Marks & Spencers Dividend Policy - Essay Example

This paper evaluates the different ways a firm pay out cash to its shareholders such as dividend payout, stock repurchase and new stock dividends as practiced by Marks & Spencer. The first step toward understanding dividend policy is to recognize that the phrase means different things to different people. A firm's decisions about dividends are often mixed up with other financing and investment decisions. Some firms pay low dividends because management is optimistic about the firm's future and wishes to retain earnings for expansion.

In this case the dividend is a by-product of the firm's capital budgeting decision. Another firm might finance capital expenditures largely by borrowing. This releases cash for dividends. In this case the firm's dividend is a by-product of the borrowing decision. There is one possible source of the firm's investment outlays and borrowing which is an issue of stock. Thus dividend policy is defined as the trade-off between retaining earnings on the one hand and paying out cash and issuing new shares on the other.

(Brealey & Myers, 2003) There are many firms that pay dividends and also issue stock from time to time. They could avoid the stock issues by paying lower dividends. Many other firms restrict dividends so that they do not have to issue shares. They could issue stock occasionally and increase the dividend. Both groups of firms are facing the dividend policy trade-off. In short, companies can hand back cash to their shareholders either by paying a dividend or by buying back their stock. (Carlson, 2001)Most companies pay a regular cash dividend each quarter, but occasionally this regular dividend is supplemented by a one-off extra or special dividend.

Dividends are not always in the form of cash. Frequently companies also declare stock dividends. Both stock dividends and splits increase the number of shares, but the company's assets, profits, and total value are unaffected. The distinction between the two is technical. A stock dividend is shown in the accounts as a transfer from retained earnings to equity capital, whereas a split is shown as a reduction in the par value of each share. (DeAngelo, DeAngelo, & Skinner, Special Dividends and the Evolution of Dividend Signaling, 2000)Many companies have automatic dividend reinvestment plans (DRIPs).

Often the new shares are issued at a 5 percent discount from the market price; the firm offers this sweetener because it saves the underwriting costs of a regular share issue. Sometimes 10 percent or more of total dividends will be reinvested under such plans. Sometimes companies not only allow shareholders to reinvest dividends but also allow them to buy additional shares at a discount. In some cases substantial amounts of money have been invested. (Scholes & Wolfson, 1989)There is an important difference in the taxation of dividends and stock repurchases.

Dividends are taxed as ordinary income, but stockholders who sell shares back to the firm pay tax only on capital gains realized in the sale. However, the Internal Revenue Service is on the lookout for companies that disguise dividends as repurchases, and it may decide that regular or proportional repurchases should be taxed as dividend payments. (Jagannathan, Stephens, & Weisbach, 2000)Stock RepurchaseThere are three main ways to repurchase stock.