Chapter 14 Stock Splits, Dividends, and Dividend Policy

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Chapter 14Stock Splits, Dividends, and Dividend
Policy

• Cash Dividends
• Dividend Policy
• Selecting a Dividend Policy
• Stock Splits and Stock Dividends
• Reasons for Stock Splits
• Reverse Splits
• Specialized Dividend Plans

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Cash Dividends

• Payments to owners of the company
• Distribution is taxed (currently)
• Decision to pay cash dividend by Board of
  Directors
• Stipulates
• Amount
• Date of Record
• Date of Payment
• Some important issues when buying and selling
  stock
• Settlement Date
• Street Name, Beneficiary Owner, and Owner of
  Record

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Cash Dividend

• Example, Pepsi Dividend of Feb. 2004
• Amount of dividend announced on Feb 5th
• Stock trades with dividend until Feb 25th
• Record date set on Feb 27th
• Actual Payment on Mar 10th
• If you buy stock before Feb 25th you receive the
  cash dividend
• If you buy stock after Feb 25th original owner
  receives dividend
• Price of stock falls on morning of Feb 26th by
  size of the dividend

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Cash Dividends

• Not all cash dividends are regular
• Typically very predictable in time
• Typically very predictable in amount
• Extra or special dividends
• One time payments not scheduled to be repeated in
  near future
• Reward to owners during good performance
• Stock Dividends just paper no real value
• Liquidating Dividends final payment to owners

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Dividend Policy

• Choice on size of dividends, large yields versus
  small (zero) yields
• Dividend Clientele
• Widows and Orphans want large dividends they
  rely on the dividend income
• Tax avoiders they want small or no dividends
  and take profits in capital gains at time of
  sale
• Does it matter? Dividend Irrelevance Theory
• Can undo any dividend policy to match needs
• Works in world of no taxes
• Complications in world of taxes
• Alternative for company, keep money and reinvest
  in company

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Dividend Policy

• Reasons for Low-Payout Policy
• Tax avoidance or postponement
• Higher potential future returns
• Firm avoids need for additional outside funds
• Reasons for High-Payout Policy
• Distribution of profits with low transaction
  costs
• Convenience of direct deposit
• Cash today versus uncertainty tomorrow

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Selecting a Dividend Policy

• From perspective of Firm
• Payment should be maintainable in future with
  some variation in earnings
• Payment should not be reduced (bad news signal)
• Payment cannot include legal capital
• Payment cannot violate bond covenants
• From perspective of owner dividend policy
  irrelevant? Individual select companies with
  current dividend policies that meet their need

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Stock Splits and Stock Dividends

• Paper Transactions of no value to owner
• Trading a 20 bill for 2 10 bills
• Stock dividends are small stock splits
• Follows trading patterns of cash dividends
• Declaration date (size of split announced)
• Date of record set by Board of Directors
• Payment date set when new shares will be mailed
• Buying after ex-date, new shares go to old
  shareholders so new owner gets due bill

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Reasons for Stock Splits

• Value comes from
• Preferred Trading Range stocks trade better in
  20 to 40 range
• Signaling Hypothesis strong past performance
  will continue
• Increased Liquidity more available shares and
  thus lower costs to transact (jury still out on
  this reason)
• Economic debate remains on value of split

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Reverse Splits

• Reduces number of outstanding shares
• Like trade 2 10 for a 20
• No apparent value
• Perceived value
• Stock price moves back into preferred trading
  range
• Can avoid potential delisting of stock from
  ex-change
• Potential reduction in liquidity?

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Specialized Dividend Plans

• Stock Repurchases
• Selective cash dividend, owner decides if
  he/she wants dividend by selling stock
• Must be for a business reason not just to avoid
  taxes
• Not all plans are completed
• 35 never start
• 35 only partially completed
• Stock repurchased
• Treasury Stock for future reissue
• Treasury stock has no voting rights and cannot
  receive dividends (cash dividends)
• DRIPs Dividend Reinvestment Plans

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Problems

• Problem 5 Dividend Pattern
• Problem 7 Creating Your Own Dividend Policy
• Problem 13 Stock Split
• Problem 17 Stock Repurchase Plan