Distribution of Dividends and Share Repurchases - Coursework Example

Running Heading: Distribution of dividend and share repurchases Distribution of Dividends and share repurchases of Instructor] [Course] Distribution of dividends and share repurchases Organizations that have operations on a bigger scale require more money for their operations. These organizations go public and they usually issue shares in order to fulfill their monetary issues and obligations. People buy shares and become the members of that organization. Public limited companies issues shares to the general public and organizations give dividends on those shares on annual or bi-annual basis. Thus, the phenomenon of shares and dividends work on this principle. In this paper we will discuss the phenomenon of distribution of shares and the element of share repurchases. Moreover, we will discuss practical examples of companies that give dividends and purchase their own shares. Similarly, the process of determining the disbursement of dividends is discussed in this paper. Introduction In an organization share holders are of utmost importance because they buyout the shares of the company and certain affairs of the company are carried out because of share holders. Therefore, organizations take care of their shareholders by giving them dividends. The profit of the company is either reinvested in the company or the share holders are given dividends. Usually, shareholders receive dividends with respect to their share holding in the company. However, giving dividends to the shareholders is a critical method and it is considered as the core decision making element of the company (Madura, 2008). Proper brainstorming and decision making capabilities is essential for in this process because through dividends shareholders are motivated more to invest in the company. There are certain forms of giving the dividends like dividends are distributed on cash basis and they are known as cash dividends. These dividends are distributed through checks and these are taxable in the recipient in the year when they are actually paid. Certain dividends are distributed in the form of additional shares and in certain cases dividends are given in the form of property and they are known as property dividends. However, the distribution process is based on certain characteristics and it is one of the crucial decisions for the top hierarchy of an organization. Divided policy of the organization is considered to be an important element in determining the distribution of dividends. This policy revolves around the idea of payout earnings versus retaining and then reinvesting them. The dividend policy includes certain factors like: How frequent the company would pay dividends What are stable or irregular dividends What is high or low dividend payout Investor preferences and theories of dividend policy Dividends are paid to the shareholders in order to keep them attached and interested with the company. Usually, there are three theories of dividend policy these are: Dividend irrelevance Bird in the hand Tax preference Dividend irrelevance This theory is widely used in the process of distributing dividends. However, this policy arises that the investors are indifferent between the phenomenon of dividends and retention-generated capital gains. Investors have the tendency to create their own policy that if they want cash they can sell their stocks (Mishkin & Eakins, 2008). Similarly, if they don't want cash then they can use dividends to buy the stock. This model was proposed by Modigliani and Miller but it was based on unrealistic assumptions. The core aspect of this theory is that investors are not concerned about the company policy on dividends because they have the choice of selling portfolio of equities if they are interested in having cash. The issuance of dividends should have negligible or no impact on the stock price. Bird-in-the-hand theory Investors think that the dividends of the company are less risky as compared to the future capital gains, therefore they prefer dividends. Similarly, investors prefer organizations that give high payout. This theory is considered to be another name for dividend relevance theory. The essential element of this theory is that stock holders prefer current dividends and there is appositive relationship between dividends and the market value (Mishkin & Eakins, 2008). Stockholders receive benefits in the form future stock prices that are relatively high and they are reinvested and retained in the company. Tax preference theory The tax preference theory revolves around the idea that retained earnings are linked with capital gains and they actually lead to long-term capital gains. Similarly, the capital gains taxes are deferred ones. Therefore, investors in such a scenario would prefer firms with low payouts. The theory assumes that there are two tax related reasons for believing the aspect that investors would prefer a low dividend payout rather than a high payout. The first reason is that until the stock is sold taxes are not paid on capital gains. The second one is that if the owner of the stock dies then the taxes of capital gain aren't due at all (Mishkin & Eakins, 2008). Which one is the best Determining the most viable theory is a difficult process because in these theories empirical methods can't evaluate which one is the most viable source. Proper judgment and decision making capability of a manger is used in setting up the policy. In depth analysis is used but these analyses must be applied with a proper judgmental approach. The distribution of the dividends is a tough ask and in most of the organizations managers literally hate giving dividends and they won't raise the amount of dividends unless they are 100% sure that the raise is sustainable (Mishkin & Eakins, 2008). However, investors on the other hand are motivated when they receive dividends and they evaluate the managements view about the future of the organization. EPS (Earnings per share) is another important factor related in the dividends and if the price of a stock increases at the time of dividend increase then it would clearly reflect the increased expectation for upcoming EPS. Investors can check the performance of a company by calculating the payout ratio. The payout ratio can be calculated by dividing the company's dividend by EPS. If the payout ratio is more than one then an investor can evaluate that the company has paid out more dividends in a year. Thus, a dividend policy would be framed for the shareholders in a way that it would set a target capital structure and it would estimate the annual equity needs of the company. Share repurchases Public limited companies have to option to buy back their shares from the market this phenomenon is known as share repurchasing. The numbers of outstanding shares are reduced because of this activity. Organizations implement this strategy when they believe that their shares are unvalued. This activity reduces the number of shares available in the market that's why the EPS of the company increases (Madura, 2008). The remaining market value of the shares experiences a boost in their prices. However, certain other aspects of share repurchases are given below: Advantages of share repurchase The advantages of repurchasing your own shares are wide and varied. However, they differ from organization to organization but the most obvious ones are listed below: Organizations believe that it's an alternative way for distributing cash as dividends. They want to dispose of one-time cash from the sale of an asset. Organization want a large change related to capital structure. The element of setting high dividend can be avoided because the shares are purchased back. Shares that are repurchases can be used in take-over or this stock can be resold back to raise the cash that's needed (Madura, 2008). Capital gains of the company increases and the income received from selling the shares are treated as capital gains. Shares of the company are repurchased when the management believes that they are undervalued. This would give a positive signal to the stockholders as they can evaluate that the management agrees that their shares are undervalued. Disadvantages of share repurchase Besides certain advantages there are certain disadvantages of share repurchases. These disadvantages are discussed below: It can be simple viewed as a negative aspect for the organization because organization is buying back its own shares therefore shareholders might believe that the firm has poor investment opportunities that's why they are buying back their own shares. Authorities might impose penalties on the organization for buying back the shares just to avoid taxes on the dividends. Stockholders that are selling in the market might not be informed in a proper manner and they would be treated unfairly by the company. In order to buy back their own shares from the market they have to bid up a price and that price is usually high as compared to the previous price. In other words company has to buy back their own shares at a higher price (Madura, 2008). Conclusion Thus, in a nutshell we can say that distribution of the dividends to the shareholders is an extremely important issue for public limited companies. Organizations must evaluate viable options for the distribution of dividends. The overall strategy of the company and the objectives of the company must be kept in mind when dividends are distributed. Moreover, organizations must remember that dividends would encourage the shareholders to invest more in the company. Therefore, depending on the company performance and the financials of the company they would decide whether to give cash, property or a stock dividend. All the taxes and legalities must be kept in mind when the dividends are distributed. Similarly, buying your own shares back from the market is a complex phenomenon and organizations must carefully implement this strategy. In all the circumstances organizations must not impart negative behavior towards the shareholders because it is the shareholders that buy and purchase the shares of the company and motivating them and giving them dividends would motivate them to invest more in the company. References Madura, J. (2008). Financial Markets and Institutions. South-Western College Pub. Mishkin, F., & Eakins, S. (2008). Financial Markets and Institutions. Addison Wesley. Read More