Dividends and Payout Policy Paper

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Dividends and Payout Policy

 

 

Dividend policy is an important subject in corporate finance, and dividends are a major cash outlay for

many corporations. At first glance, it may seem obvious that a firm would always want to give as much as

possible back to its shareholders by paying dividends. It might seem equally obvious, however, that a firm

could always invest the money for its shareholders instead of paying it out. Should the firm pay out money

to its shareholders, or should the firm take that money and invest it for its shareholders?

 

Can the wrong dividend policy bankrupt a firm? The following anecdote suggests that dividend

policy can play a role in a company’s downfall.

 

The automobile industry was quite prosperous in the 1920s, but was hit hard by the depression. Studebaker

Corporation, which was relatively weak to begin with, suffered more than other automotive manufacturers.

Part of the reason for its financial problems was the belief by the firm’s president that dividends alone could

increase the value of the stock. He implemented a dividend policy that increased the dividend payout ratio

from 43 percent in the early 1920s to 91 percent in 1929. However, the dividend was held constant in 1930

and 1931 even as sales and earnings decreased. This led to a payout ratio of 500 percent(!) in 1930 and 350

percent in 1931. In 1932, the company lost $8.7 million, but still paid $1 million in dividends! The firm’s

financial health was damaged significantly by the generous dividend policy and filed for reorganization in

March 1933. Tragically, the firm’s president took it very personally and shot himself three months later.

 

 

 

 

 

 

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Cash Dividends

• Regular cash dividend = cash payments made directly to stockholders as part of a firm’s normal operations (usually each quarter)

• Extra cash dividend = paid over and above the regular dividend (may not be repeated in the future)

• Special cash dividend = similar to extra dividend, but definitely won’t be repeated

• Liquidating dividend = some or all of the business has been sold

 

 

The most common type of dividend is a cash dividend. Later in the module, we discuss dividends paid in

stock instead of cash.

 

The basic types of cash dividends are these:

 

1. Regular cash dividend – normal dividends, usually paid on a quarterly basis.

• Commonly, public companies pay regular cash dividends four times a year.

2. Extra cash dividend – paid over and above the regular dividend, may or may not be repeated

 

3. Special dividend – one-time dividend paid over and above the regular dividend, won’t be repeated

• Special dividend is similar, but the name usually indicates that this dividend is viewed as a truly unusual or one-time.

 

4. Liquidating dividend

• The payment of a liquidating dividend usually means that some or all of the business has been liquidated

 

 

 

 

 

Slide 3


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