (Miller and Modigliani) as
well as in their presence (Miller and Scholes)
...
The fact that the annual rate of dividends
amounted continue to increase cannot be easily explained by
arguments regarding dividend irrelevance
...
Although a large amount of
research has taken place, the dividend policy issue remains
unresolved
...
For example, we cannot say that a high level of dividends
is better than a low level of dividends or that a low level of
dividends is preferable than a high dividend level
...
These are the
following:
The Rightists:
The Leftists
The Middle-of-the-Roaders

Dividend Controversy

The Rightists
A high proportion of the 'traditional' finance
literature has advocated a high level of
dividends
...


Dividend Controversy

The Rightists
Arguments
>cash dividend in hand versus capital gains in
the bush
...

They believe that such a high ratio is inconsistent
with the policy of maximising the company's value
as well as shareholders' wealth
...


Dividend Controversy
The Leftists
Why pay any dividends at all? – dividends-are-bad
school
• tax rate on dividend > effective tax rate on capital
gain
• High payout stock sells at a lower price to make
the same after-tax return
...


Dividend Controversy
The Middle-of-the-Roaders
This party is mainly represented by Miller, Black, and
Scholes
...

They raise the following question: If companies could
increase their share price by distributing more or less
cash dividends, why have they not already done so?
Perhaps dividends are where they are because no
company believes that it could increase its stock price by
simply changing its dividend policy

Dividend Controversy
The Middle-of-the-Roaders
Pay high dividends, because
• Need for dividend income for living
...
(tax clientele)
• It signals good future
...




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