Payout Policy
Payout Policy or Dividend Policy are often used interchangeably.
Payout Policy - The way a firm chooses between the alternative ways to distribute free cash
flow to equity holders.
When distribution free cash flow it has two Options either Retain or Payout.
Retain - Invest in New Projects, Increase Cash Reserve (You can earn interest but its tax
deductible)
Pay out - Repurchase Shares, Pay dividends (Cash/Stock dividends)
Cash Dividend - Paid either quarterly or yearly
Stock Dividend - Take it like a stock split. Your Investment value stays the same. As you are
rewarded new shares & proportionately the stock price goes down.
Cash Dividends impacts the dividend yield whereas Stock Repurchase primarily affects the
Stock Price.
Payout Policy of the firm in any manner depends on lots of factors like market sentiments,
current financial condition of the company, goals & objectives, competitor analysis, etc.
In an efficient markets when dividends are declared, the share price will go down by the
exact amount of dividend. That will be the cash flow going to shareholders so its not a part of
future cash flows (capital gain). It should happen on Ex-dividend date.
Share Repurchase - The firm uses cash to buy shares of its own outstanding stock. The
benefit to existing shareholders is that the outstanding shares goes down & the share price
increase & this leads to capital gain for investors.
Open Market Repurchase - Buyback existing shares in open market.
Tender Offer - A public announcement of an offer to all existing security holders to buy
back a specified amount of outstanding securities mostly on premium at a prespecified price.
, Dutch Auction - (Another form of tender Offer) - A share repurchase method in which the
firm lists different prices at which it is prepared to buy shares, & shareholders in turn indicate
how many shares they are willing to sell at each price. Matching concept kind of thing.
Targeted Repurchase - When a firm purchases shares directly from a specific shareholder at
a discount or a premium price. Could be Individual or Institutional but must hold large chunk
of shares.
Greenmail - When firm would like to avoid the threat of potential takeover so they buyback
the shares at a premium and if that shareholder holds a large % of shares so to remove them
from management they involve in this method.
Cash flow from Dividends is taxed higher than cash flow from Capital Gain.
Dividend Smoothing - The decision makes in the firm, they do not change the dividend as
frequently as Earnings per share.
Dividend smoothing is the practice by companies of maintaining steady and predictable
dividend payments to shareholders over time, even if the company's earnings fluctuate from
year to year. This strategy aims to demonstrate financial stability and reassure investors about
the company's long-term prospects.
Why is that? If the dividends increases it would be assumed in the market that the firm is
doing good. And if there is a dividend decrease the negativity would be higher than
positivity. Highs are okay but lows are lower. The share price will go down further than the
amount of declared amount in an efficient market. Firms would only increase dividends if
they can forecast that in future as well it would work out.
Dividend Controversy
Does the dividend policy affect the stock price?
There are three perspectives to this controversy -
1. The Conservative - An increase in the dividend payout increases firms value, its
positive if its increased and its taken as seen.
2. The Neutral - Dividend Policy doesn’t affect firm value or on stock price.
3. The Radical - An increase on the dividend payout reduces firms value - a signal that
the firm has no areas to develop.
The Neutral Perspective - Miller -Modigliani "Irrelevance Theory"
Assumptions -
• No agency Cost
• Individual Investors can borrow at same rate as firms
• No Bankruptcy Cost
• All firms are in same risk class when we are comparing - high payer of dividend or
low payer
• No Transaction cost
Payout Policy or Dividend Policy are often used interchangeably.
Payout Policy - The way a firm chooses between the alternative ways to distribute free cash
flow to equity holders.
When distribution free cash flow it has two Options either Retain or Payout.
Retain - Invest in New Projects, Increase Cash Reserve (You can earn interest but its tax
deductible)
Pay out - Repurchase Shares, Pay dividends (Cash/Stock dividends)
Cash Dividend - Paid either quarterly or yearly
Stock Dividend - Take it like a stock split. Your Investment value stays the same. As you are
rewarded new shares & proportionately the stock price goes down.
Cash Dividends impacts the dividend yield whereas Stock Repurchase primarily affects the
Stock Price.
Payout Policy of the firm in any manner depends on lots of factors like market sentiments,
current financial condition of the company, goals & objectives, competitor analysis, etc.
In an efficient markets when dividends are declared, the share price will go down by the
exact amount of dividend. That will be the cash flow going to shareholders so its not a part of
future cash flows (capital gain). It should happen on Ex-dividend date.
Share Repurchase - The firm uses cash to buy shares of its own outstanding stock. The
benefit to existing shareholders is that the outstanding shares goes down & the share price
increase & this leads to capital gain for investors.
Open Market Repurchase - Buyback existing shares in open market.
Tender Offer - A public announcement of an offer to all existing security holders to buy
back a specified amount of outstanding securities mostly on premium at a prespecified price.
, Dutch Auction - (Another form of tender Offer) - A share repurchase method in which the
firm lists different prices at which it is prepared to buy shares, & shareholders in turn indicate
how many shares they are willing to sell at each price. Matching concept kind of thing.
Targeted Repurchase - When a firm purchases shares directly from a specific shareholder at
a discount or a premium price. Could be Individual or Institutional but must hold large chunk
of shares.
Greenmail - When firm would like to avoid the threat of potential takeover so they buyback
the shares at a premium and if that shareholder holds a large % of shares so to remove them
from management they involve in this method.
Cash flow from Dividends is taxed higher than cash flow from Capital Gain.
Dividend Smoothing - The decision makes in the firm, they do not change the dividend as
frequently as Earnings per share.
Dividend smoothing is the practice by companies of maintaining steady and predictable
dividend payments to shareholders over time, even if the company's earnings fluctuate from
year to year. This strategy aims to demonstrate financial stability and reassure investors about
the company's long-term prospects.
Why is that? If the dividends increases it would be assumed in the market that the firm is
doing good. And if there is a dividend decrease the negativity would be higher than
positivity. Highs are okay but lows are lower. The share price will go down further than the
amount of declared amount in an efficient market. Firms would only increase dividends if
they can forecast that in future as well it would work out.
Dividend Controversy
Does the dividend policy affect the stock price?
There are three perspectives to this controversy -
1. The Conservative - An increase in the dividend payout increases firms value, its
positive if its increased and its taken as seen.
2. The Neutral - Dividend Policy doesn’t affect firm value or on stock price.
3. The Radical - An increase on the dividend payout reduces firms value - a signal that
the firm has no areas to develop.
The Neutral Perspective - Miller -Modigliani "Irrelevance Theory"
Assumptions -
• No agency Cost
• Individual Investors can borrow at same rate as firms
• No Bankruptcy Cost
• All firms are in same risk class when we are comparing - high payer of dividend or
low payer
• No Transaction cost
