Principles Of Managerial Finance

Learning Goals

• LG 1 Understand cash payout procedures, their tax treatment, and the role of dividend reinvestment plans.
• LG 2 Describe the residual theory of dividends and the key arguments with regard to dividend irrelevance and relevance.
• LG 3 Discuss the key factors involved in establishing a dividend policy.
• LG 4 Review and evaluate the three basic types of dividend policies.
• LG 5 Evaluate stock dividends from accounting, shareholder, and company points of view.
• LG 6 Explain stock splits and the firm’s motivation for undertaking them.

Why This Chapter Matters to You

In your professional life

ACCOUNTING You need to understand the types of dividends and payment procedures for them because you will need to record and report the declaration and payment of dividends; you also will provide the financial data that management must have to make dividend decisions.

INFORMATION SYSTEMS You need to understand types of dividends, payment procedures, and the financial data that the firm must have to make and implement dividend decisions.

MANAGEMENT To make appropriate dividend decisions for the firm, you need to understand types of dividends, arguments about the relevance of dividends, the factors that affect dividend policy, and types of dividend policies.

MARKETING You need to understand factors affecting dividend policy because you may want to argue that the firm would be better off retaining funds for use in new marketing programs or products, rather than paying them out as dividends.

OPERATIONS You need to understand factors affecting dividend policy because you may find that the firm’s dividend policy imposes limitations on planned expansion, replacement, or renewal projects.

In your personal life

Many individual investors buy common stock for the anticipated cash dividends. From a personal finance perspective, you should understand why and how firms pay dividends and the informational and financial implications of receiving them. Such understanding will help you select common stocks that have dividend-paying patterns consistent with your long-term financial goals.

Whirlpool Corporation Increasing Dividends

In another sign of an improving economy, Whirlpool Corporation, the worldwide appliance manufacturer, announced that it would increase the quarterly dividend that it paid to its stockholders by 25 percent, up to 62.5 cents per share from 50 cents in the previous quarter. Whirlpool’s CEO, Jeff Fettig, explained, “Our actions have delivered a strong financial position enabling us to enhance returns to shareholders through a dividend increase. This dividend increase underscores our confidence that our long-term growth and innovation strategy will continue to create value for our shareholders.” Markets reacted to this news by increasing Whirlpool’s stock price by 3.2 percent.

Why does Whirlpool pay dividends? Fettig’s press release suggests two possibilities. One is that by paying dividends the company can “enhance returns” to shareholders. In other words, Whirlpool believes that returns to shareholders will be higher if the firm pays a dividend (and increases it) than if the firm does not pay a dividend. That sounds logical, but consider that when a firm pays a dividend, it is simply taking cash out of its bank account and putting that cash in the hands of shareholders. Presumably, after a firm pays a dividend, its share price will reflect that it no longer holds as much cash as it did prior to the dividend payment. In other words, paying a dividend may simply be just switching money from one pocket (the company’s) to another (the shareholder’s).

Another reason that Whirlpool may pay a dividend is revealed in the second part of Fettig’s statement. Whirlpool increased its dividend to “underscore our confidence.” In other words, Whirlpool executives are telling the market that the firm’s financial position is strong enough and its prospects bright enough that managers are confident that they can afford to increase the dividend by 25 percent and still run the company effectively. Indeed, Whirlpool’s history suggests that managers use caution when increasing dividends. From 1995 to 2013, Whirlpool increased its dividend on just three occasions. Compare that record with the dividend history of Emerson Electric Co., a company that as of 2013 had increased its dividend for 54 consecutive years. Apparently Emerson and Whirlpool adopt different policies with respect to dividend increases.

14.1 The Basics of Payout Policy

LG 1

The term payout policy refers to the decisions that firms make about whether to distribute cash to shareholders, how much cash to distribute, and by what means the cash should be distributed. Although these decisions are probably less important than the investment decisions covered inChapters 10 through 12 and the financing choices discussed in Chapter 13, they are nonetheless decisions that managers and boards of directors face routinely. Investors monitor firms’ payout policies carefully, and unexpected changes in those policies can have significant effects on firms’ stock prices. The recent history of Whirlpool Corporation, briefly outlined in the chapter opener, demonstrates many of the important dimensions of payout policy.