KEBIJAKAN DIVIDEN Budi Purwanto. Dilema: Untuk apa sebaiknya perusahaan menggunakan laba? Membiayai investasi baru yang menguntungkan? Membiayai investasi.

KEBIJAKAN KEBIJAKAN DIVIDENDIVIDEN

Budi PurwantoBudi Purwanto

Dilema: Untuk apa sebaiknya Dilema: Untuk apa sebaiknya perusahaan menggunakan laba?perusahaan menggunakan laba?

Membiayai investasi baru yang Membiayai investasi baru yang menguntungkan?menguntungkan?

atauatau

Membayar dividen untuk pemegang Membayar dividen untuk pemegang saham?saham?

Pembayaran DividenPembayaran Dividen

Announcement date Ex-dividend day

Record day

Payment day

2-3 weeks 2-3 days 2-3 weeks

Penurunan harga pada Ex-date Penurunan harga pada Ex-date

Ex date

Price =$10

Price =$9

-t . . . –2 –1 0 +1 +2 . . . t

• The share price will fall by the amount of the dividend on the ex date (Time 0).

• If the dividend is $1 per share, the price will be equal to $10 – 1 = $9 on the ex date.

• Before ex date (Time –1) Dividend = $0 Price = $10

• On ex date (Time 0) Dividend = $1 Price = $9

Bila perusahaan menahan semua laba Bila perusahaan menahan semua laba untuk investasi yang mendatangkan laba, untuk investasi yang mendatangkan laba, dividend yield akan 0, dividend yield akan 0, namun harga saham namun harga saham akan meningkat, menghasilkan capital akan meningkat, menghasilkan capital gain yang lebih tinggi.gain yang lebih tinggi.

PP11 - Po D - Po D11

Po PoPo Po+Return =Return =

Bila perusahaan membayarkan laba Bila perusahaan membayarkan laba sebagai dividen, pemegang saham sebagai dividen, pemegang saham akan menerima kas atas investasi yang akan menerima kas atas investasi yang ditanamkan, ditanamkan, namun capital gain akan namun capital gain akan menurun, karena kas yang sama tidak menurun, karena kas yang sama tidak diinvestasikan ke dalam perusahaan. diinvestasikan ke dalam perusahaan.

PP11 - Po D - Po D11

Po PoPo Po+Return =Return =

Apakah investor lebih menyukai tingkat Apakah investor lebih menyukai tingkat pembayaran dividen tinggi atau rendah? pembayaran dividen tinggi atau rendah?

Dividends are irrelevantDividends are irrelevant: : Investors don’t care about payout.Investors don’t care about payout.

Bird-in-the-handBird-in-the-hand: : Investors prefer a high payout.Investors prefer a high payout.

Tax preferenceTax preference: : Investors prefer a low payout, hence Investors prefer a low payout, hence

growth.growth.

Dividend Payout Ratios forValue Line’s Selected Industries

Industry Payout ratioBanking 38.29Computer Software Services 13.70Drug 38.06Electric Utilities (Eastern U. S.) 67.09Internet n/aSemiconductors 24.91Steel 51.96Tobacco 55.00Water utilities 67.35*None of the internet companies included in the Value Line Investment Survey paid a dividend.

Early evidence on dividend policy: Early evidence on dividend policy: Lintner’s (1956) stylized factsLintner’s (1956) stylized facts

Lintner (1956) in a series of interviews with Lintner (1956) in a series of interviews with corporate managers observed the following factscorporate managers observed the following facts Firms have long-run target dividend payout ratios; Firms have long-run target dividend payout ratios;

mature companies pay out a high proportion of their mature companies pay out a high proportion of their earnings, while young companies have low payoutsearnings, while young companies have low payouts

Managers focus more on dividend changes than on Managers focus more on dividend changes than on absolute levelsabsolute levels

Dividend changes follow shifts in long-run, Dividend changes follow shifts in long-run, sustainable earnings; managers “smooth” dividendssustainable earnings; managers “smooth” dividends

Managers are reluctant to make dividend changes Managers are reluctant to make dividend changes that might have to be reversedthat might have to be reversed

The dividend debate: Does The dividend debate: Does dividend policy matter?dividend policy matter?

The issueThe issue: Should a firm be preoccupied with its : Should a firm be preoccupied with its dividend policy? Does the choice of dividend policy dividend policy? Does the choice of dividend policy affect firm value?affect firm value?

Dividends are irrelevantDividends are irrelevant: M & M (1961) showed that, : M & M (1961) showed that, under certain assumptions, dividends do not really under certain assumptions, dividends do not really matter because they do not affect firm valuematter because they do not affect firm value

Dividends are badDividends are bad: Dividends create a tax : Dividends create a tax disadvantage for shareholders and destroy valuedisadvantage for shareholders and destroy value

Dividends are goodDividends are good: Dividends are good because : Dividends are good because shareholders (or some of them) prefer to receive them shareholders (or some of them) prefer to receive them rather than notrather than not

Dividend Irrelevance TheoryDividend Irrelevance Theory

Investors are Investors are indifferentindifferent between dividends between dividends and retention-generated capital gains. If and retention-generated capital gains. If they want cash, they can sell stock. If they they want cash, they can sell stock. If they don’t want cash, they can use dividends to don’t want cash, they can use dividends to buy stock.buy stock.

Modigliani-Miller (1961)Modigliani-Miller (1961) support support irrelevance.irrelevance.

Theory is based on unrealistic assumptions Theory is based on unrealistic assumptions (no taxes or brokerage costs), hence may (no taxes or brokerage costs), hence may not be true. Need empirical test.not be true. Need empirical test.

M & M: Dividends are irrelevantM & M: Dividends are irrelevant

Assume thatAssume that There are no transaction costs from converting There are no transaction costs from converting

price appreciation into cashprice appreciation into cash Firms that pay too much in dividends can issue Firms that pay too much in dividends can issue

stock that is fairly priced and do not face stock that is fairly priced and do not face transaction coststransaction costs

The firm’s investment decision is not affected The firm’s investment decision is not affected by its dividend decision and operating cash by its dividend decision and operating cash flows are the same in each periodflows are the same in each period

Managers of firms that pay too little in Managers of firms that pay too little in dividends do not waste excess cashdividends do not waste excess cash

Two alternative views: Two alternative views: Dividends matter Dividends matter

Dividends are goodDividends are good The clientele argumentThe clientele argument Dividends as signalsDividends as signals Dividends may discipline managersDividends may discipline managers

Dividends are badDividends are bad Taxes: whenever dividends are taxed more heavily Taxes: whenever dividends are taxed more heavily

than capital gains, firms should pay the lowest cash than capital gains, firms should pay the lowest cash dividend they can get away with and earnings should dividend they can get away with and earnings should be retained or used to repurchase sharesbe retained or used to repurchase shares

Bird-in-the-Hand TheoryBird-in-the-Hand Theory

Investors think dividends are Investors think dividends are less less riskyrisky than potential future capital than potential future capital gains, hence they like dividends.gains, hence they like dividends.

If so, investors would value high If so, investors would value high payout firms more highly, i.e., a payout firms more highly, i.e., a high payout would result in a high payout would result in a high high PP00..

Dividends are “good”Dividends are “good”

The Clientele argumentThe Clientele argument

There are stockholders who like dividends, either because There are stockholders who like dividends, either because they value the regular cash payments or because they do they value the regular cash payments or because they do not face the tax disadvantagenot face the tax disadvantage

Given the fact that there is a vast diversity among investors Given the fact that there is a vast diversity among investors in terms of preferences, it is no surprise that investors may in terms of preferences, it is no surprise that investors may form clienteles based upon their tax bracketsform clienteles based upon their tax brackets

Thus, investors will cluster around firms whose dividend Thus, investors will cluster around firms whose dividend policies match their preference (called the policies match their preference (called the clientele effectclientele effect))

Dividends as signalsDividends as signals

By changing their dividend policy, firms send signals By changing their dividend policy, firms send signals about their future cash flows to market participantsabout their future cash flows to market participants

When firms increase dividends, they somehow commit to When firms increase dividends, they somehow commit to those higher dividends, and, thus, send a signal that they those higher dividends, and, thus, send a signal that they expect to have higher future cash flows (share price expect to have higher future cash flows (share price increases)increases)

Given that firms do not like to cut dividends, firms that Given that firms do not like to cut dividends, firms that are forced to do so send a signal that their financial are forced to do so send a signal that their financial future is troubling (share price decreases)future is troubling (share price decreases)

Dividends discipline managersDividends discipline managers

In firms with principal-agent problems between In firms with principal-agent problems between stockholders and managers and the potential of free stockholders and managers and the potential of free cash flows being wasted, making a commitment to pay cash flows being wasted, making a commitment to pay dividends imposes discipline on managersdividends imposes discipline on managers

Dividends are “bad”Dividends are “bad”

If dividends are taxed differently than capital gains If dividends are taxed differently than capital gains (dividends taxed as ordinary income) and the (dividends taxed as ordinary income) and the marginal tax rate of dividends is higher than that of marginal tax rate of dividends is higher than that of capital gains, there exists a tax disadvantage for capital gains, there exists a tax disadvantage for those stockholders who receive dividendsthose stockholders who receive dividends

Even if ordinary income and capital gains are Even if ordinary income and capital gains are taxed the same, dividends have a tax taxed the same, dividends have a tax disadvantage because investors do not have the disadvantage because investors do not have the choice of when to report the dividend as it is the choice of when to report the dividend as it is the case with capital gainscase with capital gains

Tax Preference TheoryTax Preference Theory

Retained earnings lead to capital Retained earnings lead to capital gains, which are taxed at gains, which are taxed at lower lower ratesrates than dividends: 28% than dividends: 28% maximum vs. up to 38.6%. Capital maximum vs. up to 38.6%. Capital gains taxes are also gains taxes are also deferreddeferred..

This could cause investors to prefer This could cause investors to prefer firms with low payouts, i.e., a high firms with low payouts, i.e., a high payout results in a payout results in a low Plow P00..

The tax disadvantage of dividends leads to the The tax disadvantage of dividends leads to the following conclusionsfollowing conclusions

Firms whose stockholders are primarily individuals Firms whose stockholders are primarily individuals should pay a lower dividend compared to firms that should pay a lower dividend compared to firms that are mainly owned by institutional investors (they are are mainly owned by institutional investors (they are under a tax-exempt status)under a tax-exempt status)

The higher the income level of the firm’s investors, the The higher the income level of the firm’s investors, the lower the dividend paid by the firm should belower the dividend paid by the firm should be

As the tax disadvantage of dividends increases, the As the tax disadvantage of dividends increases, the aggregate amount of dividends paid should decreaseaggregate amount of dividends paid should decrease

Some “not so good” reasons for Some “not so good” reasons for paying dividendspaying dividends

The Bird-in-the-hand fallacyThe Bird-in-the-hand fallacy

Risk-averse investors may prefer the certainty of Risk-averse investors may prefer the certainty of dividend payments over the uncertainty of capital gainsdividend payments over the uncertainty of capital gains

The proper comparison is between dividends today and The proper comparison is between dividends today and an almost equivalent amount of price appreciation todayan almost equivalent amount of price appreciation today

The evidence shows that share prices drop on the ex-The evidence shows that share prices drop on the ex-dividend day (firms that pay dividends experience a dividend day (firms that pay dividends experience a decline in their share price on that day)decline in their share price on that day)

The excess cash hypothesisThe excess cash hypothesis

A firm has excess cash in a year and decides to return it A firm has excess cash in a year and decides to return it to its stockholders through a dividend (assuming no to its stockholders through a dividend (assuming no investment projects in that year)investment projects in that year)

If the lack of investment projects is temporary, then firm If the lack of investment projects is temporary, then firm should consider future financing needs and the cost of should consider future financing needs and the cost of raising capitalraising capital

Why not return the excess cash through a share Why not return the excess cash through a share repurchase, given the evidence on firms’ reluctance to repurchase, given the evidence on firms’ reluctance to change dividends?change dividends?

Double taxation of dividendsDouble taxation of dividends

The issueThe issue: Corporate income was taxed twice, at the : Corporate income was taxed twice, at the corporate level and at the stockholder levelcorporate level and at the stockholder level

Corporate earnings were taxed at 35% and shareholders Corporate earnings were taxed at 35% and shareholders receiving dividends were also faced with marginal tax rates as receiving dividends were also faced with marginal tax rates as high as 38.6% (combined tax rate could be as high as 60%)high as 38.6% (combined tax rate could be as high as 60%)

In the US, The Bush administration passed legislation that In the US, The Bush administration passed legislation that would limit the tax rates for dividends to a maximum of 15% would limit the tax rates for dividends to a maximum of 15% during the period 2003-2008during the period 2003-2008

The capital gains tax was also reduced from 20% to 15%The capital gains tax was also reduced from 20% to 15%

““Signaling,” hypothesis?Signaling,” hypothesis?

Managers hate to cut dividends, so Managers hate to cut dividends, so won’t raise dividends unless they think won’t raise dividends unless they think raise is sustainable. So, investors view raise is sustainable. So, investors view dividend increases as dividend increases as signalssignals of of management’s view of the future.management’s view of the future.

Therefore, a stock price increase at Therefore, a stock price increase at time of a dividend increase could time of a dividend increase could reflect higher expectations for future reflect higher expectations for future EPS, not a desire for dividends.EPS, not a desire for dividends.

The “clientele effect”The “clientele effect”

Different groups of investors, or Different groups of investors, or clienteles, prefer different dividend clienteles, prefer different dividend policies.policies.

Firm’s past dividend policy determines its Firm’s past dividend policy determines its current clientele of investors.current clientele of investors.

Clientele effects impede changing Clientele effects impede changing dividend policy. Taxes & brokerage costs dividend policy. Taxes & brokerage costs hurt investors who have to switch hurt investors who have to switch companies.companies.

The “residual dividend model”The “residual dividend model”

Find the retained earnings needed Find the retained earnings needed for the capital budget.for the capital budget.

Pay out any leftover earnings (the Pay out any leftover earnings (the residual) as dividends.residual) as dividends.

This policy minimizes flotation and This policy minimizes flotation and equity signaling costs, hence equity signaling costs, hence minimizes the WACC.minimizes the WACC.

Using the Residual Model to Calculate Dividends Paid

Dividends = – .Net

income

Targetequityratio

Totalcapitalbudget[ ]))((

Data for SSCData for SSC

Capital budget: $800,000. Given.Capital budget: $800,000. Given. Target capital structure: 40% Target capital structure: 40%

debt, 60% equity. Want to debt, 60% equity. Want to maintain.maintain.

Forecasted net income: $600,000.Forecasted net income: $600,000. How much of the $600,000 should How much of the $600,000 should

we pay out as dividends?we pay out as dividends?

Of the $800,000 capital budget, 0.6($800,000) = $480,000 must be equity to keep at target capital structure. [0.4($800,000) = $320,000 will be debt.]

With $600,000 of net income, the residual is $600,000 - $480,000 = $120,000 = dividends paid.

Payout ratio = $120,000/$600,000 = 0.20 = 20%.

How would a drop in NI to How would a drop in NI to $400,000 affect the dividend? $400,000 affect the dividend?

A rise to $800,000?A rise to $800,000?

NI = $400,000NI = $400,000: Need $480,000 of : Need $480,000 of equity, so should retain the whole equity, so should retain the whole $400,000. Dividends = 0.$400,000. Dividends = 0.

NI = $800,000NI = $800,000: Dividends = : Dividends = $800,000 - $480,000 = $320,000. $800,000 - $480,000 = $320,000. Payout = $320,000/$800,000 = 40%.Payout = $320,000/$800,000 = 40%.

How would a change in How would a change in investment opportunities affect investment opportunities affect dividend under the residual policydividend under the residual policy??

Fewer good investments would lead Fewer good investments would lead to smaller capital budget, hence to to smaller capital budget, hence to a higher dividend payout.a higher dividend payout.

More good investments would lead More good investments would lead to a lower dividend payout.to a lower dividend payout.

Advantages and Disadvantages Advantages and Disadvantages of the Residual Dividend Policyof the Residual Dividend Policy

AdvantagesAdvantages: Minimizes new stock : Minimizes new stock issues and flotation costs.issues and flotation costs.

DisadvantagesDisadvantages: Results in variable : Results in variable dividends, sends conflicting signals, dividends, sends conflicting signals, increases risk, and doesn’t appeal to increases risk, and doesn’t appeal to any specific clientele.any specific clientele.

ConclusionConclusion: Consider residual policy : Consider residual policy when setting target payout, but don’t when setting target payout, but don’t follow it rigidly.follow it rigidly.

Which theory is most correct?Which theory is most correct?

Empirical testing has not been able Empirical testing has not been able to determine which theory, if any, to determine which theory, if any, is correct.is correct.

Thus, managers use judgment Thus, managers use judgment when setting policy.when setting policy.

Analysis is used, but it must be Analysis is used, but it must be applied with judgment.applied with judgment.

Implications for ManagersImplications for Managers

Theory Implication

Irrelevance Any payout OK

Bird-in-the-hand Set high payout

Tax preference Set low payout

But which, if any, is correct???

Setting Dividend PolicySetting Dividend Policy

Forecast capitalForecast capital needs over a needs over a planning horizon, often 5 years.planning horizon, often 5 years.

Set a Set a target capital structuretarget capital structure.. Estimate annual Estimate annual equity needsequity needs.. Set Set target payouttarget payout based on the based on the

residual model.residual model. Generally, some Generally, some dividend growth dividend growth

raterate emerges. Maintain target emerges. Maintain target growth rate if possible, varying growth rate if possible, varying capital structure somewhat if capital structure somewhat if necessary.necessary.

Appendix: Appendix:

ExamplesExamples

Example 1: Dividend irrelevanceExample 1: Dividend irrelevance

Suppose that Illini Corp. has after-tax operating income Suppose that Illini Corp. has after-tax operating income of $100m growing at 5% per year and its cost of capital of $100m growing at 5% per year and its cost of capital is 10%is 10%

Assume that the firm has reinvestment needs of $50m Assume that the firm has reinvestment needs of $50m also growing at 5% per year and that it has 105m also growing at 5% per year and that it has 105m outstanding sharesoutstanding shares

The firm pays out any residual cash flows as dividends The firm pays out any residual cash flows as dividends each yeareach year

The FCFF = EBIT(1 – t) – Reinvestment needs = $100m The FCFF = EBIT(1 – t) – Reinvestment needs = $100m - $50m = $50m- $50m = $50m

The firm’s value (using the Gordon growth model) isThe firm’s value (using the Gordon growth model) is

FCFF(1 + g)/(WACC – g) = $50(1.05)/(0.10 – 0.05) = FCFF(1 + g)/(WACC – g) = $50(1.05)/(0.10 – 0.05) = $1,050m$1,050m

The price per share is $1,050m/105m = $10The price per share is $1,050m/105m = $10

The dividend per share is $50m/105m = $0.476The dividend per share is $50m/105m = $0.476

The value per share is $10 + $0.48 = $10.48The value per share is $10 + $0.48 = $10.48

Case 1Case 1: UIUC Corp. decides to double its dividends, but its : UIUC Corp. decides to double its dividends, but its investment needs remain the same, meaning that the firm investment needs remain the same, meaning that the firm has to raise $50mhas to raise $50m

Suppose the firm can issue stock worth $50m at no costSuppose the firm can issue stock worth $50m at no cost

The existing shareholders receive dividends of $100m or The existing shareholders receive dividends of $100m or dividends per share equal to $100m/105m = $0.953dividends per share equal to $100m/105m = $0.953

Given no change in the firm’s cash flows, the growth rate of Given no change in the firm’s cash flows, the growth rate of cash flows or the cost of capital, the firm’s value has not cash flows or the cost of capital, the firm’s value has not changedchanged

However, existing shareholders now own $1,000m and new However, existing shareholders now own $1,000m and new shareholders $50m of the firmshareholders $50m of the firm

Thus, the price per share for existing shareholders is Thus, the price per share for existing shareholders is $1,000m/105m = $9.523$1,000m/105m = $9.523

The value per share for existing shareholders is $9.523 + The value per share for existing shareholders is $9.523 + $0.953 = $10.476$0.953 = $10.476

The average shareholder is indifferent to this change in The average shareholder is indifferent to this change in dividend policy (higher dividend per share is offset by lower dividend policy (higher dividend per share is offset by lower price per share)price per share)

Case 2Case 2: UIUC Corp. decides to eliminate dividends and : UIUC Corp. decides to eliminate dividends and retain the $50mretain the $50m

Total value of the firm is Total value of the firm is

PV of after-tax operating cash flows + Cash balance PV of after-tax operating cash flows + Cash balance

= $1,050m + $50m = $1,100m= $1,050m + $50m = $1,100m

The value per share is $1,100m/105m = $10.476, The value per share is $1,100m/105m = $10.476, meaning that the increase in share price is offset by the meaning that the increase in share price is offset by the loss of dividendsloss of dividends