3/24/2011

Agenda Introduction
 
 Dividend policy
 Theories on dividend payout policy
 Bird in the hand theory
 Its implications
Return to
 Application
Shareholder
 Relevance to Sri Lanka
MBA 630: Corporate Business Finance
Group Presentation
Capital Gains Periodic Income
(through share price
appreciation) (through dividends)

March 11

What is dividend policy Implications of Dividend Policy Theories on dividend payout

  
• Affects cost of capital and capital structure • Dividend policy would • Investors prefer lower • Investors prefer
have no effect on the payout in order to get higher payouts
value of a firm growth and capital
gains and to get the
• Sends important signals about financial health of company tax benefits.

Dividend Tax differential Bird in the

• Clientele : attracts a particular type of investors irrelevance theory hand theory

• Affects cash flow Possible Cost of Equity Effects Possible Stock Price Effects
20 40
Cost of Equity (%)

Stock Price ($)

Tax Bird in the
18 35
• Affects reinvestment in business Preference Hand
16
Indifference 30 Indifference
14 Tax
• Affects growth prospects 12 Bird in the 25 Preference
Hand
10 20
0% Payout 100% 0% Payout 100%

Factors that impact…

Implications of Bird in the hand
Bird in the Hand Argument perception
Risk appetite

 of investors

Lower cost Lower Less risk Attract investors
of capital expected to with low risk
(Ke) return investor appetite and
• Firm’s that reinvest free cash flow, put that money at risk – there is Industry Age need of steady
no certainty of investment outcome – those forfeit dividends cash flow
that are reinvested…could be lost!
• Therefore, Higher
 Certainty of dividend payments preferred to the possibility of Higher
cash
substantially higher future capital gains. outflow Dividend
 It is a cushion during period of stock price stand stills and
 Steady income (Pension funds, EPF, Individuals) Lower
capital gains
Lower
Financial Income reinvestment
goals requirements Lower Lower increase
opportunity in future
for growth earnings

1
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Reality – does bird in the hand

View from a Local Practitioner Lehman Brothers
theory prevail?
 Dividend plays a strong role in the portfolio performance
 
Lehman Brothers Share Price ($)
“Bird in the hand theory relating to dividend policy is $

more appropriate in real life, although it challenges Performance of S&P 500 over the past 10 years and 15 years 100
ending 1994 indicate that impact of dividend on portfolio 80
conventional wisdom. For instance, “High-dividend- performance is significant
payout companies tend to experience strong, not 60

weak, future earnings growth” This has been proven by 800 665 40

various studies done for international companies over a 600

20

Return
50 year period and is true for Sri Lanka too. i.e. Chevron 282
326 S&P 500 Total Return % 0
400 Ma y Jun Jul Aug Sep Oct Nov Dec Ja n Feb Ma r Apr Ma y Jun Jul Aug Sep
Lubricants Lanka PLC (LLUB).” 175
'07 '07 '07 '07 '07 '07 '07 '07 '08 '08 '08 '08 '08 '08 '08 '08 '08
S&P 500 Return without
28th Feb 2011 200
Dividend %
Ravi Abeysuriya Source: Yahoo Finance
0
CEO – Heraymila Investment Ltd.
Past President, CFA Sri Lanka 10 Years Ending 15 Years Ending Learning: Shareholder value was completely eroded overnight.
1994 1994 Shows the risk of future earnings. Favors bird in the hand theory!
Source: Calson. C (1996) Buying Stocks without a Broker

Have companies with higher payout ratio enjoyed Have companies with higher payout ratio enjoyed
higher returns? higher returns?
  Overall Dividend Yield in CSE

900 8000

800 7000
700 (%)
6000
600 8.0
5000
7.0
500
4000 6.0
400
3000 5.0
300
4.0
2000
200 3.0
100 1000 2.0
0 0 1.0
Ja n-05

Ja n-06

Ja n-07

Ja n-08

Ja n-09

Ja n-10
Apr-05
Jul -05

Apr-06
Jul -06

Apr-07
Jul -07

Apr-08
Jul -08

Apr-09
Jul -09

Apr-10
Jul -10
Oct-05

Oct-06

Oct-07

Oct-08

Oct-09

Oct-10

0.0

Chevron CTC Nestle ASPI

Source: Colombo Stock Exchange Source: Colombo Stock Exchange

Common Dividend Policies

Overview of Local Investor
 
Institutions Individuals
 Medium to long term capital  High net worth - analyses the
gains market , expects med/long
 Buy over to have controlling term growth
interest  Middle class
 Invest with Mkt
knowledge, expects short
term returns
 Invest without Mkt
knowledge (Herd Effect)
People want fast returns in terms of real money (gamble) – quick buck
- Bird in the Hand Theory less relevant to Sri Lanka
Which theory is most relevant ?
Adopted in Practice

Residual dividend model
 Although there are several competing theories of
Constant, zero or steadily increasing dividend
dividend policy and have been numerous empirical tests
of these theories, the results to date are inconclusive! Constant payout ratio
Lower regular dividend plus extras
 We can observe that dividend policy does have some
impact on the value of the firm, but no one theory can Payment procedures
adequately explain why • Declaration date
• Holder of record date
• Ex-dividend date
• Payment date
Source: Masson. D.J et al (1995) The Treasurer’s Handbook of Financial Management