When firms generate FCF, they need to decide on how to use that cash. They can reinvest and increase the value of the firm. (by investing in positive NPV project). When firm has excess cash they can use this either as cash reserve or pay to shareholders (as dividend or repurchase share from current shareholder, these are the types of payout policy).
A firms payout policy is shaped by market imperfections such as taxes, agency costs, transaction costs and asymmetric information. That’s why some firms prefer to pay dividends, some do not pay dividends at all but rely all on share repurchase. Some firms collect cash reserve but some distribute their excess .cash. The way firm chooses between these alternatives is payout policy.
The board determines how much dividend and amount per share that will be paid and when it will occur.
Declaration date- date which board authorize the dividend. After declaration, they are obliged.
Record date- the date firm will pay the SH’s on record. It takes 3 business days for shares to be registered, so only SH that purchase shares 3 days before record date receive the dividend. As a result, 2 days before the the record date is called ex-dividend date. Anyone who purchases the stock on or after the ex dividend date will not receive dividend.
Payable/distribution date-a month after record date, they will mail the cheque.
Special dividend- one time, large dividend. (occasionally)
If Microsoft declared dividend on 20th july, payable on 2nd Dec payable to all SH’s on record on Nov 17. Because the record date was Nov 17, the ex dividend date was two business days earlier, or November 15th.
-Board declares dividend
Ex dividend Date
-Buyers of stock on or after this date will not receive dividend
-SH recorded by this date will receive dividend
-Eligible shareholders receive payments
Stock split/stock dividend- 2 for 1 stock split when company issue additional share rather than cash to SH. Dividend per share is cut into half, so that the total amoung paid out as dividend is same as before.
Dividends are cash outflow, can reduce firm’s current/retained earnings.
Share Repurchase- another way to pay cash to investors. Firm uses cash to buy shares of its own outstanding stock , are held in corporate treasury then can be resold when company needs money.
Open Market Repurchase- a common way firm repurchase shares. Firm announces intention to buy its shares in the open market and takes its time to buy the shares.. may take a year or two. Its not obligated to purchase amount initially stated. This method used when firms wanna buy back substantial amount of shares.
Tender offer – offers to buy share at a prespecified price during a short time period. Generally 20 days. Price is set to a premiunm of 10-20%. The offer depends on SH’s tendering a sufficient no. of shares. If SH’s do not tender enough shares, firm may cancel the offer and no buyback occurs.
Dutch Auction- firm list diffirent prices at which it is prepared to buy shares.. the SH’s indicate how much they are willing to sell for. The firm then pays lowest price it can to buyback.
Targetted Repurchase- purchase shares directly from major share holders. Price negotiated directly with them . If market no good (willing to sell lower, if market good, sell at premium.
Choosing between Dividends & Share Repurchases
How do firms choose between these alternatives? In perfect capital market, of MM, method of payment does not matter.
Eg: Genron has $20M in excess cash, no debt. Expects to generate additional free cash flows of $48M/ year in subsequent years. If unlevered COC is 12% then the enterprise value of its ongoing operation is…
Enterprise value: PV (Future FCF) = $48m/12% = $400 M
So including the cash, total market value is $420M.
1.) Pay dividend with excess cash - use all excess