Introduction to Corporate Finance

PART 4: CAPITAL STRUCTURE AND PAYOUT POLICY

15 -1 PAYOUT POLICY FUNDAMENTALS

In Chapter 5, we argued that the value of a share equals the present value of the cash flows the

shareholder receives over time. Even though a company is not paying dividends or repurchasing shares

today, its market value reflects the likelihood that the company will either pay dividends or repurchase

shares in the future or be acquired by another company, at a price that reflects a higher stream of cash

payments. To provide an understanding of the fundamentals of payout policy, we begin with a discussion

of the procedures for paying cash dividends and the factors affecting dividend policy.

15 -1a CASH DIVIDEND PAYMENT PROCEDURES

In Australia, as in most countries, shareholders do not have a legal right to receive dividends for every

earning period. Instead, a company’s board of directors must decide whether to pay dividends. The

directors usually meet to evaluate the company’s recent financial performance and future outlook, and

to determine whether, and in what amount, dividends should be paid. The payment date of the cash

dividend, if one is declared, must also be established.

Payment Patterns and Measures

In Australia, most companies that pay dividends do so twice a year. These dividends are usually known

as the interim dividend and the final dividend. Companies can also pay special dividends related to a

particular event. In the US, companies that pay dividends usually do so once every quarter. Companies

adjust the size of their dividends periodically, but not necessarily every quarter. Figure 15.1 provides

LO 15.1

FIGURE 15.1 US PAYOUTS 1990–2009: DIVIDENDS, REPURCHASES AND EARNINGS

Aggregated earnings and payouts, non-financial firms

0

50

100

150

200

250

300

350

400

450

500

0

50

100

150

200

250

300

199

0

199

1

199

2

199

3

200

9

200

8

200

7

200

6

200

5

200

4

200

3

200

2

200

1

200

0

199

9

199

8

199

7

199

6

199

5

199

4

Earnings ($bn) Payout ($bn)

Earnings

Repurchases

Dividends

Note: Two scales. Dividends decreased a small amount for nonfinancial companies during the 2008–09 recession,

while repurchases decreased much more.