Week 9

1) corporate governance = arrangements that align the interests of managers & owners

2) Carrot (i.e., CEO compensation) and Stick (i.e., CEO turnover)

3) Board of directors, large shareholders, takeover, product market competition

4)

i) corporate governance adds value

ii) there is no one-size-fits-all approach to governance, e.g. Elon Musks compensation is only suited for Tesla

iii) there can be social/ political factors that affect governance quality

Dividend = money paid on a regular basis (mostly quarterly in US) by a company to its investors out of its profits

Share repurchase = firms issue cash to investors in exchange for a fraction of the company’s share outstanding, causing a decline in the number of share outstanding

1) Decleration Date: Board of Directors declares a payment of dividends

2) Ex-Dividend Date: On (or after) this date the security trades without its dividend

3) Record Date: A list of stockholders as of this date is prepared

4) Payment Date: Dividend checks are mailed to shareholders of recrod

1) Dividend payout = Dividends / Net Income

• measures the percentage of earnings that the company pays in dividends

• if net income is negative, payout ratio cannot be computed

2) Dividend yield = Divident per share / Stock price

• Dividend per share is payment expressed as dollars/euros per share

• Measures returns investors can make from dividends

• in practice, dividend policy does not follow the logical process of starting with your investment opportunities & working its way down to residual cash

• The two dominant factors that drive dividend policies in practice are:

  • Interia: Companies stick to their past dividend patterns

  • Peer influence: Companies want to behave like their peer group

1) dividends are sticky (=unbeständig)

2) dividends tend to follow earnings

3) Corporate life cycle & dividends

4) firms increasingly rely on share buybacks rather than dividends

5) Income Tax & dividends

• investors have to pay tax for their dividend income

• 2003 Dividend Tax Reform: Dividends are taxed 15% (instead of 35%)

  —> investors demand more dividends

6) Dividends are different across countries

• Shao, Kwok & Guedhami (2010): Companies in more “conservative” countires are more likely to pay dividends

1) When there is no tax, dividends do not matter to firm value

• if firm pays dividends, it has to issue new equity to fund the same projects -> share prices will fall by the same amount of dividends on ex-dividend day

2) If dividends create a tax disadvantage for investors (relative to capital gains)

• dividends are bad for the investors and increasing dividends will reduce firm value

3) If dividends create a tax advantage for investors (relative to capital gains)

• Dividends are good for investors and increasing dividends will increase firm value

Bild

• in a world without taxes, the share price will fall by the amount of the dividend on the ex-date (time 0)

• if the dividend is $1 per share, the price will be equal to P on the ex-date

  • Before ex-date (-1) ; Price = $ (P+1)

  • Ex date (0) ; Price = $ P

• In a wolrd with tax: dividend policies matter for value

Bild

• P = Price at which you bought the stock a “while” back

• Pb = Price before the stock goes ex-divided

• Pa = Price after the stock goes ex-divided

• D = Dividends declared on stock

• td & tcg = Tax paid on dividends & capital gains respectively

1) Cash flows from selling before ex-dividend day are:

• CFb = Pb - (Pb - P) * tcg

2) Cash flow from selling after ex-dividend day are:

• CFa = Pa - (Pa-P) * tcg + D(1-td)

3) an average investor would be indifferent between selling stocks before versus after dividend date:

• Pb - (Pb-P) tcg = Pa - (Pa-P) * tcg + (1-td)

4) price change after ex-dividend date = Pb - Pa

1) The bird in the hand fallacy

2) Excess cash

The bird in the handy fallacy:

1) Argument:

• dividends now are more certain than capital gains later

  -> dividends are more valuabel than capital gains

  -> stocks that pay dividends are more valuable than stocks that do not

2) BUT:

• stock prices reduces on the ex-dividend day

• any gain from dividend will be offset by stock reduction

We have excess cash this year

1) Argument:

• the firm has excess cash on its hand this year + no investment this year —> hence it is good to give back money to investors

2) BUT:

• firm can always repurchase its stock instead of paying dividend

• firm needs to consider future financing needs -> it may need cash in the future & it is expensive to raise external financing

1) Clientele Effect: Investors in your company like dividedns!

2) The signaling theory: Paying dividends signals to investors that your company has good cash flow prospects in the future

• Investors may form clienteles based on their tax brackets

  (Anleger können auf der Grundlage ihrer Steuerklassen Kundengruppen bilden)

• Institutional investors in high tax brackets prefer stock that do not pay dividends [Desai and Jin (JFE 2011)

• clientele effect not only based on tax preferences but also based on investor demographics

• Becker and Weisbenner (JF 2011): Firms headquartered in areas with more seniors are significantly likely to pay dividends, initiate dividends & have higher dividend yields

• signaling theory implicates that investors are happy with dividend increase

• However: there is no clear evidence thatn payout actually predicts a dfirms future performance

• dividend increases and decreaes become less informative in recent years

1) instead of paying dividends, firms may use excess cash to repurchase shares of their own stock

2) it causes a reduction in the number of shares outstanding

3)

• discouraged in USA until 1982

• legalized in UK in 1981

• recently, share repurchase has become an important way of distrubuting earnings to shareholders

• Price per share = 1.000.000/100.000 = 10$

• Price per share = Value of firm/ shares outstanding

1) Option 1: cash dividend of $100.000

Option 2: stock repurchase of $ 100.000

• Shares outstanding = Total shares issued - number of shares repurchased

2 & 3)

Option 1: Balance sheet after $1 per share cash dividend

• Shares outstanding: 100.000

• Price per Share = 900.000/ 100.000 = $9

Option 2: After stock repurchase

• Shares outstanding: 90.000

• Price per share = 900.000/ 90.000 = $10

1) Undervaluation: When managers believe that the share price is temporarily depressed

2) Flexibility: when excess cash flows are only temporary

3) Tax benefits over dividends

4) Agency problems:

• Insider control

• Beneficial for insiders who hold stock options

  • keeps stock price higher - CEO compensation

Approach 1: Free Cash FLows (FCF) vs Actual Dividend Payment

• Step 1: How much did the company pay out during the period in question?

• Step 2: How much the company could have paid out during the period in question

• Step 3: How much do we trust that CEOs use their cash efficiently

  • How well did the company make their investment decisions

  • How well has my stock performed during the period in question

Approach 2: Peer Group Analysis

• compare the dividend policy of your company to dividend policies of other similar firms

• Free Cash Flow to Shareholders = how much a firm can afford to pay dividends in a given year

• Total payouts = How much a firm actually pays out

1) Free Cash Flos (FCF) versus Dividends

• Between 1994 & 2003, Disney generated $969 million in FCF each year

• Between 1994 & 2003, Disney paid out $639 million in dividends and stock buybacks each year

2) Cash Balance: Disney had a cash balance of $ 4 billion at the end of 2003

3) Performance measures:

• Between 1994 & 2003, Disney ROE is about 2% less than the cost of equity capital

4)

• poor investment quality further weakend by 2 events:

  • 1995: Disney bought Cap Cities/ ABC for $19 billion

  • 1998: Disney invested in Go.com: search engine + contents from ABC news

    -> mostly failed investments!

• Bottom line: Since Disney made poor investments (ROE<re)

  -> it is better for Disney to return cash to investors as dividedns rather than retaining it!

• payout policy is important -> can affect investment policy

• repurchases are more flexible, and can be used to boots EPS -> therefore preferable

• payout policy does convey information about the company but is not the most important means of conveying information