Dividends

Section: Dividends and Share Repurchases Estimated study time: 45 minutes Content: Dividend policy concerns how a company distributes profits to shareholders — whether as cash dividends, stock dividends, or share repurchases. The key theoretical question is whether dividend policy affects firm value. Under Modigliani-Miller (MM) irrelevance theory (in a perfect market with no taxes, transaction costs, or information asymmetry), dividend policy is irrelevant — investors can create their own "homemade dividends" by selling shares if they want cash, or reinvesting dividends if they prefer growth. In practice, MM assumptions don't hold: taxes (dividends taxed as ordinary income vs. capital gains at lower rates), transaction costs, and information asymmetry all make dividend policy matter. The signaling effect is particularly important: dividend cuts signal financial weakness and typically cause sharp stock price declines, while increases signal management confidence in future earnings. Cash dividends are the most common form of distribution. The dividend timeline involves four dates: (1) Declaration date — board announces the dividend; (2) Ex-dividend date — the cutoff date to qualify for the dividend (buy the stock before ex-date to receive the dividend); (3) Record date — company identifies shareholders of record, typically two business days after ex-dividend date; (4) Payment date — dividend is paid. On the ex-dividend date, the stock price theoretically drops by the dividend amount because new buyers will not receive the dividend. In practice, the price drop equals the after-tax value of the dividend for the marginal investor. Understanding the ex-dividend date is critical for both tax planning and arbitrage analysis. Share repurchases (buybacks) are an alternative to cash dividends for returning capital to shareholders. When a company repurchases shares, it reduces the number…