DIVIDEND POLICY​

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“A dividend policy is a policy a company uses to structure its dividend Payout. Put simply, a dividend policy outlines how a company will distribute its dividends to its shareholders. These structures detail specifics about payouts, including how often, when, and how much is distributed.”

If a company pays a high dividend rate (a large portion of its profits as dividends), it means it is retaining less money for reinvestment and growth. So, a high dividend rate generally means a slower growth rate for the company. On the other hand, if a company retains more of its profits for reinvestment, it can grow faster, but it will pay out lower dividends. Both high growth and high dividends are desirable for investors. The company's financial manager tries to strike a balance between the two that maximizes the company's stock price (makes the stock more valuable).

 

The most important factor in deciding this balance is the company's future planned uses of cash (its investment and growth plans).Companies generally try to maintain a stable level of dividends from year to year, even if their profits fluctuate. This is because many investors buy stocks expecting a certain level of dividend income each year. So, companies tend not to raise dividends unless they are confident they can maintain the higher payout level in the future. This desire for dividend stability has led to the "signaling hypothesis," which suggests that a change in dividend policy signals to the market the management's forecast of future earnings. So, companies actively manage their dividend policies as a signal to investors. This stability in dividends often results in the company's stock selling at a higher market price, as shareholders perceive less risk in receiving their expected dividends.

 

SHARE REPURCHASES

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“A share repurchase is a transaction whereby a company buys back its own shares from the marketplace. A company might buy back its shares because management considers them undervalued. The company buys shares directly from the market or offers its shareholders the option of tendering their shares directly to the company at a fixed price.” Repurchases reduce the number of outstanding shares, which is something that investors often feel will drive up share prices. This assumes demand for the shares will not be diminished by the action.”

 

There are several motives or reasons why a company may decide to repurchase its own shares:

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• Mergers: When companies want to merge, they might buy back their own shares

• Share options: Companies often issue stock options to employees as part of their compensation. To meet the obligation of providing shares when these options are exercised, the company may need to repurchase its own shares if it doesn't have enough treasury shares available.

• Stock dividends: If a company wants to issue a stock dividend (distribute additional shares to its existing shareholders), it may need to repurchase shares to have a sufficient supply.

• Tax advantages to shareholders: Share repurchases can be more tax-efficient for shareholders compared to cash dividends, especially in certain tax jurisdictions.

• To increase earnings per share and other ratios: By reducing the number of outstanding shares, a company can increase its earnings per share (EPS) and other financial ratios, which can make it look more attractive to investors.

• To prevent a hostile takeover: By repurchasing a significant number of its own shares, a company can make it more difficult and expensive for an outside entity to acquire a controlling interest through a hostile takeover.

• To eliminate a particular ownership interest: A company may repurchase shares to remove a specific shareholder or group of shareholders from its ownership structure.

 

QUESTIONS

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1. What is the primary reason a company may choose to have a low dividend payout ratio? 

a.To retain more earnings for reinvestment and future growth

b. To signal to investors that the company is struggling financially

c. To reduce the number of outstanding shares

d. To avoid paying taxes on dividends

 

2. The signaling hypothesis suggests a change in dividend policy: 

a. Has no impact on investor perceptions

b. Signals management's forecast of future earnings

c. Is solely for tax purposes

d. Indicates the company is planning a merger

 

3. Which of the following is NOT a common motive for a company to repurchase its own shares?

a. To increase earnings per share

b. To prevent a hostile takeover

c. To pay off debt

d. To meet obligations for employee stock options

 

4. A company that repurchases its shares is: 

a. Increasing the number of outstanding shares

b. Decreasing the number of outstanding shares

c. Has no impact on the number of outstanding shares

d. Splitting its existing shares

 

5. Share repurchases can be attractive to shareholders because: 

a. They are taxed at a lower rate than dividends in some jurisdictions

b. They guarantee the share price will increase

c. They eliminate all risk for the shareholder

d. They are always a sign the company is performing poorly

 

ANSWERS:

1. a 

2. b 

3. c 

4. b 

5. a

 

References:

Banton, C. (2023, February 07). Share Repurchase: Why Do Companies Do Share Buybacks? https://www.investopedia.com/terms/s/sharerepurchase.asp#:~:text=A%20share%20repurchase%20or%20buyback,market%20is%20on%20an%20upswing.

Chen, J. (2023, September 29). Dividend Policy: What It Is and How the 3 Types Work. 

https://www.investopedia.com/terms/d/dividendpolicy.asp#:~:text=A%20dividend%20policy%20is%20a,and%20how%20much%20is%20distributed.