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Dividend Policy
Dividend policy is concerned with financial policies regarding paying cash dividend in the present or paying an increased dividend at a later stage. Whether to issue dividends, and what amount, is determined mainly on the basis of the company's unappropriated profit (excess cash) and influenced by the company's long-term earning power. When cash surplus exists and is not needed by the firm, then management is expected to pay out some or all of those surplus earnings in the form of cash dividends or to repurchase the company's stock through a share buyback program. If there are no NPV positive opportunities, i.e. projects where returns exceed the hurdle rate, and excess cash surplus is not needed, then – finance theory suggests – management should return some or all of the excess cash to shareholders as dividends. This is the general case, however there are exceptions. For example, shareholders of a "growth stock", expect that the company will, almost by definition, retain most ...
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Cash Dividend
A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed is taken to be re-invested in the business (called retained earnings). The current year profit as well as the retained earnings of previous years are available for distribution; a corporation is usually prohibited from paying a dividend out of its capital. Distribution to shareholders may be in cash (usually a deposit into a bank account) or, if the corporation has a dividend reinvestment plan, the amount can be paid by the issue of further shares or by share repurchase. In some cases, the distribution may be of assets. The dividend received by a shareholder is income of the shareholder and may be subject to income tax (see dividend tax). The tax treatment of this income varies considerably between jurisdictions. The corporation does not receive a tax deductio ...
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John Lintner
John Virgil Lintner, Jr. (February 9, 1916 – June 8, 1983) was a professor at the Harvard Business School in the 1960s and one of the co-creators (1965 a, b) of the capital asset pricing model. For a time, much confusion was created because the various economists working on this model independently failed to realize that they were saying much the same thing. They looked at the issue of capital asset valuation from different perspectives. William F. Sharpe, for example, approached the problem as an individual investor picking stocks. Lintner, on the other hand, approached it from the perspective of a corporation issuing shares of stock. Lintner was also known for 1983 presentationhe gave to the Financial Analysts Federation. For the first time he presented what has become known as the "Lintner Paper," formally titled “The Potential Role of Managed Commodity-Financial Futures Accounts (and/or Funds) in Portfolios of Stocks and Bonds.” Lintner's research combined a volatile a ...
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Dividends
A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed is taken to be re-invested in the business (called retained earnings). The current year profit as well as the retained earnings of previous years are available for distribution; a corporation is usually prohibited from paying a dividend out of its capital. Distribution to shareholders may be in cash (usually a deposit into a bank account) or, if the corporation has a dividend reinvestment plan, the amount can be paid by the issue of further shares or by share repurchase. In some cases, the distribution may be of assets. The dividend received by a shareholder is income of the shareholder and may be subject to income tax (see dividend tax). The tax treatment of this income varies considerably between jurisdictions. The corporation does not receive a tax deduct ...
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Clientele Effect
The clientele effect is the idea that the set of investors attracted to a particular kind of Security (finance), security will affect the Share price, price of the security when policies or circumstances change. For instance, some investors want a company that doesn't pay dividends but instead invests that money in growing the business, whereas other investors prefer a stock that pays a high dividend, and still others want one that balances payout and reinvestment. If a company changes its dividend policy substantially, it is said to be subject to a clientele effect as some of its investors (its established clientele) decide to sell the security due to the change. Although commonly used in reference to dividend or coupon (interest) rates, it can also be used in the context of leverage (debt levels), changes in line of business, taxes, and other aspects of the company. Overview The clientele effect refers to the idea that certain types of investors are attracted to particular type ...
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Equity Premium Puzzle
The equity premium puzzle refers to the inability of an important class of economic models to explain the average equity risk premium (ERP) provided by a diversified portfolio of U.S. equities over that of U.S. Treasury Bills, which has been observed for more than 100 years. There is significant disparity between returns produced by stocks compared to returns produced by government treasury bills. The equity premium puzzle addresses the difficulty in understanding and explaining this disparity. This disparity is calculated using the equity risk premium: The equity risk premium is equal to the difference between equity returns and returns from government bonds. It is equal to around 5% to 8% in the United States. The risk premium represents the compensation awarded to the equity holder for taking on a higher risk by investing in equities rather than government bonds. However, the 5% to 8% premium is considered to be an implausibly high difference and the equity premium puzzle refe ...
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Shareholders
A shareholder (in the United States often referred to as stockholder) of a corporation is an individual or legal entity (such as another corporation, a body politic, a trust or partnership) that is registered by the corporation as the legal owner of shares of the share capital of a public or private corporation. Shareholders may be referred to as members of a corporation. A person or legal entity becomes a shareholder in a corporation when their name and other details are entered in the corporation's register of shareholders or members, and unless required by law the corporation is not required or permitted to enquire as to the beneficial ownership of the shares. A corporation generally cannot own shares of itself. The influence of a shareholder on the business is determined by the shareholding percentage owned. Shareholders of a corporation are legally separate from the corporation itself. They are generally not liable for the corporation's debts, and the shareholders' liability ...
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Share Repurchase
Share repurchase, also known as share buyback or stock buyback, is the re-acquisition by a company of its own shares. It represents an alternate and more flexible way (relative to dividends) of returning money to shareholders. When used in coordination with increased corporate leverage, buybacks can increase share prices. In most countries, a corporation can repurchase its own stock by distributing cash to existing shareholders in exchange for a fraction of the company's outstanding equity; that is, cash is exchanged for a reduction in the number of shares outstanding. The company either retires the repurchased shares or keeps them as treasury stock, available for re-issuance. Under U.S. corporate law, there are six primary methods of stock repurchase: open market, private negotiations, repurchase " put" rights, two variants of self-tender repurchase (a fixed price tender offer and a Dutch auction), and accelerate repurchases. More than 95% of the buyback programs worldwide are ...
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Capital Structure
In corporate finance, capital structure refers to the mix of various forms of external funds, known as capital, used to finance a business. It consists of shareholders' equity, debt (borrowed funds), and preferred stock, and is detailed in the company's balance sheet. The larger the debt component is in relation to the other sources of capital, the greater financial leverage (or gearing, in the United Kingdom) the firm is said to have. Too much debt can increase the risk of the company and reduce its financial flexibility, which at some point creates concern among investors and results in a greater cost of capital. Company management is responsible for establishing a capital structure for the corporation that makes optimal use of financial leverage and holds the cost of capital as low as possible. Capital structure is an important issue in setting rates charged to customers by regulated utilities in the United States. The utility company has the right to choose any capital str ...
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Capital Structure Substitution Theory
In finance, the capital structure substitution theory (CSS) describes the relationship between earnings, stock price and capital structure of public companies. The CSS theory hypothesizes that managements of public companies manipulate capital structure such that earnings per share (EPS) are maximized. Managements have an incentive to do so because shareholders and analysts value EPS growth. The theory is used to explain trends in capital structure, valuation (finance), stock market valuation, dividend decision, dividend policy, the monetary transmission mechanism, and volatility (finance), stock volatility, and provides an alternative to the Modigliani–Miller theorem that has limited descriptive validity in real markets. The CSS theory is only applicable in markets where share repurchases are allowed. Investors can use the CSS theory to identify undervalued stocks. The formula The CSS theory assumes that company managements can freely change the capital structure of the company ...
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Corporate Action
A corporate action is an event initiated by a public company that brings or could bring an actual change to the securities—equity or debt—issued by the company. Corporate actions are typically agreed upon by a company's board of directors and authorized by the shareholders. For some events, shareholders or bondholders are permitted to vote on the event. Examples of corporate actions include stock splits, dividends, mergers and acquisitions, rights issues, and spin-offs. Some corporate actions such as a dividend (for equity securities) or coupon payment (for debt securities) may have a direct financial impact on the shareholders or bondholders; another example is a call (early redemption) of a debt security. Other corporate actions such as stock split may have an indirect financial impact, as the increased liquidity of shares may cause the price of the stock to decrease. Some corporate actions, such as name changes or ticker symbol changes to better reflect a company's busi ...
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Share Repurchase
Share repurchase, also known as share buyback or stock buyback, is the re-acquisition by a company of its own shares. It represents an alternate and more flexible way (relative to dividends) of returning money to shareholders. When used in coordination with increased corporate leverage, buybacks can increase share prices. In most countries, a corporation can repurchase its own stock by distributing cash to existing shareholders in exchange for a fraction of the company's outstanding equity; that is, cash is exchanged for a reduction in the number of shares outstanding. The company either retires the repurchased shares or keeps them as treasury stock, available for re-issuance. Under U.S. corporate law, there are six primary methods of stock repurchase: open market, private negotiations, repurchase " put" rights, two variants of self-tender repurchase (a fixed price tender offer and a Dutch auction), and accelerate repurchases. More than 95% of the buyback programs worldwide are ...
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Dividend Tax
A dividend tax is a tax imposed by a jurisdiction on dividends paid by a corporation to its shareholders (stockholders). The primary tax liability is that of the shareholder, though a tax obligation may also be imposed on the corporation in the form of a withholding tax. In some cases the withholding tax may be the extent of the tax liability in relation to the dividend. A dividend tax is in addition to any tax imposed directly on the corporation on its profits. Some jurisdictions do not tax dividends. To avoid a dividend tax being levied, a corporation may distribute surplus funds to shareholders by way of a share buy-back. These, however, are normally treated as capital gains, but may offer tax benefits when the tax rate on capital gains is lower than the tax rate on dividends. Another potential strategy is to for a corporation not to distribute surplus funds to shareholders, who benefit from an increase in the value of their shareholding. These may also be subject to capital g ...
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