Set out what shapes the dividend policies companies actually adopt
The idea
Several practical forces shape payouts. Plentiful profitable investment opportunities argue for retaining earnings. Volatile earnings argue for a lower dividend that can be sustained through bad years. Financial flexibility favours modest regular dividends supplemented by repurchases. Taxes matter: where dividends are taxed more heavily than gains, taxable investors prefer lower payouts, whereas tax-exempt investors are indifferent. Flotation costs make it wasteful to pay dividends and then issue new equity. Finally, contractual and legal limits apply: debt covenants may cap payouts, and impairment-of-capital rules stop dividends that exceed retained earnings. The trap is citing a factor that points the opposite way, such as stable earnings as a reason to cut.
In the app: 2 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
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- Explain the expected impact on shareholder wealth and on a company's financial ratios of cash dividends (regular, extra or liquidating), stock dividends, reverse stock splits and stock splits
- Contrast the main dividend policy theories and, for a described dividend decision by a company, explain what each theory implies for its share value
- Explain what signals a company may send by starting, raising, cutting or omitting its dividend
- Set out the ways agency costs can influence a firm's payout policy
- Work out and explain the effective tax rate borne by each currency unit a company earns, under double-taxation, imputation and split-rate tax regimes
- Contrast a stable dividend policy with a constant payout ratio policy and work out the dividend each would produce
- Outline how corporate payout policies have broadly changed over time
- Contrast the ways a firm can buy back shares
- Work out and contrast how a share buyback affects EPS when it is funded 1) from surplus cash and 2) with borrowed money
- Work out how buying back shares changes book value per share
- Weigh up returning cash through dividends against buying back shares
- Work out and explain how well dividends are covered, measured against free cash flow and against net income
- Recognise the traits of firms whose cash dividend may prove unsustainable