RETURNING CASH TO THE

OWNERS: DIVIDEND POLICY

First Principles

Maximize the value of the business (firm)

The Investment Decision The Financing Decision The Dividend Decision

Invest in assets that earn a Find the right kind of debt If you cannot find investments
return greater than the for your firm and the right that make your minimum
minimum acceptable hurdle mix of debt and equity to acceptable rate, return the cash
rate fund your operations to owners of your business

The hurdle rate The return should How much How you choose
should reflect the The optimal The right kind
reflect the cash you can to return cash to
riskiness of the mix of debt and of debt
magnitude and return the owners will
investment and equity matches the
the timing of the depends upon depend on
the mix of debt maximizes firm tenor of your
cashflows as welll current & whether they
and equity used value assets
as all side effects. potential prefer dividends
to fund it. investment or buybacks
opportunities
Ways of Returning Cash to Shareholders
1. Dividends
A dividend is the distribution of some of a company's earnings
to a class of its shareholders, as determined by the
company's board of directors.

2. Share buybacks or Share repurchases

A share repurchase is a transaction whereby a company buys
back its own shares from the marketplace.
Conditions for Paying Cash Dividends
1. Enough unrestricted retained earnings
2. Sufficient cash
3. Vote by board of directors
4. No legal or contractual impediments (e.g. debt
covenants and restrictions)
5. Makes financial and economic sense ()
https://seekingalpha.com/article/4359063-dividend-growth-investing-makes-retirees-happy
From an Investor’s Stanpoint: Which to
choose?
From an Investor’s Stanpoint
Total Shareholder Returns

https://www.simplysafedividends.com/intelligent-income/posts/36-5-reasons-to-be-a-dividend-growth-investor
Investment Performance by Dividend Policy
https://www.ft.com/content/63216518-5929-4a73-bf28-8923e7c01ac6
https://www.cnbc.com/2020/05/18/share-buybacks-case-for-and-against-a-company-
buying-back-its-own-stock.html
https://markets.businessinsider.com/news/stocks/warren-buffett-stock-buybacks-reasons-loves-face-bailout-ban-
coronavirus-2020-3-1029032498
https://www.reuters.com/article/us-health-coronavirus-trump-buybacks/trump-slams-companies-
for-using-u-s-tax-credit-to-buy-back-stocks-idUSKBN2173HY
Dividends and Stock Buybacks

https://voxeu.org/article/monetary-easing-leveraged-payouts-and-lack-investment
Investment Levels

https://voxeu.org/article/monetary-easing-leveraged-payouts-and-lack-investment
Tax on Recipients of Cash Dividends
TAXPAYER TAX RATE

Domestic Corporation or Exempt

Resident Foreign Corporation

Non-resident Foreign 30% but may be reduced to

Corporation 15% if with tax treaty

Individual 10% (but may be increased to

15% under “Trabaho“ Law)
Arguments FOR and AGAINST Stock Buybacks
FOR AGAINST

May boost “undervalued” share price Reduces amount of capital and share
by creating demand float

Boosts metrics such as EPS, ROACE, In some cases, tendency to overpay

ROE when stock price already inflated

Not taxable on part of shareholders Creates impression company does not

have good future prospects

Unlike dividends, does not create

future expectations
Tax on Share Buybacks/ Stock Repurchases
TAXPAYER TAX RATE

Listed in Philippine Stock Exchange 0.6% of gross value of stocks sold or

(PSE) purchased

Unlisted companies 15% Capital gains tax (TRAIN Law) for

individuals, domestic corporations and
resident foreign corporations

5%/10% of gain if foreign, non-resident

corporation
* Capital gain on unlisted shares is calculated based on amount received (money plus
fair market value property) versus cost
I. Dividends are sticky
Dividend Changes at US companies

80.00%

70.00%

60.00%

50.00%
Increase
40.00%
Decrease

No change
30.00%

20.00%

10.00%

0.00%
II. Dividends tend to follow earnings
III. Are affected by tax laws…

In 2003 In the last quarter of 2012

• As the possibility of tax
rates reverting back to
pre-‐2003 levels rose, 233
companies paid out $31
billion in dividends.
• Of these companies,
101 had insider holdings
in excess of 20% of the
outstanding stock.
IV. More and more firms are buying back
stock, rather than pay dividends...
V. And there are differences across countries…
Measures of Dividend Policy

• Dividend Payout = Dividends/ Net Income

 Measures the percentage of earnings that the
company pays in dividends
 If the net income is negative, the payout ratio cannot be
computed.
• Dividend Yield = Dividends per share/ Stock
price
 Measures the return that an investor can make
from dividends alone
 Becomes part of the expected return on the
investment.
Dividend Payout Ratios
Dividend Payout Ratios in 2014
18.00%

16.00%

14.00%

12.00%

10.00% Global

US
8.00%

6.00%

4.00%

2.00%

0.00%
0-‐10% 10-‐20% 20-‐30% 30-‐40% 40-‐50% 50-‐60% 60-‐70% 70-‐80% 70-‐90% 90-‐100% >100%
Dividend Yields

Dividend Yields in 2014

18.00%

16.00%

14.00%

12.00%

10.00%
Global
8.00%
US

6.00%

4.00%

2.00%

0.00%
Three Schools Of Thought On Dividends
1. If there are no tax disadvantages associated with
dividends & companies can issue stock, at no issuance
cost, to raise equity, whenever needed
Dividends do not matter, and dividend policy does not affect
value.
2. If dividends create a tax disadvantage for investors
(relative to capital gains)
Dividends are bad, and increasing dividends will reduce value
3. If dividends create a tax advantage for investors (relative
to capital gains) and/or stockholders like dividends
Dividends are good, and increasing dividends will increase value
The balanced viewpoint

• If a company has excess cash, and few good

investment opportunities (NPV>0), returning
money to stockholders (dividends or stock
repurchases) is good.
• If a company does not have excess cash, and/or has
several good investment opportunities (NPV>0),
returning money to stockholders (dividends or
stock repurchases) is bad.
Assessing Dividend Policy: The Cash/Trust
Assessment
• Step 1: How much could the company have paid
out during the period under question?
• Step 2: Howmuch did the the company actually pay
out during the period in question?
• Step 3: How much do I trust the management of
this company with excess cash?
 How well did they make investments during the period
in question?
 How well has my stock performed during the period
in question?
How much has the company returned to
stockholders?
• As firms increasing use stock buybacks, we have to
measure cash returned to stockholders as not only
dividends but also buybacks.
• For instance, for the companies we are analyzing the
cash returned looked as follows.
Disney Yandex

Year Dividends Buybacks Dividends Buybacks

2009 $648 $648 0 RUB 0 RUB
2010 $653 $2,669 0 RUB 0 RUB
2011 $756 $4,993 0 RUB 0 RUB
2012 $1,076 $3,015 0 RUB 0 RUB
2013 $1,324 $4,087 0 RUB 0 RUB
2009-‐13 $4,457 $15,412 0 RUB 0 RUB
A Measure of How Much a Company Could
have Afforded to Pay out: FCFE
• The Free Cashflow to Equity (FCFE) is a measure of how much
cash is left in the business after non-‐equity claimholders (debt
and preferred stock) have been paid, and after any
reinvestment needed to sustain the firm’s assets and future
growth.
Net Income
+ Depreciation & Amortization
= Cash flows from Operations to Equity Investors
-‐ Preferred Dividends
-‐ Capital Expenditures
-‐ Working Capital Needs
-‐ Principal Repayments
+ Proceeds from New Debt Issues
= Free Cash flow to Equity
Disney’s FCFE: 2009-‐2013
2013 2012 2011 2010 2009 Aggregate
Net Income $6,136 $5,682 $4,807 $3,963 $3,307 $23,895
- (Cap. Exp - Depr) $604 $1,797 $1,718 $397 $122 $4,638
- ∂ Working Capital ($133) $940 $950 $308 ($109) $1,956
Free CF to Equity (pre-debt) $5,665 $2,945 $2,139 $3,258 $3,294 $17,301
+ Net Debt Issued $1,881 $4,246 $2,743 $1,190 ($235) $9,825
= Free CF to Equity (actual debt) $7,546 $7,191 $4,882 $4,448 $3,059 $27,126
Free CF to Equity (target debt ratio) $5,720 $3,262 $2,448 $3,340 $3,296 $18,065
Dividends $1,324 $1,076 $756 $653 $648 $4,457
Dividends + Buybacks $5,411 $4,091 $5,749 $3,322 $1,296 $19,869

Disney returned about $1.5 billion more than the $18.1

billion it had available as FCFE with a normalized debt
ratio of 11.58% (its current debt ratio).
Yandex FCFE: 2009-‐2013

1 2 3 4 5 Aggregate

Net Income RUB 13,474 RUB 8,223 RUB 5,773 RUB 3,817 RUB 2,010 RUB 33,297

- (Cap. Exp - Depr) RUB 3,679 RUB 1,033 RUB 4,391 RUB 1,253 RUB 307 RUB 10,663

- ∂ Working Capital RUB 1,142 RUB 162 RUB 544 RUB 638 RUB 494 RUB 716

Free CF to Equity (pre-

debt) RUB 8,653 RUB 7,028 RUB 838 RUB 3,202 RUB 2,197 RUB 21,918
Dividends versus FCFE: Across the globe

Figure 11.2: Dividends versus FCFE in 2014

70.00%

60.00%

50.00%
FCFE<0, No dividends
40.00% FCFE<0, Dividends

FCFE>0, FCFE<Dividends
30.00%
FCFE>0, No dividends

FCFE>0,FCFE>Dividends
20.00%

10.00%

0.00%
Australia, NZ Developed Emerging Japan United States Global
and Canada Europe Markets
A Practical Framework for Analyzing Dividend
Policy
How much did the firm pay out? How much could it have afforded to pay out?
What it could have paid out What it actually paid out
Net Income Dividends
- (Cap Ex - Depr’n) (1-DR) + Equity Repurchase
- Chg Working Capital (1-DR)
= FCFE

Firm pays out too little Firm pays out too much
FCFE > Dividends FCFE < Dividends

Do you trust managers in the company with What investment opportunities does the
your cash? firm have?
Look at past project choice: Look at past project choice:
Compare ROE to Cost of Equity Compare ROE to Cost of Equity
ROC to WACC ROC to WACC

Firm has history of Firm has history Firm has good Firm has poor
good project choice of poor project projects projects
and good projects in choice
the future

Give managers the Force managers to Firm should Firm should deal
flexibility to keep justify holding cash cut dividends with its investment
cash and set or return cash to and reinvest problem first and
dividends stockholders more then cut dividends
A Dividend Matrix
Quality of projects taken: ROE versus Cost of Equity
Poor projects Good projects

Cash Surplus + Poor Cash Surplus + Good

Projects Projects
Significant pressure to Maximum flexibility in
pay out more to setting dividend policy
stockholders as
dividends or stock
buybacks

Cash Deficit + Poor Cash Deficit + Good

Projects Projects
Cut out dividends but Reduce cash payout, if
real problem is in any, to stockholders
investment policy.
Case 1: Disney in 2003
• FCFE versus Dividends
 Between 1994 & 2003, Disney generated $969 million in FCFE
each year.
 Between 1994 & 2003, Disney paid out $639 million in dividends
and stock buybacks each year.
• Cash Balance
 Disney had a cash balance in excess of $ 4 billion at the end of 2003.
• Performance measures
 Between 1994 and 2003, Disney has generated a return on equity,
on it’s projects, about 2% less than the cost of equity, on average
each year.
 Between 1994 and 2003, Disney’s stock has delivered about 3%
less than the cost of equity, on average each year.
 The underperformance has been primarily post 1996 (after the
Capital Cities acquisition).
Can you trust Disney’s management?

• Given Disney’s track record between 1994 and 2003,

if you were a Disney stockholder, would you be
comfortable with Disney’s dividend policy?
a. Yes
b. No
Does the fact that the company is run by Michael Eisner,
the CEO for the last 10 years and the initiator of the Cap
Cites acquisition have an effect on your decision.
a. Yes
b. No
Following up: Disney in 2009
• Between 2004 and 2008, Disney made significant changes:
 It replaced its CEO, Michael Eisner, with a new CEO, Bob Iger, who at
least on the surface seemed to be more receptive to stockholder
concerns.
 Its stock price performance improved (positive Jensen’s alpha)
 Its project choice improved (ROC moved from being well below cost
of capital to above)
• The firm also shifted from cash returned < FCFE to cash
returned > FCFE and avoided making large acquisitions.
• If you were a stockholder in 2009 and Iger made a plea to
retain cash in Disney to pursue investment opportunities,
would you be more receptive?
a. Yes
b. No
Final twist: Disney in 2013
• Disney did return to holding cash between 2008 and
2013, with dividends and buybacks amounting TO $2.6
billion less than the FCFE (with a target debt ratio)
• Disney continues to earn a return on capital well in
excess of the cost of capital and its stock has doubled
over the last two years.
• Now, assume that Bob Iger asks you for permission to
withhold even more cash to cover future investment
needs. Are you likely to go along?
a. Yes
b. No
Case 2: Yandex
• Yandex has been accumulating cash for the last few
years. Do you trust Yandex’s management with
your cash?
a. Yes
b. No
• If yes, why? What may cause your trust to shif t ?
• If no, why not? What do you plan to do to try to
get the cash out of the company?