Introduction to Corporate Finance

15: Payout Policy

evidence suggesting that most companies adjust their dividends infrequently, ‘smoothing’ dividends over

time rather than adjusting them up or down each quarter as earnings fluctuate. The figure plots average

earnings, dividends and share repurchases for US nonfinancial companies from 1990–2009.^1 Observe

that the earnings and repurchases lines dip significantly during the recessions in the early 1990s and

in 2001–02, but in both cases the change in dividends was muted. However, a modest reduction in

dividends occurred as earnings fell dramatically during the recession that began with the global financial

crisis in 2007.

Investors closely track two ratios related to corporate dividend payments. The first is the dividend yield,

which equals the annual cash dividend divided by the current share price. The second ratio related to

dividend payments is the dividend payout ratio, which equals dividends paid per share divided by earnings

per share in a given period.

example

On 18 May 2011, US company Intel Corp. (INTC) announced a 16% increase in its quarterly dividend to
US$0.21 per share (US$0.84 annually). On the day of that announcement, Intel’s shares traded for US$23.50, so
its dividend yield was 3.6% [($0.21 3 4) ÷ US$23.50]. Intel’s earnings during the prior quarter were US$0.56 per
share, which implies a dividend payout ratio of about 37.5% ($0.21 ÷ $0.56).

Relevant Dates

When companies announce dividends, they also establish certain dates that determine which

shareholders receive the dividends. The day on which companies release this information to the public

is the announcement date. Shareholders of record, all persons whose names appear as shareholders on the

record date, are entitled to the dividend. The ASX defines the record date as ‘5.00 p.m. on the date a

company closes its share register to determine which shareholders are entitled to receive the current

dividend’.^2 However, because it takes time to make bookkeeping entries after shares trade, investors who

buy shares on the record date will miss the dividend payment. To receive the dividend, an investor must

own the share before the ex-dividend date, usually two business days before the record date. Companies

distribute dividends on the date payable, which usually comes a few weeks after the record date. Prior

to the ex-dividend date, after the announcement date, shares are said to be cum dividend, indicating that

current shareholders are entitled to receive the dividends. Figure 15.2 shows a timeline illustrating

these events.

In a perfect market (no taxes and transactions costs) and in the absence of any new information,

when a share ‘goes ex-dividend’, its price should drop by the amount of the dividend. To see why, consider

that an investor who buys a share just before the ex-dividend date will receive the dividend a few days

later, whereas an investor who buys on the ex-dividend date misses this payment. Therefore, investors

who buy on the ex-dividend date will pay less for the share. For example, suppose a share that pays a $1

dividend sells for $51 just before going ex-dividend. Once the ex-dividend date passes, the price should

drop to $50 (ignoring market imperfections like income taxes).

1 We thank Mark T Leary of Washington University in St Louis for providing data for the figure.
2 Information on this and other aspects of dividend payments are provided on the ASX website: http://www.asx.com.au/prices/dividends.htm.

dividend yield

Annual cash dividend per

share divided by the current

share price

dividend payout ratio

The percentage of current

earnings available for ordinary

shareholders paid out as

dividends. Calculated by

dividing the company’s cash

dividend paid per share by its

earnings per share in a given

period

announcement date

The day a company declares

the amount of the dividend,

plus the dividend record and

payment dates to the public

record date

The date on which the names

of all persons who appear as

shareholders are entitled to

receive a dividend (which will

be distributed on the date

payable)

ex-dividend date

The date on or after which a

purchaser of a share does not

receive the current dividend,

usually two business days

before the record date

date payable

The actual date on which the

company makes the dividend

payment to the holders of

record entitled to receive

dividends

cum dividend

Between the announcement

date and ex-dividend date,

shares are said to be cum

dividend, meaning that current

or new shareholders are

entitled to receive dividends

Why might a company choose to

maintain its dividend per share

even if its profits have fallen

significantly?

thinking cap

question