412 Part Five Payout Policy and Capital Structure
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◗ FIGURE 16.2 Pfizer’s fourth-quarter dividend in 2014.
Pfizer
declares regular
quarterly dividend
of $.28 per share.Shares start to
trade ex dividend.Dividend will be paid
to shareholders
registered
on this date.Dividend checks
are mailed
to shareholders.December 15, 2014 February 4, 2015 February 6, 2015 March 3, 2015Declaration date Ex-dividend date Record date Payment date(^2) Where there is no par value, legal capital is defined as part or all of the receipts from the issue of shares. Companies with wasting
assets, such as mining companies, are sometimes permitted to pay out legal capital.
(^3) Sometimes companies not only allow shareholders to reinvest dividends but also allow them to buy additional shares at a discount.
For an amusing and true rags-to-riches story, see M. S. Scholes and M. A. Wolfson, “Decentralized Investment Banking: The Case of
Dividend-Reinvestment and Stock-Purchase Plans,” Journal of Financial Economics 24 (September 1989), pp. 7–36.
(^4) The distinction between a stock dividend and a stock split is technical. A stock dividend is shown in the accounts as a transfer from
retained earnings to equity capital. A split is shown as a reduction in the par value of each share.
Figure 16.1 shows that dividends are more stable than repurchases. Notice how repur-
chases were cut back in the early 2000s and in the crisis of 2007–2009. Dividends also fell in
the crisis, but by less than repurchases.
How Firms Pay Dividends
On December 15, 2014, Pfizer’s board of directors announced a quarterly cash dividend of
$.28 per share. Who received this dividend? That may seem an obvious question, but shares
trade constantly, and the firm’s records of who owns its shares are never fully up to date. So
corporations specify a particular day’s roster of shareholders who qualify to receive each
dividend. For example, Pfizer announced that it would send a dividend check on March 3 (the
payment date) to all shareholders recorded in its books on February 6 (the record date).
Two business days before the record date, Pfizer stock began to trade ex-dividend. Investors
who bought shares on or after that date did not have their purchases registered by the record
date and were not entitled to the dividend. Other things equal, a stock is worth less if you miss
out on the dividend. So when a stock “goes ex-dividend,” its price falls by about the amount
of the dividend. Figure 16.2 illustrates the sequence of the key dividend dates. This sequence
is the same whenever companies pay a dividend (though of course the actual dates will differ).
Corporations are not free to declare whatever dividend they choose. In some countries,
such as Brazil and Chile, companies are obliged by law to pay out a minimum proportion of
their earnings. Conversely, some restrictions may be imposed by lenders, who are concerned
that excessive dividend payments would not leave enough in the kitty to repay their loans. In
the U.S., state law also helps to protect the firm’s creditors against excessive dividend pay-
ments. For example, companies are not allowed to pay a dividend out of legal capital, which
is generally defined as the par value of outstanding shares.^2
Most U.S. companies pay a regular cash dividend each quarter, but occasionally this is sup-
plemented by a one-off extra or special dividend. Many companies offer shareholders automatic
dividend reinvestment plans (DRIPs). Often the new shares are issued at a 5% discount from the
market price. Sometimes 10% or more of total dividends will be reinvested under such plans.^3
Dividends are not always in the form of cash. Companies also declare stock dividends. For
example, if the firm pays a stock dividend of 5%, it sends each shareholder 5 extra shares for
every 100 shares currently owned. A stock dividend is essentially the same as a stock split.
Both increase the number of shares but do not affect the company’s assets, profits, or total
value. So both reduce value per share.^4 In this chapter we focus on cash dividends.