Factors of Apple's Dividend Policy - Essay Example

? Carry out your own research to find a non-financial firm that changed its dividend policy over the last few years. Assess the (possible) reasons for the change and critically argue the impact of the change on its share price. Introduction Dividend policy is the strategy that a particular company uses to determine the amount of funds that should be retained for reinvestment in new projects and the amount of dividend that should be paid out to the shareholders. This means that the primary role of such a policy is to determine the proportion of the company’s funds, which should be paid to the shareholders and what should be set aside for investment in new opportunities. In order to determine this policy, managers of firms must consider the options that would lead to optimisation of the shareholders’ wealth. One of the key theories that explain the relationship between dividend policy and stock price is the irrelevance of dividend policy, in which Miller and Modigliani (1961) suggest that dividend policy is immaterial when it comes to determination of the shareholders’ wealth. They specifically argued that, without considering market imperfection and taxes; the shareholders’ wealth is not affected in any way. Hakansson (1982) supported the views of Miller and Modigliani by maintaining that dividend do not play any role in the value of the firm, regardless of whether they are informative or not; but this applies only when investors possess time additive utility and homogenous belief as well as when the market is fully efficient. Different empirical studies associated with dividend theory policies do not show consistent results. As such, it is not possible to give a general view as to whether the investors prefer dividend or capital gain. Brigham (2010) asserts that it is the prerogative of the management to decide the dividend policy based on industry trends and the long-term objectives of the organisation, a view that squarely explains the reasons why the management of Apple has dramatically changed its dividend policy. Even so, it is imprudent for the management to rely on any specific theory in determination of dividend policy for the corporations they head, because the best policy depends on different circumstances and times. Irrelevance theory is neutral with regard to preference of either capital gain or dividend payout (Miller and Modigliani, 1961). In this model MM concluded that capital structure does not have any effect on the value of the firm. However, MM II, argued that by introducing corporate taxes in to the first model, it gives rise to tax shields which in turn leads to optimal capital structure (Black, 2006). The paper puts into perspective the issue of dividend policy in the context of Apple Inc. The paper also gives a brief overview of the company, as well as putting into perspective the imminent change in divided policy that has been lined up, and those that have already been implemented. The analysis will also incorporate different theories that have been put across by several researchers regarding the relationship between dividend policy and share price volatility. Company Overview The Apple Company designs, manufactures and markets computers, networking solutions, software, peripherals and services. Among the many available products are portable music players, which they both design and develop. Notwithstanding, they engage in online distribution of television shows, audio books, short films, third-party music-both audio and videos. Apple Inc. (Apple) was founded by Stephen Wozniak and Steve Jobs in the latter’s garage. January 3, 1977 saw the incorporation of Apple. The Apple II computer was then later introduced by the duo later that year at a West Coast Computer Fair in San Francisco (Linzmayer, 1999). Dividend Policy Trend in the Technology Industry Distribution policy refers to Companies’ policies put in place to govern issues of dividend payout. For instance, a company can have either high or low dividend distribution policy to its both preference and ordinary shareholders. Distribution policy can either take the form of cash or share buyback. The players in the technology industry have been making a steady shift in several of their distributions policies. Apple Inc. is the latest player in the industry to join other players share repurchase. The companies in the technology industry, including Google, Microsoft, and Siemens, have all had a history of share buyback, cash dividend, and share repurchases. For example, IBM Corporation took a record-breaking move by resulting to significant share payback in 1980. Moreover, in 2012, IBM, just like many conglomerates, announced a major share buyback programme as well dividend. Google has not been left behind as the players in the technology sector realign their shares to the current industry practice. In a bid to remain relevant and attractive to their investors, Google rolled out a one for a two-share stock split to its current shareholders. IBM has been consistent with its share buyback programme, up to a level that exceeded its dividend payout programme. Although many technology-based companies have been focussing on buybacks, the share prices in the market have remained lacklustre. This scenario begs the need for the companies to result to distribution policies such as stock split and stock repurchases. Generally, the trend in the technology sector is that the companies are steadily shifting from dividend payouts to other distribution options such as share split, share buybacks, and share repurchase. Stock repurchases refer to a scenario through which a firm pays out cash to its shareholders, to effect repurchase of its own share as an alternative to dividend payout. The major advantage of such a strategy is that it gives the stockholders the option of tendering their cash for shares or otherwise. Furthermore, the repurchased stock is strategic as the firm can use it to facilitate mergers in future expansion plans. Bardhan (2007) asserts that the major disadvantage of repurchase stock is that it is lower in value as compared to the actual market rate resulting to loss to stockholders. It usually inconveniences stockholders who in many instances resort to legal battles with the firms. Stock splits refer to alternative to a cash dividend where a firm awards a stockholder additional stock at a given percentage (Black, 2006). For instance, a stockholder with 100 stocks gets five additional stocks. On the other hand, stock split refers to increase in the number of outstanding shares. The main advantage of stock split and stock dividend is that the firm does not incur any cash expenditure; hence they are able to maintain a superb working capital. On the other hand, the main undoing of this move is that the stockholders do not enjoy any cash benefit in the short run. The table below illuminates the impact of buy backs and dividend payout to annual return, on different technology-based companies. Impact of change in Dividend Policy to Share Price There has been an argument that the change of Apple’s dividend policy would increase the company’s liquidity, as a result of attracting many institutional investors, which eventually leads to an increase in the prices of the shares. This argument means that the decision by the management of Apple to start paying dividend at any particular period leads to leakage of the information to the market, which essentially stimulates the participants to purchase Apple’s stocks since they are very attractive – this also stimulates the share price to rise up. One of the events that saw a dramatic impact in the amount of shares traded was the March 19, 2012, press release, where forward-looking statements were announced, hence sending a positive signal in the market. Furthermore, when the company’s announcement that a quarterly dividend would be offered starting July 1, 2012, the shares traded started to rise up dramatically. Similarly, the announcement of the September 30, 2012 shares repurchase programme seems to have stimulated trading volume, which lasted up to mid September. The April 23, 2013 announcement by the board of Directors to return substantial capital to the shareholders saw a significant trading, at least for the succeeding one month (Figure 1). Figure 1: Apple monthly trading volume (Source: http://stockcharts.com/h-sc/ui). Notably, announcements mean that the funds that were held up in Apple when it was not paid to investors in form of dividend will now be released. As shown in Figure 1, the share price dramatically rose after April 23, 2013 dividend announcement. However, after April, the trading volume started to decline, with no unusual high or low being registered. Besides changes in trading volumes, institutional holding is the other indicator that can be used to explain the impact of dividend policy on Apple’s share price. Since late 2010, there has not been any significant increase in the share of institutional investors in comparison with all outstanding shares; in overall this share has been on a decline trend. Nevertheless, the fact that the institutional investors have not responded to the company’s changes in dividends policy, is a usual event that can be explained by Modigliani and Miller’s irrelevant theory (Modigliani & Miller, 1961). In line with dividend optimal investment policy, the management of Apple would want to adjust the company’s dividend policy as a means of adjusting the capital structure. As postulated by Modigliani and Miller (1961), neither the dividend policy nor the capital structure causes any impact on the value of the firm. In other words, Modigliani and Miller demonstrated that the way firms make decisions concerning dividend policy or capital structure does not affect the wealth of the shareholders. In view of this perspective, the management of Apple is more concerned with other important issues, such as what and where the firm’s cash should be invested. As such, dividends policy does not add any value to the company, but what really matters is the perceived net present value of all free and future cash flows. In other words, whether the company holds funds inside the company or outside the company does not determine its value; after all the shareholders are still the owners of the funds. Furthermore, the implication of the market is merely fundamental, and hence it does not signal any change in the amounts of funds that the company holds as a result of attracting more buyers. In this vein, an increase in the company’s share price can be taken to mean that its future is more promising, and that a cloud of doubt is slowly wearing out. However, it cannot be construed that the dividend policy does not have any impact on the stock price, because the management of Apple would want to choose a certain capital structure, which is better than others, due to the consideration of real-life-frictions such as tax. Different literatures reveal that a sustainable level of debt can be achieved when a firm can enjoy many tax advantages while the NPV of the cost of financial distress is minimal (Modigliani & Miller, 1963; DeAngelo & Masulis, 1980). This is because if stock repurchases and dividend are not taxed in a similar manner, then Apple Inc. would want to choose the cash payout that is most advantageous, in terms of having the highest tax deduction. Figure 2: Share of outstanding shares held by institutional investors – APPLE (Source: asymsco.com) Effect of share repurchase on share prices on ex-dividend date According to Dilger (2013), Apple is currently distributing a total of $2.77 billion out of its 908.11 million outstanding shares, out of which $3.05 per share will be distributed by the ex-dividend date. For the third quarter of 2013, Apple spent a total of $16 billion on its stock buyback programme, which resulted to buying of 36 million shares off the market. A total of $44 billion was left by the end of June, which would be used for stock repurchase under the current programme that is slated for the following two years. Figure 3: Apple’s shares outstanding chart (source: Ycharts.com) Apparently, the share repurchase will lead to a drastic reduction in the outstanding shares as shown in Figure 3.One of the major reasons why the management of Apple could have resulted to such a drastic share repurchases policy is that the executive compensation is normally pegged on the ability to meet earnings per share targets. However, the choice of this policy could also mean that Apple has few or no opportunities for organic growth. According to Bhargava(2013) explains that stock option decisions increases future stock repurchases, which in turn prevents a firm from focusing on more productive ventures; this reduces the price of the firm’s share price in the long-run. Furthermore, in accordance with Modigliani and Miller (1961), increasing earnings per share does not necessarily result to an increase in the shareholder’s value. This is because focusing on the earnings per share ratio does not take into account future cash flows and the cost of capital, which are the real determinants of shareholders’ value. Internal factors affecting change in dividend Policy There are scores of internal factors, which affects dividend policy at Apple Inc. One such critical factor is the issue of the competing needs for extra cash. In order to meet this objective, the company is required to continue to investment in market research as well as penetrate the global market. Such moves are quite costly and as such; the company opts to offer other incentives other than dividend payout as a way of rewarding its shareholders. In addition, the need by the shareholders to remain in control is a factor that affects dividend policy as Apple Inc. Unfortunately, the more shareholders the company has the harder it becomes to make decision. It is due to this factor that Apple Inc. has embarked on an aggressive share repurchase programme, which would lead to reduction of the number of shareholders through the share repurchase programme. It is worth noting that this is an elaborate and deliberate step that will ensure that the shareholders have total control and ease in decision-making. The management of Apple Inc., under the leadership of CEO Tim Cook, has reiterated that despite the hefty amount they are going to spend on the repurchase programme and other distribution obligations such as dividend payout, the company will remain committed to making great investment in the industry. The company’s leadership also gave an assurance that more market research programmes; new acquisitions, and development of infrastructure is on the pipeline. These sentiments are clear indication that the company intends to maintain control, and it is, therefore, keen to avoid issues that might dilute the control and make the strategic decision-making process easier. It can also be argued that Apple Inc. determines its capital structure mix in a manner consistent with trade off theory as shown by increase in debt level which has a positive relationship with earnings. Increase in debt, leads to further increase in capital costs (Modigliani & Miller, 1958). Capital costs on debt are tax deductible, thus the company enjoys the benefit of tax shield which minimizes the effects of finance costs on net profits. The static trade-off theory posits that firms establish an optimal capital structure, whereby tax shields and financial distress of debt financing are balanced. Under this theory, a firm with low tax shields and high financial distress should adopt a low-leverage policy (Modigliani & Miller, 1958). Debt is an important component of a capital structure for any firm, but unfortunately this has been a source of conflict amongst security holders, especially following change of investment policy or issue of new securities. Managers of Apple tend to adopt low leverage policy with the aim of reducing financial pressure and enhancing liquid asset. The company passes through the three different stages of development. This sees the company adopting different dividend payout policies. During the initial stage and the growth stage, the company share price tends to continue rising but when the company matures, the share price stabilizes and at this point, the company pays higher residual dividends. The dividend policy adopted, positively relates to the net profit generated by the company. Initially the company profits are low, but as they stabilise, the company employs stable dividend policy. At maturity stage, the company applies the residual dividend policy, whereby it distributes dividends according to the residual amount left. The company has matured and, therefore, has no intentions of reinvesting its residual income to expand the business. External Factors affecting Changes in Dividend Policy The current Apple’s policy making is also determined by the external environment. Reports say that, in 2007, Apple obtained 52% of its business from outside US. Terrorism and wars are likely to significantly influence the company as a result of poor international relations. Therefore, it is critical that the company controls these external factors. Apple Inc produces some of its products from outside the US, including Korea, Cork, China, Ireland and Czech Republic. The awful political relations between US and the external world influence the management when make decisions regarding dividend policy, for example, because when the international relations are so threatening the management would want to retain most of the funds inside the company due to uncertainty (Linzmayer, 1999). On the other hand, political stability leads to optimism, hence encouraging the management to pay out more dividends. The company’s performance is highly dependent on the impact of the global economic crisis. Since Apple’s products are associated with luxury, the customer reduces their budgets in them when the inflation as well as the rate of unemployment goes high - which influences the management to adopt a more conservative dividend policy. The company’s products also experience enormous challenges due to endless fluctuation of the US dollar. However, the economic impacts on the company are reduced because Apple has, however, hedged most of the risks by purchasing foreign currencies – hence this does not have enormous influence on the dividend policy (Linzmayer, 1999).). More importantly, Apple has had to defend several lawsuits that have been filed against it by Nokia, alleging that it has violated 13 additional patents by iPad, iPhone, and iPod. There are also a couple of other US complains involving 24 Nokia patents. In addition, in China, Apple has been defending its right to the iPad trademark. The potential outcomes of these lawsuits have dire consequences on the future of the company’s products and business – and hence its dividend policy because when a lot of funds are used in paying damages, the amount distributed in form of dividend has to be cut down (Linzmayer, 1999). Over-all progress to date: On March 19, 2012, Apple declared its intention to start a dividend and share repurchase programme, which would commence later in the year. Besides, the company declared its plans to launch a quarterly dividend of $2.65 per share, which was slated to start in the fourth quarter of the same year (July 1). In addition, the company endorsed a $10 billion share repurchase, which was slated for 2012-2013 fiscal year; starting September 30, 2012 (Hoover, 2013). On April 23, 2013, the Board of Directors sanctioned a more a drastic, whose aim was to return a significant proportion of the company’s capital to its shareholders. In the new strategy, the company allocated a total of $100 billion, which was to be distributed to the shareholders by the end of 2015 calendar year. This resulted to a $55 billion increase to the programme announced the previous year (2012). As part of the same programme, the management increased its share repurchase by approximately 83 percent (from $10 billion to $60 billion), which is slated for execution in the year 2015. This marked the largest single share repurchase authorization in the history of the company. Additionally, the company announced a 15% increase in its quarterly dividend, while at the same time a $3.05 per common share of dividend was announced (payable on May 16, 2013) (Hoover, 2013). As illustrated in the stock movements indicated in Figure 4 below, it can be seen that these important announcements must be sending some positive signals in the market, hence causing the prices of shares to increase around the windows of these events. Nevertheless, there is no abnormal increase in stock price as a result of these announcements; and any changes in prices seem to occur only in the short-term. This observation supports the signalling theory, which proposes that payment of higher dividends end some positive signals to the markets, which portrays a firm as having a better earnings and dividend outlook in the future (Brickley, 1983). Figure 4: Apple Inc. Historical stock price changes (source: http://www.nasdaq.com) Conclusion By and large, this study has led to a number of conclusions. The management of Apple adopts different dividend policy due to both internal and external factors. One of the major factors is constraints of funds, which forces the management to adopt a more conservative dividend policy; and becomes generous with dividend payout only when the company is having significant amount of cash balances. When Apple’s announces new developments regarding its dividend policy, some signals are sent into the market-which influences stock prices, in support of signalling theory. The idea behind this view is that Apple’s change of dividend policy by would attract many institutional investors, who would bring in more funds and stimulate the prices of the company shares upwards. However, from the analysis, this view is skewed because it has been observed that the institutional investors are not really motivated to invest in Apple, when dividend policy is changed. As such, the level of institutional ownership does not have any influence on the dividend policy nor the price of shares. Also, importantly, the corporate lifecycle has been found to be a key determinant of dividend policy, because when the company is in a growth stage, it tends to distribute dividend at a very high rate – this is the case with Apple which has recorded a very successful growth trend into the recent years, hence resulting to distributions of hefty dividend. Although Modigliani and Miller (1961) demonstrated that the manner in which firms make decisions concerning dividend policy or capital structure does not affect the wealth of the shareholders, it has been alluded in this paper that the management of Apple is highly motivated by the need to maximise shareholders’ wealth when determining the best dividend policy. References Bardhan, P., 2007. Corruption and Development: A Review of Issues, Journal of Economic Literature, 12(3), pp. 1320-1346. Bhargava, A., 2013. Executive compensation, share repurchases and investment expenditures: Econometric evidence from US firms. Review of Quantitative Finance and Accounting, 40, pp. 403-422 Black, F., 2006.The Dividend Puzzle.Journal of Portfolio Management89(2) 104-112 Brigham, E., 2010.Financial Management: Theory & Practice. Cengage Learning, Boston, Masachessets Black, F., 2006. The Dividend Puzzle. Journal of Portfolio Management 89(2) 104-112 DeAngelo, H., Masulis, R., 1980. Optimal Capital Structure under Corporate and Evidence from the Field. Journal of Financial Economics, 60, pp. 187-243. Dilger, D., 2013. Apple, Inc. to distribute another $2.77 billion in dividend to shareholders Thursday. [online] Available from: [accessed 12 November 201]. Hakansson, N. H. (1982). To pay or not to pay dividend.The Journal of Finance, 37(2), pp. 415-428. Hoover, J., 2013. Apple Announces Plans to Initiate Dividend and Share Repurchase Programme.Apple Press Information, Linzmayer, O.W., 1999. Apple Confidential: The Real Story of Apple Computer, Inc.. No Starch Press. Miller M. and Modigliani, F., 1961. Dividend Policy, Growth, and the Valuation of Shares. Journal of Business, October, pp. 411-133. Modigliani, F. and Miller M. H., 1958. The Cost of Capital, Corporation Finance and the Theory of Investment. American Economic Review 48(3), pp. 261–297. Read More