dividend decision

Examples of dividend decision in the following topics:

• Signaling

  • Dividend decisions are frequently seen by investors as revealing information about a firm's prospects; therefore firms are cautious with these decisions.
  • A dividend decision may have an information signalling effect that firms will consider in formulating their policy.
  • Investors can use this knowledge about managers' behavior to inform their decision to buy or sell the firm's stock, bidding the price up in the case of a positive dividend surprise, or selling it down when dividends do not meet expectations.
  • This, in turn, may influence the dividend decision as managers know that stock holders closely watch dividend announcements looking for good or bad news.
  • A company's dividend decision may signal what management believes is the future prospects of the firm and its stock price.

• The Nature of Dividends

  • A firm's dividend decision may also serve as a signaling device which gives clues about a firm's future prospects.
  • Due to information asymmetry between investors and the firm managers, investors will look to indicators like dividend decisions.
  • Managers have more information than investors about the firm, and such information may inform their dividend decisions.
  • This, in turn, may influence the dividend decision as managers know that stock holders closely watch dividend announcements looking for good or bad news.
  • Analyze what dividends mean to an investor making a decision on which stock to include in her portfolio

• Expected Dividends, No Growth

  • A no-growth company would be expected to return high dividends under traditional finance theory.
  • This suggests that a particular pattern of dividend payments may suit one type of stock holder more than another; this is sometimes called the "clientele effect. " A retiree may prefer to invest in a firm that provides a consistently high dividend yield, whereas a person with a high income from employment may prefer to avoid dividends due to their high marginal tax rate on income.
  • This model may help to explain the relatively consistent dividend policies followed by mostlisted companies.
  • No growth, high dividend stocks may appeal to value investors.
  • Describe how a company should make a dividend decision when it expect no growth

• Dividend Irrelevance Theory

  • Dividend irrelevance follows from this capital structure irrelevance.
  • However, the total return from both dividends and capital gains to stockholders should be the same.
  • If dividends are too small, a stockholder can simply choose to sell some portion of his stock.
  • However, the importance of a firm's dividend decision is still contested, with a number of theories arguing for dividend relevance.
  • Merton Miller, one of the co-authors of the capital irrelevance theory which implied dividend irrelevance.

• Residual Dividend Model

  • The Residual Dividend Model first uses earnings to finance new projects, then distributes the remainder as dividends.
  • The Residual Dividend Model is a method a company uses to determine the dividend it will pay to its shareholders.
  • The Residual Dividend Model is an outgrowth of The Modigliani and Miller Theory that posits that dividends are irrelevant to investors.
  • It goes on to say that dividend policy does not determine market value of a stock.
  • The Residual Model dividend policy is a passive one and, in theory, does not influence market price because the same wealth is created for the investor regardless of the dividend.

• Impact of Dividend Policy on Clientele

  • Change in a firm's dividend policy may cause loss of old clientele and gain of new clientele, based on their different dividend preferences.
  • Suppose Firm A had been in a growth stage and did not offer dividends to its shareholders, but their policy changed to paying low cash dividends.
  • Clientele interested in long term capital gains might be alarmed, interpreting this decision as a sign of slowing growth, which would mean less stock price appreciation in the future.
  • These investors are known as dividend clientele.
  • Although commonly used in reference to dividend or coupon (interest) rates, the clientele effect can also be used in the context of leverage (debt levels), changes in line of business, taxes, and other management decisions.

• Accounting for Preferred Stock

  • Stock preferred as to dividends means that the preferred stockholders receive a specified dividend per share before common stockholders receive any dividends.
  • Companies must pay unpaid cumulative preferred dividends before paying any dividends on the common stock.
  • It has paid no dividends for two years.
  • Dividends in arrears are cumulative unpaid dividends, including the quarterly dividends not declared for the current year.
  • However, since the amount of dividends in arrears may influence the decisions of users of a corporation's financial statements, firms disclose such dividends in a footnote.

• The Cost of Retained Earnings

  • The cost of retained earnings is slightly less than the cost of common stock, as it excludes transaction costs and taxes associated with dividends.
  • Retained earnings refers to the portion of net income (or loss) that is retained by a company rather than distributed to its owners as dividends.
  • The retention rate also can be expressed in terms of the dividend payout ratio: .
  • The retention rate and the dividend payout rate are opposites, as are retained earnings and dividends paid out.
  • Therefore, we also can calculate retained earnings by subtracting dividends paid out from total net income.

• The Valuation of Stocks

  • Then we build our sequence by examining an investor's decision for Period 3, andsubstitute that equation into Equation 14 for variable P2.We continue to examine an investor's future decision for each time period until we derive an infinite sequence in Equation 15.
  • Many investors want their dividends to grow over time, and Equation 16 can include a dividend growth rate.If the dividend grows at g percent per year, then we update the present value formula to include a dividend growth rate in Equation 18.Consequently, we can simplify this infinite sequence into something similar to a perpetuity.
  • We calculate a market value of $25 per share because the dividend grows slowly in Equation 20.
  • Two forces reduce future cash flows.First, a greater discount rate lowers the future value of cash flows.Second, a larger dividend growth rate increases the value of future cash flows, causing the dividends to grow faster than the rate of return.Nevertheless, the dividend growth rate must become lower than the discount rate, or g > r.
  • As an illustration, we set the rate of return to 10%.A corporation pays a dividend of $6 at time 1.Corporation expects to increase the dividend by 2% for the first year, 4% for the second year, and 6% for year 3.After Year 3, the dividend grows at a constant rate of 6% per year.In this case, we solve for the dollar value of the dividend for each year with no fixed growth rate.We calculate the following:

• Common and Preferred Stock

  • However, because equity financing involves trading funds for ownership in the company, these new investors do gain some decision-making power in the company, and the managers lose some autonomy.
  • They also receive dividend payments if the firm offers them.
  • Almost all preferred shares have a negotiated, fixed-dividend amount.
  • Sometimes, dividends on preferred shares may be negotiated as floating.
  • With non-cumulative preferred stock, dividends will not accumulate if they are unpaid.