% This is lecture no. 11 of BU8201/: Business Finance.

\chapter{Distributions to Shareholders}%
\label{cha:distributions_to_shareholders}

Dividend policy has to do with the decision of whether to pay dividends versus retaining funds to reinvest, and also the decision to pay back using cash dividends or repurchase shares.

\begin{figure}[h]
	\centering
	\begin{tikzpicture}
		\draw (-0.2,0) node{\begin{tabular}{c}Cash flows \\ from \\ operations\end{tabular}};
		\draw (2,0.5) node{\begin{tabular}{c}Pay off debt \\ holders\end{tabular}};
		\draw (2,-0.5) node{\begin{tabular}{c}For equity \\ holders\end{tabular}};
		\draw (5,0.5) node{\begin{tabular}{c}Retain and reinvest \\ in new projects\end{tabular}};
		\draw (4,-1) node{\begin{tabular}{c}Pay \\ out\end{tabular}};
		\draw (6,-0.5) node{\begin{tabular}{c}Cash \\ dividends\end{tabular}};
		\draw (6,-1.5) node{\begin{tabular}{c}Repurchase \\ shares\end{tabular}};
		\draw (8,0.5) node{\begin{tabular}{c}Capital \\ gains yield\end{tabular}};
		\draw (8,-0.5) node{\begin{tabular}{c}Dividend \\ yield\end{tabular}};

		\draw [->] (0.5,0) to [out=0,in=180] (1.1,0.5);
		\draw [->] (0.5,0) to [out=0,in=180] (1.1,-0.5);
		\draw [->] (2.8,-0.5) to [out=0,in=180] (3.5,0.5);
		\draw [->] (2.8,-0.5) to [out=0,in=180] (3.5,-1);
		\draw [->] (4.5,-1) to [out=0,in=180] (5.2,-0.5);
		\draw [->] (4.5,-1) to [out=0,in=180] (5.1,-1.5);
		\draw [->] (6.6,0.5) to [out=0,in=180] (7.2,0.5);
		\draw [->] (6.7,-0.5) to [out=0,in=180] (7.2,-0.5);
	\end{tikzpicture}
	\caption{Decision map for dividend policy.}
\end{figure}

\section{Optimal Dividend Policy}%
\label{sec:optimal_dividend_policy}

The optimal dividend policy should maximise stock price:
\[
	\hat{P}_0 = \frac{D_1}{r_s - g}
.\]
Increasing dividends has two opposing effects on the stock price:
\begin{enumerate}
	\item Increasing $D_1$ puts upward pressure on the stock price.
	\item Decreasing $g$ puts downward pressure on stock price.
\end{enumerate}

\subsection{Dividend Irrelevance Theory}%
\label{sub:dividend_irrelevance_theory}

This counter action of changes is part of the Dividend Irrelevance Theory, which suggests that any change in dividend policy does not change the stock price.
Rather, stock price is determined only by the earning power and risk of its assets.

We can see that investors would be indifferent between dividends and retention-generated capital gains.

\subsection{Bird-in-Hand Theory}%
\label{sub:bird_in_hand_theory}

The Bird-in-Hand Theory suggests that investors prefer dividends, since dividends obtained today are less risky than potential future capital gains.

\subsection{Tax Issues}%
\label{sub:tax_issues}

There is a tax disadvantage of distributing dividends, as investors will have to pay tax on their earnings.
Therefore, if investors wish to continue investing their dividends into the stock, they will lose some money.

\subsection{Signalling Hypothesis}%
\label{sub:signalling_hypothesis}

Investors view dividend changes as signals of management's view of the future.
The underlying assumption is that since managers hate to cut dividends, they will not raise dividends unless they think the raise is sustainable.

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

\subsection{Clientele Effect}%
\label{sub:clientele_effect}

Different groups of investors prefer different dividend policies.
For example:
\begin{enumerate}
	\item Working adults with regular salaries may prefer capital gains.
	\item Retired individuals without regular salaries may prefer dividends.
\end{enumerate}

\noindent
The firms' past dividend policy determines its current type of investors.

\section{Other Distributions}%
\label{sec:other_distributions}

\subsection{Dividend Reinvestment Plans (DRIPs)}%
\label{sub:dividend_reinvestment_plans_drips_}

If a firm has a DRIP, then shareholders choose to receive the cash dividends or to have the company use the dividends to buy more stock in the firm on behalf of the investor.

\begin{figure}[h]
	\centering
	\begin{tikzpicture}[scale=0.9, every node/.style={transform shape}]
		\draw (0,0) node{\begin{tabular}{c}Investors enrol \\ in DRIP?\end{tabular}};
		\draw (3,0.5) node{\begin{tabular}{c}Cash dividends \\ to shareholders\end{tabular}};
		\draw (5.75,0.5) node{\begin{tabular}{c}Open market \\ plan\end{tabular}};
		\draw (8.25,0.5) node{\begin{tabular}{c}Cash given \\ to trustee\end{tabular}};
		\draw (10.75,-0.5) node{\begin{tabular}{c}Trustee buys \\ stock in \\ open market\end{tabular}};
		\draw (5.75,-0.5) node{\begin{tabular}{c}New stock \\ plan\end{tabular}};
		\draw (8.25,-0.7) node{\begin{tabular}{c}Company \\ issues new \\ stock\end{tabular}};
		\draw (8.25,-2.5) node{\begin{tabular}{c}Stock \\ allocated to \\ shareholder\end{tabular}};
		\draw (10.75,-2.5) node{\begin{tabular}{c}Stock \\ allocated to \\ shareholder\end{tabular}};

		\draw [->] (1.25,0) to [out=0,in=180] (1.75,0.5);
		\draw [-] (1.25,0) to [out=0,in=180] (4,-0.3);
		\draw [->] (4,-0.3) to [out=0,in=180] (4.7,0.5);
		\draw [->] (4,-0.3) to [out=0,in=180] (4.9,-0.5);
		\draw [->] (6.9,0.5) to [out=0,in=180] (7.25,0.5);
		\draw [->] (6.6,-0.5) to [out=0,in=180] (7.25,-0.7);
		\draw [->] (8.25,-1.35) to [out=270,in=90] (8.25,-1.8);
		\draw [->] (10.75,-1.15) to [out=270,in=90] (10.75,-1.8);
		\draw [->] (9.25,0.5) to [out=0,in=90] (10.75,0.2);
	\end{tikzpicture}
	\caption{DRIP process map.}
\end{figure}

\bigbreak
\noindent
There are two types of DRIPs:
\begin{enumerate}
	\item Open Market Reinvestment Plan
	\item New Stock Reinvestment Plan
\end{enumerate}

In the open market plan, brokerage costs are reduced by volume purchases.
In the new stock plan, the firm issues new stock to the enrollees at a discount price, keeping the money.
This conserves cash, and companies that need capital use this plan.

\subsection{Stock Repurchase}%
\label{sub:stock_repurchase}

When companies decide to pay out cash instead of retaining it, they can choose to pay cash dividends or buy back their own stock from stockholders.
Shares outstanding are reduced. The shares bought back are held as treasury stock and can be resold in the future to raise capital.

\subsection{Stock Dividends}%
\label{sub:stock_dividends}

When this option is chosen, the firm issues new shares in lieu of paying a cash dividend:
\begin{mdframed}
	\begin{exmp}
		If a 10\% stock dividend is announced, shareholders get 10 shares for each 100 shares owned.
		Shares outstanding increases.
	\end{exmp}
\end{mdframed}

\subsection{Stock Split}%
\label{sub:stock_split}

In this case, the firm increases the number of shares outstanding by a certain ratio, this way shareholders get more shares.
This is usually done when the stock price rises to the point where it may be hard for new investors to buy stock.

\begin{mdframed}
	\begin{exmp}
		Assume a company has 100 shares outstanding and each share is trading at \$10.
		The company announces a 2 for 1 stock split.
		After the split, the company would have 200 shares outstanding and each share should be worth \$5.
		Market value of equity remains constant.
	\end{exmp}
\end{mdframed}
