Introduction to Corporate Finance

PART 4: CAPITAL STRUCTURE AND PAYOUT POLICY

1 What policies and payments comprise a company’s payout policy? Why is determining payout

policy more difficult today than in decades past?

2 Why should we expect a company’s share price to decline by approximately the amount of the

dividend payment on the ex-dividend date? Define and differentiate between issuing bonus shares

and conducting share splits. Are they both forms of payout by the company? Explain.

3 Why is a share repurchase considered to be an alternative to a cash dividend payment?

Compare the tax consequences to the recipient of a cash dividend versus an equal-dollar share

repurchase.

CONCEPT REVIEW QUESTIONS 15-1

15-2 FACTORS AFFECTING DIVIDEND AND

SHARE REPURCHASE DECISIONS

Here we begin with a look at some survey evidence on the views of CFOs on dividends and share

repurchases in order to better understand payout policy practices. In addition, we consider some other

important evidence regarding dividend and share repurchase decisions.

15-2a CFO VIEWS ON DIVIDENDS AND REPURCHASES

The findings from a 2005 survey of 384 CFOs and treasurers, along with extensive one-on-one interviews

with two dozen additional CFOs and treasurers, provide insight into how financial executives approach

payout policy decisions. Figure 15.3 compares and contrasts executive views on dividends and

repurchases. For example, an overwhelming percentage of CFOs agree with the statement that ‘there are

negative consequences to reducing dividends’, but fewer than 30% agree with that statement when applied

to share repurchases. In other words, CFOs believe that investors view dividends as a commitment made

by the company that must be fulfilled, whereas share repurchases are more discretionary. In that spirit,

nearly 80% of CFOs say that they make repurchase decisions after investment plans are in place, but

fewer than 35% make the same claim about dividends. Apparently, dividend decisions are as important

as (or perhaps more important than) at least some investment decisions for these executives. This view is

confirmed by the question asking whether CFOs would raise external capital to fund a new investment

rather than cutting payouts to shareholders. More than 60% of the CFOs say that they would raise

external funds rather than cut dividends to finance a profitable new investment, but fewer than 20% say

that they would raise capital to avoid cutting repurchases.

15-2b FURTHER EVIDENCE ON DIVIDEND AND SHARE

REPURCHASE PRACTICES

A key advantage of share repurchases is their flexibility as a form of payout. Managers don’t feel that

their company is penalised if repurchases are reduced from one year to the next; they curtail repurchases

in order to pursue attractive investments; and they are not generally inclined to raise external funds to

LO 15.2

John Graham, Duke

University

‘Why do companies

hesitate to initiate a

dividend or to increase a

dividend?’

See the entire interview on

the CourseMate website.

Source: Cengage Learning

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SMART VIDEO