FINANCE IN A CANADIAN
SETTING
Sixth Canadian Edition
Lusztig, Cleary, Schwab
CHAPTER
SEVENTEEN
Dividend Policy
Learning Objectives
1. Discuss when a company should pay out
dividends and why.
2. Explain how dividend policy may create
value in its own right.
3. Define the terms ex-dividend date, date
recorded, and payment date, and
demonstrate how they each play a role in
share prices.
Learning Objectives
4. Describe stock splits, and compare them
to stock dividends.
5. Understand how a company repurchases
its own shares, and why and how this
affects earnings per share (EPS) and the
market price per share.
Introduction

The chapter looks at:




the conceptual foundations of dividend
policy
how investors should explore alternative
dividend policies
the practical aspects that often influence
the formulation of dividend policy by firms
relevant institutional setting and the
alternative forms of dividend payments
Dividend Policy Conceptual Considerations

Four factors that affect a firm’s decision on
dividend policy include:
1. Investors’ propensity for current income

not a major concern to the firm when formulating
dividend policy
2. Reinvestment opportunities versus current
dividends


important to both the investor and the firm
firm should retain earnings whenever it can
achieve yields greater than those of a shareholder
who reinvests the same funds at the same risk
level
Dividend Policy-Conceptual
Considerations

Dividend policy and investors’ taxes


difficult to formulate because of the
complex tax system and the heterogeneity
of individual investors
Dividend policy as a financing decision

the firm’s total uses of funds for dividends
and new investments over any time period
can not exceed its source of funds from
earnings and external financing
Dividend Policy in Practice



Approximate number of firms on the major
exchanges that pay dividends are:
 50% on TSE
 75% on NYSE
Dividend payout ratio – the proportion of
earnings that a firm pays out in dividends
Dividend yield – relates the dividend income
received by shareholders to the price of the
common share on a percentage basis
Dividend Policy in Practice

When setting dividend policy management
tries to:



avoid making changes in their payout ratio
that may have to be reversed
strive to maintain an uninterrupted record
of dividend payments
have target payout ratios and periodically
adjust the dividend payout towards the
target
Dividend Policy in Practice
Dividend Policy in Practice
Dividend Policy in Practice

Other factors which may influence a
company’s dividend policy are:
1.
2.
3.
4.
5.
corporate control
the firm’s cash position
restrictions imposed by creditors
restrictions on foreign transfers
corporate growth potential
Payment Procedures


Dividends are:
 payable only when declared by the
corporation’s board of directors
 distributed quarterly or semi-annually
 labeled regular, extra, or liquidating
 usually paid in cash
The corporation sets a date of record and
payment is made to shareholders appearing
on the company’s books at the date of
record.
Payment Procedures



To allow for processing delays, the date of
record precedes the payment date
Shares are said to trade ex-dividends
when a purchaser is no longer entitled to
the dividend just declared
Ex-dividend date - is the two days prior to
the date of record
Payment Procedures
Dividend Payment Time Line
Stock Dividends

Stock dividends:




are occasionally issued by corporations
are issued on a pro rata basis to their
shareholders
do not affect the value
of the firm
do not affect
shareholders’ wealth
Stock Splits

Stock splits:



are similar to stock dividends in that, in
both cases, additional share certificates are
issued and distributed without cost to
current shareholders
are proposed to alter the stock price,
moving the share into a range investors
find more attractive
do not change the value of the firm
Repurchase of Shares

Stock repurchase programs:




are an alternative to issuing dividends
are often practiced in Canada and U.S.
take place in the open market or, after
filing an appropriate notice, a company can
offer to buy back a proportion of the
outstanding shares
shareholders trade-off cash dividends
against capital gains
Summary
1. Dividends ought to be paid only if the firm
has surplus cash that cannot be reinvested to
yield a positive net present value or,
equivalently, whenever the firm’s returns on
reinvestments fall below the returns that
shareholders could achieve on their own in
the marketplace. In practice, most firms have
a strong commitment to maintain stable or
steadily increasing dividends, and dividend
payments often appear to take precedence
over other uses of funds, including new
investments.
Summary
2. Other practical considerations that influence
dividend policy include the firm’s cash and
liquidity position, restrictions to protect
creditors, and restrictions on foreign
transfers.
3. Stock dividends are an alternative to cash
dividends. Stock dividends involve issuance of
additional share certificates to existing
shareholders.
Summary
4. A stock split should not affect the wealth
position of shareholders as it leaves the
proportional ownership of each shareholder
and the value of the firm unchanged.
5. The purchase by a firm of its own shares
may be an alternative to paying cash
dividends. With the number of outstanding
shares reduced, earnings per share will
increase and the market price of the
remaining shares should appreciate.
Summary
6. Miller and Modigliani developed the
theoretical framework for analyzing dividend
policy. The relevance of dividend policy for
share prices stems from market imperfections
such as transaction costs, taxes, and limited
investor information.