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