Dividend policy - Four Decisions Case Solution
Introduction
Dividend policy is associated with corporate finance concerns that provide the smallest amount of guidelines to the managers when they are seeking a concrete policy on which to base their dividend decisions. Various proposed frameworks of dividend policy are conceivable when they are considered individually but are vague and inconsistent when considered together.
In this case study the four decisions taken by certain renowned organizations (Microsoft, Berkshire Hathaway, Exxon Mobil, and Wynn Resorts) regarding dividends are evaluated and examined and an opinion on what would be the best dividend decision that should be considered is set.
Problem Statement
One of the key decisions for the firms to make occasionally is whether to share a portion of their earnings and how large the proportion should be if it would consider sharing. The existing theories failed to provide concrete guidelines related to the topic. The four decisions need to be evaluated to reach the significant variables for this thoughtful decision to be made by the managers.
Situational Analysis
Evaluating Dividend Policies
Dividend decisions are mainly a part of the organization’s policy that is used to construct its dividend disbursements to its shareholders. Rendering to some examiners the dividend policy is unrelated in concept as investors can trade a percentage of their shares when they need funds. The irrelevance theory suggests that dividend payouts have only a slight effect on a stock’s price. The different dividend policies are discussed below.
High Payouts
One plausible argument for high payouts is the bird-in-hand argument, which suggests that investors prefer a certain dollar in their pocket rather than an uncertain capital gain in the future. Additionally, excess cash not returned to shareholders may lead managers to build empires that ultimately destroy shareholder value.
Low Payouts
However, low payouts may also be desirable, as capital gains are often taxed at a lower rate than income, and paying dividends may be an inefficient way to distribute profits. Managers may make shareholders better off by using the company’s earnings to repurchase shares instead of paying dividends.
Arguments on the Irrelevancy of Dividend Policy
Franco Modigliani and Merton Miller have argued that dividend policy is irrelevant since shareholders can undo any undesirable dividend policy by buying and selling shares in the company, creating their desired stream of income.
Important Variables in Dividend Policy
The evidence on dividend policy highlights the importance of four variables: dividend smoothing, signals, clientele, and growth opportunities. Dividend smoothing involves determining the amount to be paid based not just on the current period’s earnings but also on dividends paid in the past. The signaling effect of different dividend policies is also crucial, as an increase in payout may signal higher earnings down the road.
Investors may migrate to companies that have a dividend policy that suits their needs, grouping them into clientele. Finally, growth opportunities may influence a company’s dividend policy, as companies with prospects of investing in new sectors or countries may prefer to retain cash to take advantage of those opportunities.
In conclusion, the decision of whether to distribute earnings to shareholders as dividends is complex and managers must consider several variables when making this decision. While the financial theory does not provide clear guidance, evidence suggests that dividend smoothing, signals, clientele, and growth opportunities are all crucial factors that managers should consider.
The Four Decisions
Berkshire Hathaway
In the early days of August 2020, Warren Buffett and Marc Hamburg (CFO) were waiting for Charlie Monger, Vice Chairman of the Board, to join them on a Zoom call to discuss Berkshire Hathaway’s (second-quarter) results. The company’s dividend policy was not on the agenda, as Buffett has notably denied using Berkshire’s cash to pay dividends.
However, the company rewards shareholders by repurchasing its shares when the price is below its inherent value, predictably determined by Buffett and Monger. Berkshire spent over $1.3 billion in 2018, over $5 billion in 2019, and nearly $6.7 billion in the first two quarters of 2020 repurchasing its shares.
The company was in a strong financial position, with profits increasing by 87% from just over $14 billion in the second quarter of 2019 to over $26 billion in the same quarter of 2020. The company had nearly $143 billion in cash and short-term securities, which Buffett calls his (elephant gun) denoting the capital he can swiftly organize on a major acquisition.
However, Berkshire had not made a major acquisition in some time, and the last acquisition, modest for Berkshire standards, had been Dominion Energy, in July 2020, for $9.7 billion including debt. The word dividend was not even mentioned during the half-hour Zoom meeting...............
Dividend policy – Four Decisions Case Solution
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