Page 21 - FINAL CFA II SLIDES JUNE 2019 DAY 6

LOS 22.a: Describe the expected effect of regular cash dividends, extra
dividends, liquidating dividends, stock dividends, stock splits, and reverse READING 22: DIVIDENDS AND SHARE REPURCHASES: ANALYSIS
stock splits on shareholders’ wealth and a company’s financial ratios.

Types of dividends: MODULE 22.1: THEORIES OF DIVIDEND POLICY

Regular cash dividends (RCD): Periodic dividend payments made in cash. Stock dividends: A non-cash dividend paid in the form of additional share.
• More shares, MV of company stays same, so share price drops and EPPS too; thus no
Dividend Reinvestment Plans (DRPs): At shareholders’ request,
automatically reinvest all or part of RCD by purchasing additional shares: net gain in value to shareholders!
• in the open market (open market DRP) or • Shareholders’ proportionate ownership of the company does not change;
• newly issued (new issue DRP, or scrip dividend scheme in the U.K.). • Usually not takes!
Advantages:
Advantages for the company:
• Promotes a diverse shareholder -cost effective opportunity for small • Encourage long-term investing and, hence, may reduce the cost of equity capital.
shareholders to accumulate shares. • Help increase a stock’s float, and therefore, its liquidity.
• Decrease market price of stock to a desirable trading range that attracts more investors
• Promote long-term investment -new issue DRPs allow companies to
raise additional capital without the floatation cost of a secondary offering.
If you wish to maintain DPS, following a stock dividend, you must raise cash dividends
Advantages for the shareholders:
• Allow for purchase of additional shares with no transaction costs. If you keep cash dividend same, DPS drops (though dividend yield would be unchanged,
• Allow shareholders to benefit from cost averaging. because dividends and price decrease by same %).
• Shares sometimes at a discount to market price.
Stock splits: These are similar to stock dividends (non-cash) but generally larger in size. A
Disadvantages for shareholders: two-for-one stock split is the same as a 100% stock dividend.
• May have to cope with additional record keeping for tax purposes.
• Dividends reinvested at a market price higher than the original purchase Reverse stock splits reduce the number of outstanding shares and increase the price per
price increase the average cost basis. share. The intent is similar to that of a regular stock split—to bring the market price of the
• Dividends are fully taxed in the year they are paid—even if they are stock within a desirable range, but in this case the firm is trying to attract institutional
reinvested. Therefore, it makes sense to hold DRPs in tax-sheltered investors and mutual funds that shun low-priced stocks.
accounts (e.g., retirement accounts).
Extra or special (irregular) dividends: A cash dividend Accounting Issues:
supplementing regular dividends, or a dividend of a company that • Cash dividend lowers quick and current ratios, and increases leverage (e.g.,
normally does not pay dividends, is known as a special dividend. debt-to-equity and debt-to-asset) ratios.
• Stock dividends (and stock splits) leave capital structure unchanged and do not
Liquidating dividend: Paid when the whole firm or part of the firm affect any of these ratios.
is sold, or when dividends in excess of cumulative retained earnings • For stock dividend, a decrease in retained earnings is offset by an increase in
are paid (resulting in a reduction of stated capital). It is called a contributed capital, leaving the value of total equity unchanged.
return of capital as opposed to a return on capital.