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Equity Payouts: Dividends and Share Repurchases
Chief Finance Officer takes different decisions when the company or the corporation earns money. However four ways are there at the moment for him as reinvesting or spending, pay off to the liabilities, paying to the dividends and use of the money in repurchasing of shares. These are common and important ways and one can select any one of them.
Sometimes paying to the dividends ad repurchasing of shares may create the situation where firm size gets reduced. These actions indicate that there is ratio of debt/equity and thus money goes from inside to the outside of a firm.
By paying to the equity holders they get some pay back that creates interest in their investment. Board takes decision for that in a proper way and declares for paying once in a year according to his convenience.
Background
Cash dividends are important and for that you need to understand the perfect and imperfect markets. In case of a perfect market, anyone can sell his share. It means there is breaking between the links. These happen when there is cash that comes through a project and when anyone needs it. Cash dividends are unable to generate or destroy any value.
Now, it is also important to understand the background of an imperfect market. It is clear that dividends do not have the ability to payout cash as it is not a way of tax-efficient. Investors are unable to share IRS dividends.
Debt and equity relationship is important to understand for companies to follow a proper strategy in finance. But, if you go through the strategy of empirical evidence, then that it is true that suggestions explain that share repurchases and dividends are not many valuable terms for them.
However, perfect knowledge of these terms makes the things completely perfect. So, it is true to know that empirical evidences Equity payouts and equity share issue are completely opposite. The importance of equity issue is there to increase the size of a firm and also helpful in reducing the ratio equity/debt. However, the share repurchases and cash dividends reduce the size of the firm and debt/ equity ratio gets reduced.
Dividends Mechanics
Before getting the explanation of dividend mechanics, it is important to know about the dividends. Dividends mean distribution to the investors. In case this is not qualified, then it is a cash dividend. This comes under any one out of two different firms as Special dividends or regular dividends.
Regular dividend means the distribution to the investors in the regular form. Suppose, a company had provided dividend in every quarter to the investors because of its large earning, then it is known a regular dividends. In the year 2004 this took place as each investor get dividends in each quarter.
However, if you go through second part of the dividends, then it is always said that it does not get repeated, through a lot of companies repeat the thing again and again.
When does the execution of dividend take place?
Execution of a dividend takes place in two different dates and these are – Declaration date and Cum-dividend date. Go through the details as follows –
- Declaration Date – In this particular date votes are important and board of directors votes only for paying dividends. This date of paying takes place after a few weeks of voting. Usually this is a part when the market understands about the payment. In case of the learners or experienced holders that they could easily know everything in advance.
- Cum-dividend Date – This is the date when a share has right to accept dividend. The ex dividend day is that day when share traded without having the payment of the dividend.
There are two different bookkeeping dates and these dates are record date and the payment date. Record date indicates about the share ascertained or to know where to send a check and the date of payment when firm sends the money.
What is DRIP?
The exact value of DRIP is Dividend Reinvestment plan and in this, participant’s shareholders desire to get facility of reinvesting automatically any payments of dividends into more and more company’s share.
This facilitates in tax obligation rather than cash. In this investors are unable to receive cash because they reinvest. So, at the end of a year an investor get tax obligation. In case company keeps all money, then investors do not have to pay their personal income taxes on dividends.
A firm pays tax penalty with an amount of shareholder. If corporation gets set up itself in place of a brokerage firm, then DRIPs compensate investors only with shares where discount rates are provided to them. In case of discount is not given, then investors get shares in a rate that is much lower than the market rate. In this way an income tax liability to the investors is always there. In addition, an income tax liability personally is given to the investors, but with an exact compensate for them.
If you desire to know about Stock dividend, then you just need to understand that it is a rare type in which involvement of cash is not there. There is an excellent term known as Stock split. In case a company has 10 million shares and it desire to split this into 20 million shares by splitting the value of $ 100 into $ 50.
A stock dividend is also work like a stock split in case there are 10 Billion shares with value of each $ 100. Now, if increasing of 1-share takes place in each 10 share, then the total number of share would be 11 billion in place of 10 billion.
As stock splits just reduces the value of share, but in case of a reverse stock split, the value gets increased, but similar exchange of shares take place. So, if you want to know the fraction of shareholders, then it is similar.
Share repurchases Mechanics
What do you mean by share repurchases? Share repurchases means allowance of purchasing back of stocks by a corporation. Equity issues are considered as the opposite of share repurchases.
If you go through the types or the ways of repurchases, then there are mainly two types of repurchases as –
Open market repurchases – This one is known as a genuine way of repurchasing of stocks through open market. Only after declaration a firm is able to purchase shares at its decision. Corporate board approved that program and then it needs to disclose. In this type there is no exact limit of the shares. Basically a firm repurchases shares nearly 5%. Repurchase program remains active for 2-3 years. If you look for SEC, then it does not need any progress disclosure or filing.
Auction based repurchases – This type of repurchasing is done in rare case and is not much common like open market. In this kind, share holders get offers by the company in which it desires to purchase the shares. The price premium is fixed in this case. Sometimes, shareholders also get notice from a firm. This notice possesses offer of purchasing at lowest premium rate. In case of too much interest of shareholders, basically a company repurchases pro rata of shares.
This kind of repurchases come in front of the people after 1990 when different firms at a time announced auction based repurchase of worth $ 5 to $10. Now, low premium means an exact way to repurchase large number of shares as soon as possible. This kind of repurchasing takes place when there is a proxy fight for firms. This can also take place by outside hostile acquirers.
The exact way of getting repurchasing of open market comes in front of people or the corporation sectors after 1982. Before that it was a point of confusion to some extent corporates do not follow proper rule for manipulation of price. At that time SEC declared safe purchasing rule and it became perfect for safe purchase through safe harbor.
This term Safe harbor indicates that SEC is not going to manipulate price for the shares which are used for repurchasing against corporation. There can be a clear declaration of the firm. According to that in case there is only a single broker, then repurchasing does not take place during the last 30 minutes of the open market or just at the beginning of the market.
Along with that it is also important to know that trading must not be done unnecessarily and thus the limitation of 25 % of daily trading value.
These took place till 1987 and after a stock market crash in this year. Rule 10b-18 is followed even after that, but it is not necessary to follow the letter of that law.
Repurchase programs are important as these are common. Moreover, open-based programs are more accurate and convenient for all. However, it is also true that these programs are suitable for the companies because these are flexible. It means the condition of purchasing is also flexible for a company. In case a firm does not desire to repurchase, it will do so.
In second half of 1990, lots of publicly traded firms together declare their worth for repurchasing between $150 and $ 200 billion. The programs of repurchasing of shares for the firms S&P 500 at any given point of time was about 80%. In addition, one in every 4 companies of S&P 500 announced a program for a given time.
Experts estimate that a firm mostly repurchases its share announced part of share as 3-quarter and it has a target of 3 years. Any firm does not require disclosing its outcome. With the help of researches, experts can only guess the exact outcome.
Questions:
- Write in detail about the various types of repurchase programs?
- If a specific firm takes up an open market repurchasing program then can it be said that it is manipulating the stock levels?
Links of Previous Main Topic:-
- Introduction of corporate finance
- The time value of money and net present value
- Stock and bond valuation annuities and perpetuities
- A first encounter with capital budgeting rules
- Working with time varying rates of return
- Uncertainty default and risk
- Risk and return risk aversion in a perfect market
- Investor choice risk and reward
- The capital asset pricing model
- Market imperfections
- Perfect and efficient markets and classical and behavioral finance
- Capital budgeting applications and pitfalls
- From financial statements to economic cash flows
- Valuation comparables financial ratios
- Corporate claims
- Capital structure and capital budgeting in a perfect market
- The weighted cost of capital and adjusted present value in an imperfect market with taxes
- What matters
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