This case will give you an opportunity to understand and appreciate numerous dividend policy related issues. It considers most of the conventional factors in dividend policy decisions such as cash needs, target capital structure, sources of financing, signaling effect, clientele effect, and trend in the market.
Questions to be answered:
1. What are the arguments for paying dividends? (Theory question; consult finance book)
Signal. It signals to investors that the firm has cash in hand to pay cash dividend
The company has a history of paying dividend. Omitting a dividend sends a negative signal to investors and may cause a further drop in stock price.
2. What are the arguments for not paying dividend? (Theory question: consult finance book)
It is cash out flow. The company has poor earnings in 1982 Q1 and Q2
Economic recession. The earnings of this company is not expected to pick up very soon
The competitors in the same industry are cutting dividends. So even if Finning cuts dividend, the investors will not be surprised.
Stock price dropped from $10.5 in Oct. 1 to $7.375 in mid-May, which was a 30% drop in 8 months. It further dropped to $5.375 in mid-Oct, which was 27% drop in 2 months since Finning delayed its dividend announcement. The price drop reflected the investor’s expectation of omitting dividends
Finning’s earnings in 1981 was $0.2 per share, but its dividend is $0.3. So dividend was greater than earnings
In 1982 Q1, EPS is $0.04 but DPS in a quarter is $0.3/4 = $0.075. Again its 1981 Q1 dividend is greater than EPS
In 1982 Q2, EPS is $0.04, a quarterly DPS of $0.075 will be much larger than its earnings,
If it wants to pay dividends, it has to borrow money, which is an increase in long-term debt. (we will examine leverage ratios later)
3. What is the dividend signaling effect? Explain it in the light of this case. What kind of signal the market would get, if (i) the firm decides to pay dividends OR (ii) the firm decides not to pay dividend?
Finning is labelled as a “growth company”. Investors do not expect large stable dividends from a growth company. So cutting a dividend is not a very bad surprise
Considering the economic recession and the fact that competitors stopped dividends, Finning’s dividend omission will not be a big surprise
4. What is the clientele effect? Explain it in the light of this case. Who are the major shareholders or stakeholders of this firm? How would they react if the firm decides not to pay dividend?
Consider a company the currently pays a high dividend and has attracted clientele whose investment goal is to obtain stock with a high dividend payout. If the company decides to decrease its dividend, these investors will sell their stock and move to another company that pays a higher dividend. As a result, the company’s share price will decline.
2 family members who sit on the board and control 70% voting
