Ross et al.: Fundamentals

of Corporate Finance, Sixth

Edition, Alternate Edition

VI. Cost of Capital and

Long−Term Financial

Policy

18. Dividends and Dividend
    Policy

(^632) © The McGraw−Hill
Companies, 2002

CHAPTER

18

Dividends and

Dividend Policy

In December 1999,General Electric Company (better known as GE) announced

a broad plan to reward stockholders for the recent success of the firm’s

business. Under the plan, GE would (1) boost its quarterly dividend by 17

percent from 35 cents per share to 41 cents per share, (2) expand its plans to

buy back its common stock by as much as $5 billion, and (3) undertake a three-

for-one stock split, meaning that each existing common share would be

replaced with three new ones. Investors cheered, bidding the stock price up by

2.9 percent on the day of the announcement. Why were investors so pleased?

To find out, this chapter explores all three of these actions and their implications

for shareholders.

ividend policy is an important subject in corporate finance, and dividends are a

major cash outlay for many corporations. In 1995 alone, for example, New York

Stock Exchange–listed firms paid out in excess of $130 billion in cash dividends.

At the same time, however, about 25 percent of the listed companies paid no div-

idend at all.

At first glance, it may seem obvious that a firm would always want to give as much

as possible back to its shareholders by paying dividends. It might seem equally obvious,

however, that a firm could always invest the money for its shareholders instead of pay-

ing it out. The heart of the dividend policy question is just this: Should the firm pay out

money to its shareholders, or should the firm take that money and invest it for its share-

holders?

It may seem surprising, but much research and economic logic suggest that dividend

policy doesn’t matter. In fact, it turns out that the dividend policy issue is much like the

capital structure question. The important elements are not difficult to identify, but the in-

teractions between those elements are complex and no easy answer exists.

Dividend policy is controversial. Many implausible reasons are given for why divi-

dend policy might be important, and many of the claims made about dividend policy are

economically illogical. Even so, in the real world of corporate finance, determining the

most appropriate dividend policy is considered an important issue. It could be that fi-

nancial managers who worry about dividend policy are wasting time, but it could also

be true that we are missing something important in our discussions.

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