15: Payout Policy15-5 PAYOUT POLICY: KEY LESSONS
In this chapter, we have learned that companies take a conservative approach to paying dividends. The
key factor driving dividend payments is the stability of long-run cash flows. Dividends are smoothed,
and do not vary as much as earnings from year to year, and once companies start paying dividends they
are reluctant to reduce them. Companies that pay dividends tend to be older and larger and to produce
ample cash flows, and they grow more slowly than companies that do not pay dividends.
Share repurchases, on the other hand, are viewed by managers as being more flexible. Managers say
that they are willing to cut back on share repurchases if necessary to finance new investments, whereas
managers say that they would raise external capital to fund new investments before cutting dividends.
Not surprisingly, as a percentage of total cash paid to shareholders, repurchases have been gaining
ground for many years. In addition to valuing the flexibility of share repurchases, managers appear to
engage in repurchases most actively when they perceive their shares to be undervalued.
We also learned that taxes have some influence on dividend decisions, but changes in tax rates do
not generally bring about radical and widespread changes in dividend payout. The agency and signalling
payout theories help explain payout decisions at some companies, but research findings so far do not offer
a lot of support of these theories explaining payout policies for the broad cross-section of companies.LO 15.6
■ Large publicly traded corporations almost
invariably choose to pay regular cash
dividends to their shareholders. These
payments are generally a fairly stable dollar
amount per period, rather than a constant
fraction of the company’s earnings. In
Australia, dividends are usually paid on a
semi-annual basis.
■ Share repurchases have grown relative to
dividends for several decades. In most
tax jurisdictions, share repurchases and
dividends are subject to the same tax rates.
The appeal of share repurchase programs
is that they are much more flexible than
dividend payout commitments.
■ Dividend payout decisions are made
conservatively. Companies do not initiate or
increase dividend payments until they are
comfortable that long-run earnings will be
stable and reliable. Repurchases may be
paid out of stable earnings or when a
company has a temporary increase in cash
flows or cash on the balance sheet.■ Bonus share issues and share splits are
used by companies that want to reduce the
per-share price of their equity in the open
market. In a 2-for-1 share split, for example,
two new shares are distributed for every
existing share an investor holds, and the
price of the share falls by roughly half.
■ CFOs believe that investors view dividends
as a commitment made by the company that
must be fulfilled, whereas share repurchases
are more discretionary. Most CFOs would
raise external funds rather than cut dividends
to finance a profitable new investment, but
most would not raise capital to avoid cutting
repurchases. Dividend decisions are typically
made very conservatively: Companies are
hesitant to start paying dividends (or to
increase the amount of dividends they pay)
in part because they will be reluctant to
reduce them in the future.
■ In a perfect and frictionless world (one
without market imperfections), dividend
policy is irrelevant, in the sense that it doesLO15.1LO15.2LO15.3SUMMARY