(1) Describe the most common characteristics of corporate dividend policies.

(2) Explain the timing of the dividend declaration date, ex-dividend date, record date, and payment date.

(3) Apply the three-step approach to the dividend decision outlined in the chapter to determine an appropriate dividend action.

(4) Distinguish "special" dividends from regular cash dividends.

(5) Explain why a stock dividend is not a perfect substitute for a cash dividend.

(6) Describe five alternative methods of repurchasing shares.

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(1) Dividend payout ratios vary systematically across industries due primarily to the comparable investment opportunities within an industry and to differences across industries.

(2) Drugs and health care industries generally have low payout ratios, while electric utilities and chemicals have high payout ratios.

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(1) In practice, publicly traded firms prefer to pay at least some dividends on a regular basis, maintain a stable payout ratio and dividend, and make orderly changes in the dividend, and avoid cutting the dividend.

(2) Smaller and younger firms generally do not pay cash dividends, but at some point in its life cycle it will start paying dividends.

(a) This may be due to a desire to show the firm's stability.

(b) It may be do to a decline in profitable investment opportunities.

(c) It may be due to investor preference for cash distribution.

(d) It may reflect a desire to broaden the market for the firm's stock to include investors prohibited from buying non-dividend paying stock.

(3) Among NYSE-listed firms, in any given year since WW II, from 75 to 90% paid cash dividends.

(4) Dividends are more stable than earnings. Dividends follow the trend in cash flow per share much more closely than the trend in earnings per share.

(5) Most companies make quarterly dividend payments. Once they start paying dividends, firms try to continue making regular payments.

(6) Firms are reluctant to cut dividends because of the fear of signaling negative news about future earnings.

(7) Firms tend to pay "extra" dividends when the year-end review reveals unusually high earnings for the year. The regular dividend will be increased only when managers believe they have reached a higher level of sustainable earnings.

(8) Most companies review their dividend policy annually. Board of directors must declare the payment of dividends before they are paid.

(a) The record date is established to determine who is the "shareholder of record" in terms of getting the dividend.

(b) The "ex-dividend date" is two business days before the record date.

(i) On the "ex" day the shares begin to sell without the right to the next dividend payment.

(ii) The shares will start selling at the preceding day's closing price less the amount of the dividend per share.

(c) The "payment date" is the date on which the firm will send a check to each shareholder.

(9) Bond indentures, loan agreements, and preferred stock agreements usually contain restrictions on the amount of common dividends a firm can pay.

(a) These are done to lower agency costs.

(b) State laws also impose dividend restrictions that prevent firms from becoming solvent because all of their cash is paid out.

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(1) The behavioral principle (which directs managers to follow others in the industry if unsure as to what is best) provides a good starting point for establishing a target payout range. After factoring in its own specific firm-related and investor-related considerations, a firm can choose an appropriate long-term target payout ratio.

(2) Determining an appropriate dividend policy for a firm involves a three-step approach.

(a) First, the first must forecast its future residual funds.

(b) Second it must determine an appropriate target payout ration.

(c) It must then decide on the quarterly dividend.

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(1) In applying the dividend policy guidelines, estimate the future residual funds over about a 5-year period.

(2) When setting a target payout ratio, remember that as long as dividend policies are clearly articulated and stable, particular industries and particular firms tend to attract certain shareholder clienteles.

(3) If a company has heavy expected capital budgeting requirements (relative to other firms in its industry) then the payout ratio should be below the industry average.

(4) When considering a dividend policy, one can consider several plan. Any plan that is chosen should be evaluated periodically.

(5) Privately held firms do not have informational effects to worry about when implementing a dividend policy.

(a) However, tax considerations and owners' liquidity needs are of great importance.

(b) Because of taxes, the owners of a privately held firm normally benefit from capital gains more than from cash dividends.

(c) For this reason, IRS regulations prohibit excessive retention of earnings.

(d) Private firms are usually small and need more cash to insure that liquidity needs are met.

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(1) Firms in cyclical businesses often pay extra (or special) dividends during periods when earnings are at cyclical peak.

(2) Cyclical firms do not want to set too high of a regular dividend payout. If it does then the following will have to done.

(a) Managers will have to buildup excess cash balances during high income periods. This buildup would be used to pay dividends during low income periods.

(b) Otherwise, managers will have to require additional borrowing during low-income periods. The borrowings would be repaid during high income periods.

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(1) In lieu of paying cash dividends, firms can pay stock dividends.

(a) A stock dividend is a bookkeeping reapportioning of the claim size of a share of stock so that there are more shares and each share has a proportionally smaller claim.

(b) The fair market value of the shares distributed in the stock dividend is transferred from the "retained earnings" account to the "Paid-in capital" and "capital contributed in excess of pay value" accounts.

(c) A stock dividend involves administrative expenses and may also convey negative news about a cash shortage.

(2) A firm can achieve much the same financial effect as a stock dividend through a stock split.

(a) Like a stock dividend, a stock split does not affect the net worth of the firm or the proportional ownership interest of any of its shareholders.

(b) A stock split alters the par value of the shares but does not involved any transfer of balances between the components of common stockholders' equity.

(c) In the case of a 2-for-1 split, the value of each share is halved.

(3) Firms generally use stocks for small share distributions and stock splits for larger ones.

(4) Apart from an information effect, a stock dividend or split should leave the stock market value of a firm unchanged.

(a) Since most shares trade in a range of $10 to $30 per share, a stock split may signal firm growth (because growth means that the share price would get too high without the stock split).

(b) Empirical studies show that the market react favorably to stock split announcements.

(c) It is important to note that dividend increases frequently accompany stock splits. This is more positive news.

(d) Finally, a stock split may increase trading activity in a stock and thus improve the firm's liquidity.

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(1) Firms should consider many factors when deciding on a share repurchase program.

(a) It is important to know if there is a tax advantage to a capital gains over a dividend for its individual and institutional owners.

(b) Managers will want to know how the market will react to any public statement about the repurchase plans.

(i) The repurchase may be seen as negative if the market believes there is a cut-back in projects.

(ii) If the market believes the firm is buying back undervalued stock, then there will be a positive market response.

(c) The leverage increase from a large repurchase can increase leverage significantly and cause a lowering of the firm's bond rating.

(2) Implementing a share repurchase program can take one of five paths.

(a) An open-market repurchase buys back shares of a firm's common stock in market transactions at current market prices.

(i) An open-market repurchase program averages the firm's repurchase prices during the repurchase period. More than 90% of the shares repurchased in the U.S. are bought in open-market purchases.

(ii) Firms typically use such programs to satisfy their needs for shares, for example, for stock option and other employee benefit programs and to have them available upon conversion of convertible securities.

(b) Cash tender offers (called a fixed price or a Dutch auction) repurchase a stated number of shares at fixed price.

(i) Tender offers often pay a premium and thus have a more positive market response.

(ii) Tender offers often pay a premium between 10% and 25%.

(iii) Using an investment dealer can reduce the premium paid due to their solicitation efforts.

(c) A firm can issue transferable put rights to its shareholders. Those who do not want to sell shares can sell the put rights. This method is more "tax efficient" than a fixed-price tender offer.

(d) Privately negotiated block purchases are most often made in connection with, rather than as a substitute for, an open-market purchase program. Large blocks can often be purchased for less than the current market price.

(e) An exchange offer is where a firm offers bonds or preferred stock (instead of cash) to repurchase shares. Usually larger premiums must be given because the stock is being replaced with a security that has less liquidity.

(3) In the final analysis, striving for the optimal dividend policy may not be cost-effective even if possible. Thus firms should try to maintain a stable dividend policy by doing the following.

(a) Pay at least some dividends on a regular basis once the firm is well establish.

(b) Have a relatively consistent target payout ratio.

(c) Avoid a reduction in an established dividend.

(d) Use the additional tools of special dividends and/or share repurchases to shareholder advantage whenever possible.

(e) Make any deliberate changes in a careful and orderly way.

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