Introduction to Corporate Finance

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

(^634) © The McGraw−Hill
Companies, 2002
However it is labeled, a cash dividend payment reduces corporate cash and retained
earnings, except in the case of a liquidating dividend (which may reduce paid-in capital).
Standard Method of Cash Dividend Payment
The decision to pay a dividend rests in the hands of the board of directors of the corpo-
ration. When a dividend has been declared, it becomes a debt of the firm and cannot be
rescinded easily. Sometime after it has been declared, a dividend is distributed to all
shareholders as of some specific date.
Commonly, the amount of the cash dividend is expressed in terms of dollars per share
(dividends per share). As we have seen in other chapters, it is also expressed as a per-
centage of the market price (the dividend yield) or as a percentage of net income or earn-
ings per share (the dividend payout).
Dividend Payment: A Chronology
The mechanics of a cash dividend payment can be illustrated by the example in Figure
18.1 and the following description:
1.Declaration date.On January 15, the board of directors passes a resolution to pay
a dividend of $1 per share on February 16 to all holders of record as of January 30.
2.Ex-dividend date.To make sure that dividend checks go to the right people,
brokerage firms and stock exchanges establish an ex-dividend date. This date is two
business days before the date of record (discussed next). If you buy the stock before
this date, then you are entitled to the dividend. If you buy on this date or after, then
the previous owner will get the dividend.
In Figure 18.1, Wednesday, January 28, is the ex-dividend date. Before this date,
the stock is said to trade “with dividend” or “cum dividend.” Afterwards, the stock
trades “ex dividend.”
The ex-dividend date convention removes any ambiguity about who is entitled
to the dividend. Because the dividend is valuable, the stock price will be affected
when the stock goes “ex.” We examine this effect in a moment.
3.Date of record.Based on its records, the corporation prepares a list on January 30
of all individuals believed to be stockholders. These are the holders of record,and
January 30 is the date of record (or record date). The word believedis important
here. If you buy the stock just before this date, the corporation’s records may not
CHAPTER 18 Dividends and Dividend Policy 607

FIGURE 18.1

Example of Procedure

Thursday, for Dividend Payment

January

15

Wednesday,

January

28

Friday,

January

30

Declaration

date

Ex-dividend

date

Record

date

Payment

date

1. Declaration date: The board of directors declares a payment of dividends.


2. Ex-dividend date: A share of stock goes ex dividend on the date the seller is
   entitled to keep the dividend; under NYSE rules, shares are traded ex
   dividend on and after the second business day before the record date.


3. Record date: The declared dividends are distributable to those people who
   are shareholders of record as of this specific date.


4. Payment date: The dividend checks are mailed to shareholders of record.

Days

Monday,

February

16

declaration date

The date on which the

board of directors

passes a resolution to

pay a dividend.

ex-dividend date

The date two business

days before the date of

record, establishing

those individuals entitled

to a dividend.

date of record

The date by which a

holder must be on record

in order to be designated

to receive a dividend.