Chapter 14 Distributions to Shareholders: Dividends and Share Repurchases 463In earlier editions of this book, we argued that companies ought to be doing
more repurchasing and paying out less cash as dividends. Increases in the size and
frequency of repurchases in recent years suggest that companies have! nally
reached this same conclusion.
SELF^ TEST Explain how repurchases can (1) help stockholders hold down taxes and
(2) help " rms change their capital structures.
What is treasury stock?
What are three procedures a " rm can use to repurchase its stock?
What are some advantages and disadvantages of stock repurchases?
How can stock repurchases help a company operate in accordance with the
residual dividend model?Once a company becomes pro! table, it must decide what to do with the cash it gener-
ates. It may choose to retain cash and use it to purchase additional operating assets,
to repay outstanding debt, or to acquire other companies. Alternatively, it may choose
to return cash to shareholders. Keep in mind that every dollar that management
chooses to retain is a dollar that shareholders could have received and invested else-
where. Therefore, managers should retain earnings if and only if they can invest the
money within the! rm and earn more than stockholders can earn outside the! rm.
Consequently, high-growth companies with many good projects tend to retain a high
percentage of earnings, whereas mature companies with a great deal of cash but lim-
ited investment opportunities tend to have generous cash distribution policies.
T Y I N G I T A L L T O G E T H E R
KEY TERMS Define each of the following terms:
a. Target payout ratio; optimal dividend policy
b. Dividend irrelevance theory; bird-in-the-hand fallacy
c. Information content, or signaling; clientele effect; signal; clienteles
d. Residual dividend model
e. Low-regular-dividend-plus-extras
f. Declaration date; holder-of-record date; ex-dividend date; payment date
g. Dividend reinvestment plan (DRIP)
h. Stock split; stock dividend
i. Stock repurchase
ALTERNATIVE DIVIDEND POLICIES Components Manufacturing Corporation (CMC) has
an all-common-equity capital structure. It has 200,000 shares of $2 par value common
stock outstanding. When CMC’s founder, who was also its research director and most
successful inventor, retired unexpectedly to the South Pacific in late 2008, CMC was left