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Corporate Finance Outline Ucla

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					                        Overview
            What are Dividends?
       Does Payout Policy Matter
                       Summary




Lecture 5: Dividend Payout Decisions
         IRGN424 - Corporate Finance
       University of California, San Diego
   International Relations and Paci…c Studies


                Brian Kelleher Richter


                    29 October 2007



           Brian Kelleher Richter   IRGN424 - Corporate Finance
                                    Overview
                        What are Dividends?     First Principles
                   Does Payout Policy Matter    Conceptual Overview
                                   Summary



Lecture Outline
    I   Overview
          I   First Principles
          I   Conceptual Overview
    I   What are Dividends?
    I   Does Payout Policy Matter?
    I   Summary




                       Brian Kelleher Richter   IRGN424 - Corporate Finance
                                       Overview
                           What are Dividends?     First Principles
                      Does Payout Policy Matter    Conceptual Overview
                                      Summary



First Principles
E¢ cient Financial Market Hypotheses
       I   There are three di¤erent e¢ cient markets hypotheses:
            1. Weak:
                  I   Using past returns alone it is impossible to outperform
                      the market
                  I   Prices re‡ect information in the past prices
            2. Semi-strong:
                  I   Prices adjust immediately to new information
                  I   Prices re‡ect information in past prices plus all
                      information in the press
            3. Strong:
                  I   There is no way to outperform the market on average
                  I   Assumes Prices re‡ect all information
                          Brian Kelleher Richter   IRGN424 - Corporate Finance
                                      Overview
                          What are Dividends?     First Principles
                     Does Payout Policy Matter    Conceptual Overview
                                     Summary



First Principles
E¢ cient Financial Market Hypotheses
       I   Nonetheless many anomalies exist in …nancial markets
           suggesting they may not be completely e¢ cient
       I   Assumptions about frictionless markets may not hold
       I   Behavioral …nance helps explain away some anomalies




                         Brian Kelleher Richter   IRGN424 - Corporate Finance
                                  Overview
                      What are Dividends?     First Principles
                 Does Payout Policy Matter    Conceptual Overview
                                 Summary



Conceptual Overview
    I   Over the …rst couple of lectures, we established that
        companies can earn positive NPV on their projects
    I   That means they have extra cash on hand beyond what is
        needed to pay employees, cover costs, etc.




                     Brian Kelleher Richter   IRGN424 - Corporate Finance
                                  Overview
                      What are Dividends?     First Principles
                 Does Payout Policy Matter    Conceptual Overview
                                 Summary



Conceptual Overview
    I   What should companies do with the extra cash they have?
    I   The most obvious choices are:
         1. Use it for new investments
         2. Return it to shareholders




                     Brian Kelleher Richter   IRGN424 - Corporate Finance
                                    Overview
                        What are Dividends?
                   Does Payout Policy Matter
                                   Summary



What are Dividends?
    I   Dividends are a tool used by …rms to return cash to
        shareholders
          I   The most common type is a regular cash dividends in
              which a …rm announces that all shareholders of record
              on a certain date will receive a certain cash payment for
              each share they hold




                       Brian Kelleher Richter   IRGN424 - Corporate Finance
                                       Overview
                           What are Dividends?     Dividend Policy is Irrelevant
                      Does Payout Policy Matter    Dividend Policy is Important
                                      Summary



Does Payout Policy Matter
Overview
      I    Two schools of thought
             I   Dividend payout policy does not matter
             I   Dividend payout policy does matter




                          Brian Kelleher Richter   IRGN424 - Corporate Finance
                                        Overview
                            What are Dividends?     Dividend Policy is Irrelevant
                       Does Payout Policy Matter    Dividend Policy is Important
                                       Summary



Does Payout Policy Matter
Dividend Irrelevance
       I   Part of the Modigliani and Miller (MM) Theorem has a
           component about Dividend Irrelevance:
             I   Dividend policy does not matter because it does not
                 impact the value to its shareholders if we have
                 frictionless …nancial markets
       I   Modigliani and Miller each won the Nobel Prize in
           Economics for their work in corporate …nance




                           Brian Kelleher Richter   IRGN424 - Corporate Finance
                                        Overview
                            What are Dividends?     Dividend Policy is Irrelevant
                       Does Payout Policy Matter    Dividend Policy is Important
                                       Summary



Does Payout Policy Matter
Dividend Irrelevance
       I   A simple example of why dividends do not matter can be
           seen by thinking about shareholders’options to cash out:
             I   If you are a shareholder and you receive a dividend then
                 you can use the cash to buy shares
             I   If you are a shareholder that does not receive a dividend
                 then you can sell some shares to obtain cash




                           Brian Kelleher Richter   IRGN424 - Corporate Finance
                                        Overview
                            What are Dividends?     Dividend Policy is Irrelevant
                       Does Payout Policy Matter    Dividend Policy is Important
                                       Summary



Does Payout Policy Matter
Importance of Dividend Policy
       I   Assumptions of MM Theorem are not completely realistic
       I   We do not have frictionless capital markets
             I   Two types of frictions are:
                   I   Di¤erential taxation
                   I   Possibility of informational content embedded in
                       …nancial decisions




                           Brian Kelleher Richter   IRGN424 - Corporate Finance
                                        Overview
                            What are Dividends?     Dividend Policy is Irrelevant
                       Does Payout Policy Matter    Dividend Policy is Important
                                       Summary



Does Payout Policy Matter
Importance of Dividend Policy
       I   Frictionless markets assume away di¤erential taxes as a
           form of transaction cost:
             I   Di¤erential Taxes exist
                   I   Subject of a lot of controversy today because of private
                       equity industry executives treating what some view as
                       income as capital gains
                   I   Importantly for dividend policy the tax rates on capital
                       gains and dividends (which are treated as income) vary




                           Brian Kelleher Richter   IRGN424 - Corporate Finance
                                       Overview
                           What are Dividends?     Dividend Policy is Irrelevant
                      Does Payout Policy Matter    Dividend Policy is Important
                                      Summary



Does Payout Policy Matter
Importance of Dividend Policy
       I   Shareholder interested in maximizing their returns would
           rather be able to cash-out of an investment in the way
           that is taxed the least:
             I   If dividends are taxed at a higher rate they would rather
                 see capital gains
             I   If capital gains are taxed at a higher rate, they would
                 rather see dividends




                          Brian Kelleher Richter   IRGN424 - Corporate Finance
                                        Overview
                            What are Dividends?     Dividend Policy is Irrelevant
                       Does Payout Policy Matter    Dividend Policy is Important
                                       Summary



Does Payout Policy Matter
Importance of Dividend Policy
       I   Frictionless markets assume away informational content of
           dividend policy
             I                                                 s
                 Is there any information conveyed in a manager’
                 decision to issue dividends or hold cash?
                   I   Some managers and market participants believe that
                       increases in dividend payments signal stronger future
                       earnings




                           Brian Kelleher Richter   IRGN424 - Corporate Finance
                                       Overview
                           What are Dividends?     Dividend Policy is Irrelevant
                      Does Payout Policy Matter    Dividend Policy is Important
                                      Summary



Does Payout Policy Matter
Importance of Dividend Policy
       I   Empirical studies suggest:
             I   Firms have longer term target dividend payout ratios
             I   Managers focus more on dividend changes than on
                 absolute levels
             I   Dividends changes follow shifts in long-run, sustainable
                 levels of earnings rather than short-run changes in
                 earnings
             I   Managers are reluctant to make dividend changes that
                 might have to be reversed
             I   Firms repurchase stock when they have accumulated a
                 large amount of unwanted cash


                          Brian Kelleher Richter   IRGN424 - Corporate Finance
                                        Overview
                            What are Dividends?     Dividend Policy is Irrelevant
                       Does Payout Policy Matter    Dividend Policy is Important
                                       Summary



Does Payout Policy Matter
Importance of Dividend Policy
       I   For example, Microsoft did not pay
           any dividends until recently
             I   They amassed tens of billions of dollars of cash because
                 they were not paying dividends through 2003
             I   In July 2003, they paid out $33B in dividends
                   I   Did this signal something about the company?




                           Brian Kelleher Richter   IRGN424 - Corporate Finance
                                    Overview
                        What are Dividends?     Main Ideas
                   Does Payout Policy Matter    Questions
                                   Summary



Main Ideas
    I   Dividend Policy
          I   Some believe that dividend policy does not matter
              because it does not impact the value of the …rm given
              certain assumptions
          I   Others believe that payout policy has subtle implications
              given market frictions




                       Brian Kelleher Richter   IRGN424 - Corporate Finance
                                     Overview
                         What are Dividends?     Main Ideas
                    Does Payout Policy Matter    Questions
                                    Summary



Questions
    I   How do we implement these concepts in Excel?
          I   See the Examples in the Week 5 Spreadsheet
                I   Work through these from scratch without full answers,
                    e.g. start from just the assumptions
    I   Book questions I think are good to look at in
        week 5 include:
          I   BMA, Ch. 16, Practice Questions 3, 4, 6, 7, 8, 9
          I   BMA, Ch. 16, Challenge Question 1, 4
    I   Note: Due to the …res, you are not responsible for this
        material on any exam


                        Brian Kelleher Richter   IRGN424 - Corporate Finance

				
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