Mi c r o s o f t S h i f t s Ge a r s a n d B e g i n s t o Un l o a d P a r t

o f I t s Va s t C a s h Ho a r d

Distributions to Shareholders:

Dividends and Share Repurchases

© NIGEL

TREBLIN/AFP/GETTY

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CHAPTER

440

Profitable companies regularly face three impor-

tant questions: (1) How much of our free cash flow

should we pass on to shareholders? (2) Should

we provide this cash to stockholders by raising

the dividend or by repurchasing stock? (3) Should

we maintain a stable, consistent payment policy;

or should we let the payments vary as conditions

change?

In this chapter, we discuss many of the issues

that affect firms’ cash distribution policies. As we

will see, mature companies with stable cash

flows and limited growth opportunities tend to

return a significant amount of their cash to

shareholders either by paying dividends or by

using the cash to repurchase common stock. By

contrast, rapidly growing companies with good

investment opportunities are prone to invest

most of their available cash in new projects

rather than paying dividends or repurchasing

stock. Microsoft, which has long been regarded

as the epitome of a growth company, illustrates

this tendency. Its sales grew from $786 million in

1989 to a projected $60.3 billion in 2008, which

translates to an annual growth rate of nearly

26%. Much of this growth came from large, long-

term investments in new products and technol-

ogy; and, given the firm’s emphasis on growth, it

paid no dividends over most of its life.

However, over time, this quintessential

growth company began to evolve into a mature

“cash cow.” Its Windows® and Office products

have saturated the market, and they help the

company produce large amounts of free cash

flow each month. Moreover, until 2003, the com-

pany did not pay any dividends to its sharehold-

ers because management wanted to keep the

cash available for acquisitions and other invest-

ments. As a result, the company reported a stag-

gering $49 billion in cash on its balance sheet as

of June 30, 2003.

Since then, Microsoft has shifted gears; and it

now pays a significant portion of its cash to

shareholders. First, in 2003, it initiated a regular

quarterly dividend of 8 cents a share. That regu-

lar dividend was doubled in 2004. However, the

cash kept pouring in; and by mid-2004, Microsoft’s

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