Main Methods of Distributing the Cash back to the Shareholders

Main Methods of Distributing the Cash back to the Shareholders

Conventional wisdom suggests that dividend payment affects shareholder's wealth as well as the value of the organization with regards to the exploration of growth opportunities and retaining earnings. Dividend refers to a payment or return made by the corporation to the shareholders (Acharya et al., 2011). Payments such as these are made in the forms of cash. The major types of dividends in the organization include stock dividend and special dividends.

Special Dividend

Special dividend refers to the payment made to the shareholders by a business entity but is declared separate from the normal periodic dividend payment cycle. It signals a one-off payment to mark sustained rise of the corporation and can be larger than the normal or regular dividend payments (Fuller et al., 2011). Large multinationals such as Microsoft distribute special dividends to the shareholders after a period of five years.

Stock Dividend

Stock dividend refers to the payout conducted in the form of added shares to the shareholder rather than in the form of cash. Business organizations make decisions to distribute stocks to the business owners (shareholders) especially if there is a short supply of liquid cash to run the operations (Hillier, 2012). Often, the management acknowledges this added dividend payout as a fraction of the existent shares. 

Share Repurchases

            Share repurchase, on the other hand, refers to a program that entails a reacquisition of its own from the holders to minimize the number of outstanding shares. It is common for corporations to conduct share repurchases when the leadership sees its shares as undervalued in the marketplace. Therefore, the firm accords the shareholder with an option of tendering their shares directly at affixed price to the organization.

Types of Share Repurchases

Open Market Repurchase

In an open market repurchase, the business entity relies on market conditions to decide periodic repurchase of shares from the open market. The entire process can take years or months depending on the economic prospects and shareholder willingness. Up to 95% of all repurchases of shares are conducted in the open stock market (BAbenko et al., 2012).

Tender Offer

            Tender offer specifies a unitary share purchase price in advance, the offer duration, and the share number with a mandatory requirement of public disclosure. Normally, corporations set the share premium price between 10% and 20% of the existing market price spanning over a period of 20 days (Chen et al., 2013). The organization has a right to the offer without buyback if the shareholders fail to meet the threshold of tendering adequate shares.

Dutch Auction

In a Dutch auction, the company lists different pricing for shares while the shareholders disclose the number of shares they will sell at each listed price. Thereafter, the company acquires the shares with the lowest price on a pro rata basis depending on the number of investors.

Targeted Repurchase

The targeted repurchase is strategic and is applied to thwart a potentially hostile or malicious takeover of the corporation by an unfriendly bidder. The organization repurchases its stock at a higher and convincing price, without necessarily disclosing the reasons to the shareholder.

Greenmail

 Greenmailing refers to antitakeover strategy necessitated by an unfriendly competing firm holding large stock blocks hence a direct threat of hostile takeover. Mostly, greenmail applies in acquisition and mergers and involves payment of money (substantial premium) to a corporate raider to prevent loss of ownership (Erahtina, 2013).

Modigliani-Miller Theorem (MM Theory)

MM is a financial theory that states that the risk of underlying assets coupled with the earning power determines the corporation’s market value independently on the way it decides to distribute dividends and finance investments (Brusov et al., 2011). Furthermore, MM theory argues that the sources of finance to a corporation do not matter because financial decisions do not affect viability and profitability of the organization.

Formula

Assumptions

MM theory assumes that the capital market is frictionless due to the absence of trade barriers and economic volatility. In addition, stock securities are priced efficiently because no cost can be incurred during financial transactions. In some cases, shares can be issued to investors and shareholders with minimal or no cost due to the absence of intermediaries. Finally, there is no corporate or personal taxation according to MM theory. As a consequence, the investors become indifferent with the ability to replicate payout policies including homemade dividends (Brusov et al., 2013).

Obstacles to MM Theory in Real Life

MM theory is inapplicable in the real business environment because of its stance on debt tax subsidy. It fails to consider the taxpayer value implicitly and explicitly. For example, if a given financial institution holds 100% of its equity, there will be abrupt risk fall on the shareholder with the support of the society being 0%. The societal contribution will be significant especially if the financial institution has 95% debt and equity of 5% (Miles et al., 2013). Worth noting is that perfect capital markets do not exist in the real word because the relevance of dividends is evident under specific market conditions.

Transaction Cost

Most investors sell their shares to raise liquid cash especially if they withhold non-dividend stocks, thus making the transactions costly to cover. However, it is a common phenomenon for corporations to conduct share repurchase automatically if shareholders are unsatisfied with the costs incurred during transactions.

Clientele Effect

Of keen to note is that tax rates are variable according to investment horizons, jurisdiction, and income. In light of this, it is possible for a business entity to attract varied groups of investors as per the policies of investment. Clientele is not perfect because high tax investors are eligible for dividends, thus implying that taxes on dividends are not the sole determinants of investment portfolios (Rubinstein, 2014). Despite clientele effect on business transactions, it cannot eliminate relative tax disadvantage.

Signaling

Signaling refers to the notification from the organization to investors that it can afford to pay higher dividend rates for the foreseeable future by increasing dividends. On the other hand, its decrease signals less optimism on market conditions. However, surveys indicate that most investors and shareholders prefer table dividends if there are market uncertainties and volatilities. Therefore, the majority of organizations are mandated to raise dividend rates only if there is a perception of long-term and sustainable growth. According to the bird-in-the hand argument, investors go for cash dividends instead of uncertain capital gains. Therefore, the value of companies that pay dividends will be higher in comparison to those that do not.

Bibliography

Acharya, V.V., Gujral, I., Kulkarni, N., and Shin, H.S., 2011. Dividends And Bank Capital in the Financial Crisis of 2007-2009 (No. w16896). National Bureau of Economic Research.

Babenko, I., Tserlukevich, Y. and Vedrashko, A., 2012. The Credibility of Open Market Share Repurchase Signalling. Journal of Financial and Quantitative Analysis, 47(05), pp.1059-1088.

Brusov, P.N., Filatova, T.V. and Orekhova, N.P., 2013. Absence of an Optimal Capital Structure In the Famous Tradeoff Theory!. Journal of Reviews on Global Economics, 2, p.94.

Chen, S.S. and Wang, Y., 2013. Financial Constraints and Share Repurchases. Journal of Financial Economics, 105(2), pp.311-331.

Erahtina, O., 2013, February. The Preventive Measures of Internal Protection Against Abuses of Rights in Corporate Conflicts. In ICMLG2013-Proceedings of the International Conference on Management, Leadership and Governance: ICMLG 2013 (p. 110). Academic Conferences Limited.

Fuller, K.P., and Goldstein, M.A., 2011. Do Dividends Matter More in Declining Markets?. Journal of Corporate Finance, 17(3), pp.457-473.

Hillier, D., Grinblatt, M. and Titman, S., 2012. Financial Markets and Corporate Strategy (No. 2nd Eu). London: McGraw-Hill.

Lee, W.S., and Tu, W.S., 2011. Combined MCDM Techniques for Exploring Company Value Based on Modigliani–Miller Theorem. Expert Systems with Applications, 38(7), pp.8037-8044.

Miles, D., Yang, J. and Marcheggiano, G., 2013. Optimal Bank Capital*. The Economic Journal, 123(567), pp.1-37.

Rubinstein, M., 2014. Great Moments in Financial Economics: II. Modigliani-Miller Theorem. Journal of Investment Management, 1(2), pp.7-13.