1. Dividend Policy
What are dividends?
Why do companies pay dividends?
Does dividend policy affect value?
Why could dividends affect value?
What are the influences on the dividend
decision?

2. What are dividends?
Cash payments to shareholders
Paid out of after-tax profits
Interim dividend
Final dividend
Final dividend voted on at AGM

3. Dividends can be paid from past and
present earnings but cannot be paid from
any capital reserve
Companies whose external liabilities
exceed their assets cannot legally pay
dividends.
Profits vs cash flow

4. Why do companies pay dividends?
Reward to shareholders?
What is the Total Shareholders’ Return
(TSR) made up of?
Why else might companies pay dividends?

5. Do all companies pay the same
amount of dividends?
Amount paid is discretionary
Zero dividend policy
% of after-tax profit
Constant dividend or constantly growing
dividend

6. Marks and Spencer plc (M&S Annual Report 2009)
Year 2009 2008 2007 2006 2005
EPS 32.3p 49.2p 39.1p 31.3p 17.6p
(basic)
Div 17.8p 22.5p 18.3p 14.0p 12.1p
per
share

7. Marks and Spencer dividends
What do you notice about M&S dividends?
What do you think has influenced the level
of dividends paid to shareholders?

8. What influences the level of
dividend?
 Variability of profits
 But dividends are cash flows
 Investment opportunities
 Ability/willingness to raise external finance
 Influence of investors
 Nature of business/stage of business in lifecycle
 Market expectations?

9. Alternatives to cash dividends
 Scrip dividends
Saves cash
Lowers gearing
 Share repurchase
Reduces liquidity
Increases underlying share value
 Non-pecuniary benefits
Discounts
Complementary goods/services
Eg Channel Tunnel, Legal and General

10. Do dividends affect Value?
Residual Theory
 Dividend payments depend on the investment
opportunities available to the firm
 This implies that investors are indifferent
between dividend payments and increases in
share prices due to reinvested earnings
 The dividend decision is a passive decision??

11. Dividend Irrelevance
Modigliani and Miller 1961
the value of the firm is determined by the
earnings power of its assets and the split
between dividends and retained earnings is
irrelevant.
Shareholders can manufacture their own
level of dividends
Assumptions
no tax
no transaction costs

12. Why might Dividends affect Value?
Dividends may be preferred to an increase
in share price
Certainty
Liquidity
Tax impact
Different tax treatments between dividends and
capital gains
Clientele effect

13. The Clientele Effect
Dividends themselves do not affect share
price
Companies with particular dividend
policies attract groups of investors
according to their tax situation
A change in dividend policy will bring
about a change in share price due to the
demand and supply by different investor
groups for that type of investment.

14. Why might Dividends affect Value?
Dividends as a basis for company
valuation
Dividend Valuation Model (Gordon)
MP of a share = PV of future dividend payments
P0 = D1/(ke – g) P0 = Current Share Price
D1 = next yr’s dividend
ke = cost of equity
g = annual growth rate of divs

15. Example
Shareholders require a 12% return on their
investment and the company has just
paid a dividend of 80p per share.
Dividends have grown on average by
3.4% per year. What is the theoretical
share price using the dividend growth
model?

16. Why might Dividends affect Value?
Something else?
Market expectations
Signalling
Information asymmetry

17. Signalling Effects
Dividends carry information to the market
(information asymmetry)
Dividends are usually stable
A change in dividend policy may make
investors believe that management is
announcing a change in future profitability
but …..

18. Do dividends affect share prices
(value)?
All research is inconclusive
Dividend policy can be observed and
share prices can be observed
But
Other factors cause movements in share
prices
It is difficult to separate out the clientele
effect from the signalling effect

19. What have we discussed today?
Influences on dividend payments
The debate about the link between
dividends and share price (value)
Why we cannot answer the question about
the link between dividends and value