Corporate Finance Chapter 17

1. retain

- invest

-increase cash reserve

2.payout

-repurchase shares

-pay dividends

1. declaration date (board declares dividend)

2. ex dividend date (buyers after this date do not receive)

3. record date (shareholders recorded by this date receive)

4. payable date (eligible shareholders receive)

company issues additional shares rather than cash to its shareholders

1. reduce current retained earnings

2. or paid in capital (known as return capital)

3. or liquidation of assets (known as liquidating dividend)

different tax treatment!!

-Most common ways for firms to repurchase -shares

-announced to investors

- not obligated to repurchase full amount

SEC not purchase more than 25% of average daily trading volume or within 30 min of the colse of trade

firm offers to buy shares at prespecified price during short time period- generally wihin 20 days.

usually substantial premium.

-someimes might cancel when not enough are tendered

firm lists different prices, shareholder indicate at each price how much they are willin to sell. Firm pays lowest price at which it can buy back desired number of shares

repurchase shares directly from large shareholder (eg greenmail)

1. open market repurchase

2. tender offer

3. dutch auction

4.targeted repurchase

just before exdividend date, stock is traded at cum dividend.

in perfect capital markets, when a dividend is paid, the share price drops by the amoun of the dividend when the stock begins to trade ex-dividend

.. open market share repurchase has no effect on the stock price, and stock price is the same as cum dividend price if a dividend were paid instead

... investors are indifferent between firm distr funds through dividend or repurchase.

... firms choice of dividend policy is irrelevant for shareprice

1. payout all cash as dividend

2. pay no dividend and use cash to repurchase

3. issue equity to finance larger dividend

1. capital gains tax < dividend tax

2. capital gains tax can be deferred until investor sells, so also reason to prefer repurchase>dividend

3. higher tax rate on dividends also makes undesirable for a firm to raise funds to pay div

No dividend at all

firms continue to issue dividends despite their tax disadvantages

-depends on difference cap gains and dividend tax rate

-depends on income, jurisdiction, retirement account or not

-because these differences frms attract different kinds of investors

p.545

measures the additional tax paid by the investor per dollar of after tax capital gains income that is instead received as a dividend

- income level

- investment horizon

- tax jurisdiction

- type of investor account

1. heavily taxed on dividends, prefer repurchase

2. and 3. non taxed so no preference, want payout policy that most closely matches their cash needs

4. enjoy a tax advantage with dividends

1. investors with high income prefer low dividends

2. tax free, like corporation prefer high dividend

absent transaction costs, investors trade shares at time of dividend so that non taxed investors receive and need not hold the stock all the time.

evidence: large volume traded between announcement and ex dividend date.

but wealthy investors also keep sometimes, transaction costs.

retaining cash can reduce costs of raising capital, but also increase taxes and agency costs

in perfect capital markets, if a firm invests excess cashflows in financial securities, the firms choice of payout versus retention is irrelevant and does not affect initial value of the firm

cash: when receiving interest, you have to pay taxes on it. tax disadvantage on holding cash.

-to cover future potential cash shortfalls (eg R&D!)

-in case of large investments, avoid transaction costs of raising new capital (direct and indirect)

- firms with volatile earnings, to prepare for periods of loss.

-mng may use funds inefficiently

- divided/repo may reduce mng incentive to waste

maintaining relatively constant dividends. also more frequently increased rather than cut

1. Increased: positive signal or lack of investment opportunities.

2. decreased: earnings rebound in the near term

dividend policy reflects mng views on firms future earnings prospects

- actual amount vs amount annouced can be different

- may take several years to complete share repurchase

- firms do not smooth repurchase from year to year

- cost of share repurchase depends on market price of stock.

share repurchase signal undervalued

receive stocks from company (stock split if stock dividend >50%) or from subsidiary (spin off)

1. keep shareprice in range to be attractive for small investors.

2. increased liquidity may boost share price (on average 2%)

3. usually keep stock from exceeding $100

4. also dont want shareprice too low: transaction costs relatively too high: reverse split

5. through these mechanisms firms can keep price in a range

distribute shares of subsidiary

1. avoids transaction costs associated with sale

2. special dividend is not taxed as a cash distribution, shareholders only liable for cap gains tax when they sell spin off shares.

dm fk