03. Making Distributions To Shareholders (10%) (P3)

Front 1

Dividend policy & s/h wealth - effects on the stmt of financial position of paying a div

Back 1

S/h funds:
Reduce profits retained which reduce value of s/h funds, so must tf have suff distributable profits.

Cash balance:
Reduce co's cash & tf must have suff cash to pay div. If insuff - issue more shares, borrow, cut back on capital investments.

Front 2

Dividend policy theories

3 theoretical conclusions of dividends (irrelevant, increase or decrease wealth)

Back 2

TIMECARD

Tax system (inds - income tax v CGT)
Information asymmetry (increase wealth)
MM's dividend irrelevance theory (irrelevant)
Empirical work
Clientele effect (decrease & increase wealth)
Agency costs (increase wealth)
Bird-in-the-hand theory/risk aversion (increase wealth)
Dividends as residual (decrease wealth)

Front 3

Dividends affect form in which s/hs receive their 'return' bc of tax:

Back 3

Ind taxpayers - cash div subj to income tax but if retained in co subj to capital gains tax (more generous)

Non-taxpayers - indifferent in terms of taxation

Corporate - pay both at corporation tax rate so indifferent.

Front 4

Information asymmetry

(increase wealth)

Back 4

'Signalling hypothesis'

S/hs only have access to info released to them.

Dividends as a signal of the future prospects of the business.

Maintain div payments so that stated div policy & trend growth not interrupted.

Front 5

Modigliani & Miller's dividend irrelevance theory

Back 5

The value of a co is determined by the NPV of its investments and NOT by its distributions policy.

If chooses to pay divs, can raise new capital at same cost as return earned by investors on money paid out as divs.

Front 6

Modigliani & Miller's dividend irrelevance policy - assumptions and their limitations

(div policy irrelevant)

Back 6

Key assumptions - perfect markets & rational investors.

BITT

Borrow at same rate of interest (inds/co's) - often not the case
Info equal & costless in a perfect capital market for all traders as well as s/hs - imperfect info means NPVs of projects not immediately reflected in sh price & div announcements have rapid impact on sh price
Transaction costs or difficulties in borrowing ignored - wrong
Taxation ignored - wrong

Also investors prefer a div policy w either constant or steadily growing divs - certain div now rather than an uncertain capital gain later.

Front 7

Empirical work

Back 7

Suggests that stock market likes stable but growing divs. Tf firms engage in 'div smoothing' where growth in divs is related to expected LT growth rate. Firms avoid cutting divs.

Wool ridge & Gosh:
But cut not necy bad news - adverse effects of cut outweigh positive signal of investment, but all cos enjoy recovery in sh price in the next yr if:
Communicate investment strategy
Signals that are costly are more successful (eg stock repurchase)
Deliver on its promises or forfeit credibility.

Front 8

Clientele effect

(increase & decrease wealth)

Back 8

Diff shs have diff needs -
High payouts for regular income (pension funds, retired ppl)
Low dive if on high marginal rates of income tax.

Can't meet needs of all bc diffs in liability to taxation & attitudes to risk. Tf adopt div policy that maximises wealth of one group. Shs will then invest if co operates div policy in line w their needs.

Front 9

Agency costs

(increase wealth)

Back 9

Interests groups looking after own interests, protecting themselves & in the process impose costs or restraints on behaviour of others. Profits should be distributed as dive thereby reducing surplus cash in co & opp for managers to indulge in expensive tastes.

But - inefficcients in terms of transaction costs if continue to pay divs so that then necy to issue more shares to fund projects.

Front 10

Risk aversion / bird-in-the-hand theory

(increase wealth)

Back 10

Prefer cash div now, certain, to a future capital gain or div which in uncertain.

Smaller multiplier used for undistributed balance when valuing shares on basis of earnings, and
View that cos carrying out riskier activities choose lower payout policy (to reduce need to borrow which would further increase risk profile).

Therefore, div payouts reduce the risk that shs may lose all their investment.

Front 11

Dividends as a residual

(decrease wealth)

Back 11

Must identify akk positive NPV projects available & use the cash availabel to invest. Surplus paid as div. Div amount is a balancing figure & would fluctuate as availability of +ve NPV projects fluctuates.

Considers the cost of administering the div payments & sig cost of undertaking a share issue.

Issues:
Depends on shs accepting wide variations in div payments
Info content of div - negative signal if div cut adversely affecting sh price. Stock market likes stable but growing divs.

Front 12

Importance of dividends

Back 12

CHROMES

Choice to be made by growth cos - divs v capital expenditure. High div - transaction costs of sh issue, gearing, opp cost in terms of foregone cap expenditure.
High profile w/in corporate decision-making when deciding amount (AGM)
Returns manifest themselves as divs, which represent cash return to shs for bearing risk. Further return on sale but future sh value influenced by div policy. S/hs purchase shs for the returns.
Outflow of cash sig for divs - must be planned for & ensure doesn't damage liquidity/solvency.
Mngt must provide advanced explanation/forewarning to mitigate any fluctuations - sudden variations lead to sig changes in sh price.
Expectations of certain level of divs by many groups of shs, t/f many cos pay interim divs as well (BP quarterly).
Signal d's expectations - influence shs expectations by div policy - growing over time at what they consider cos growth rate, despite actual PAT.

Front 13

Factors & considerations when determining the levels of dividends

Back 13

REDRILLING

Return of surplus cash to s/hs - bc future cash flow predictions strong or no profitable opps for investing in (eg Microsoft).
Expectations of s/hs - co should match div policy to these to avoid excessive turnover of shares
Defence against takeover bids - market may perceive increased div as indicator of improved future profitability, leading to increase in sh price + tf more expensive to bidder. (eg Endesa)
Restrictive covenants - on amount co can pay out, imposed by lenders to ensure suff cash in bus to pay annual interest + provide for eventual repayment.
Industry practice - market expects cos to follow this (eg tobacco sector high divs)
Liquidity of co - needs to remain solvent, also consider timing of cash flows, level of inflation, suff co to maintain operating capability.
Legal limitations - level of profits determines level of divs. Also consider laws in country operating in (UK - divs only paid out of realised profits).
Investment demands - restrict divs to finance investment - avoids issue expenses/diluting ownership or increasing gearing (eg Vodafone). In UK majority of investment finance provided from retained earnings.
Need for realistic attitude of co to commercial pressures (M&S increased divs despite setback in profits, then had to acknowledge LT issue + reduce profits)
Gearing of co - reduction in retained earnings will increase its gearing + gearing ratio will further deteriorate if co has to borrow to replace cash lost through paying divs.

Front 14

Scrip dividends

Back 14

A conversion of profit reserves into issued share capital, offered to s/hs in lieu of a cash dividend.

Enhanced scrip divs - value of shares is greater than the cash div offered as an alternative.

Benefit to co - retain cash w/in the business.
Benefit to shs - increase shareholdings w/out paying brokers commission or stamp duty, but poss tax implications for ind investors.

Front 15

If surplus cash resources, can return to shs in 3 ways:

Back 15

Increase annual div + return to the 'normal' LT div pattern pattern following yr
Pay a 'special' dividend (similar to normal div but usually bigger & paid on one-off basis - must signal special nature to s/hs)
Repurchase or buy back shares

Front 16

Repurchase or buy-back of shares - why?

Back 16

CRAPPIES

Change capital structure - increase gearing + benefit from advantages of debt finance.
Return unwanted cash - cash generated exceeds amount of cash needed for investment opps.
Allocative efficiency - cash but ltd opps hand it back so shs can invest in cos w/ little cash but many prospects.
Prevent takeover bid bc control by existing shs increased.
Private - to prevent takeovers, reduce costs of listing reqs, agency prob, focus on LT reqs.
Ind s/hs choose whether to be bought back (sp div goes to all).
Enhance EPS + divs per share + poss lead to higher sh price, bc reduces ord shs in circulation.
Stock market withdrawal.

Front 17

Disadvantages of share buy-back

Back 17

FARCED

Failure of co to manage funds profitability for shs (poss viewed that way)
Approval of existing shs required
Require cash for the repurchase so need large cash balances
Capital gains tax may be payable by shs whom shares are purchased
Equity reduced but loans left unchanged - increases gearing
Diff to fix a repurchase price to advantage all involved

Front 18

Share repurchase regulation

Back 18

Out of distributable profits or new issue of shares
Can't purchase own shares if there would no longer be a member holding shares other redeemable pref shares (?)
In the market or off-market (shares purchased not subj to the marketing arrangements of the SE).