How Are Stock Dividends Figured Out?
One one hand, if you are on a board of directors, you will consider that dividends are payments made out of retained earnings, so those earnings are no longer available for other uses--you can't use them to finance expansions or to pay down debt after you have sent them out to shareholders.
On the other hand, dividends do reward shareholders, and may help fend off any proxy challenge to your leadership or a hostile takeover.
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Cash Considerations
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As a general rule, if a company has a lot of cash, and a shortage of good projects in which to reinvest it, then it will generally want to return some of that cash to shareholders. You should remember, even in this situation, that dividends aren't the only way of doing that. A company can return cash to shareholders by buying back some of its stock.
Tax Considerations
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Further, buying stock back in more tax efficient. The shareholders will be taxed on their capital gains for selling some of their holdings back to the company, which will generally be preferable to taxation at ordinary income rates for the dividend.
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Signalling
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A company manager or director may wonder if your company should ever pay dividends at all. The earnings could be kept in the treasury and used for reinvestment opportunities or used for cash buybacks when there are not.
Unexpected changes in the level of dividends, in either direction, send a signal to investors. If a company has a history of paying dividends, then it cannot easily stop doing so, or cut the level, without raising concerns about its weakness.. On the other hand, a firm that had not been paying dividends may start doing so, or a firm may increase the level of its payments, to signal its strength.
According to the signalling literature, summarized for example by Luis Correia da Silva and two colleagues in their book "Dividend Policy and Corporate Governance," you would determine dividends by guestimating the amount that will be needed to send the desired signal, within the limits of what the corporate treasury can afford.
Dividends and Regulators
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One school of scholars has developed the contrast between the dividend policies of two types of firms, those in heavily regulated industries (such as electrical utilities, which require permission for rate changes) and those in unregulated industries.
Expert Insight
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One difference in the capital structure of the two types of firms is that unregulated firms have a much larger share of their stock owned by insiders, for example, a larger overlap between managers and stockholders. "On average, the insiders of unregulated firms hold almost three times as much of their firm's common stock," than regulated firms, according to Atul K. Saxena, an associate professor of finance at Mercer University. Also, Saxena noted, the mean dividend payout for the regulated firms is higher than the payout for unregulated firms. He suggests that these facts may be closely related. Insider owners do not want to pay themselves dividends, they would rather reinvest. As insider owners disappear, the tendency to pay dividends (to outsiders) increases.
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