Dividend Controversy - Handelshøyskolen BI
Dividend Controversy
(Chapter 18)
1. types of dividend
a. cash dividend – regular, mostly quarterly
b. stock dividend and stock split
c. liquidating dividend
d. ex-dividend day, What will happen to stock price on the ex-day?
2. Lintner's model
Four stylized facts
a. long-run target dividend payout ratio – high payout with stable earnings, low payout by growth firms
b. Managers focus more on dividend changes than on absolute levels.
c. Smooth dividends
d. Reluctant to reverse dividend changes
Div1 = target dividend = target ratio * EPS1
Change in dividend = Div1- Div0 = target ratio * EPS1 – Div0
Managers prefer steady progression of dividend.
Div1- Div0 = Adjustment rate * (target ratio * EPS1 – Div0)
3. Controversy of dividend policy
Does dividend decision change the value of stocks, given investment and borrowing policy?
a. Dividend policy is irrelevant in perfect capital markets (M&M world)
1) issue new shares and pay dividend to old shareholders
2) reduce dividends and stock repurchase
3) homemade dividends
b. Rightists argument in favor of liberal dividends
1) cash dividend in hand versus capital gains in the bush.
Does this make sense? (Fallacy)
2) market imperfections – dividend clientele
3) free cash flow – managerial entrenchment
c. Taxes and radical left view to reduce dividend
Why pay any dividends at all? – dividends-are-bad school
tax rate on dividend > effective tax rate on capital gain
Firm A Firm B
Total pretax payoff 112.50 112.50
Dividend 0 10
Today's Stock price 100 ? 96.67
Next year's price 112.50 ? 102.50 (=112.50-10)
Before-tax return 12.5/100=12.5% ? 16.4% (=15.83/96.67)
Tax on dividend (50%) 0 ? 5
Tax on capital gain (20%) 12.5*.2=2.50 ? 1.17 (=5.83*0.2)
Total after-tax return 10 ? 9.66 (5 +4.66)
After-tax return 10/100=10% ? 10%
- High payout stock sells at a lower price to make the same after-tax return.
- When a firm invest in preferred stock of another company, 70% of dividends are excluded from corporate taxes.
d. middle-of-the-roaders
I like high dividends, because
- I need dividend income for my living. (Why orphans, widows and elders?)
- My marginal tax rate is low, and taxes on dividends are not bigger than capital gains taxes. (tax clientele)
- It signals good future. (information effects)
- I don't like firm to squander my money (free-cash-flow)
But,
I like the firm to put my money in good use by,
- investing in positive NPV projects
- If they don't have any, repurchase (undervalued) stocks to avoid taxes on dividend income.
................
................
In order to avoid copyright disputes, this page is only a partial summary.
To fulfill the demand for quickly locating and searching documents.
It is intelligent file search solution for home and business.