Dividend Payout and Firm Performance

The assignment delves into the relationship between dividend payout policies and a firm's financial performance. Students are expected to critically analyze various academic papers and research studies on this topic, drawing insights from their findings to understand how dividend distribution strategies impact a company's overall success.

Running head: FUNDAMENTALS OF CORPORATE FINANCE
Fundamentals of corporate finance
Name of the student
Name of the university
Author note

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Table of Contents
Question 1..................................................................................................................................2
a. Difference among residual payout policy and managed payout policy..........................2
b. Findings of Lintern published during 1956 with regard to dividend policy...................3
c. Academics meaning while it says companies cater to particular “payout clientele”......3
Question 2..................................................................................................................................3
a. Main issues while making the initial public offering (IPO)............................................3
b. Main issues while considering whether to take the company private.............................5
Question 3..................................................................................................................................5
a. Description of repurchase method..................................................................................5
b. Analysis of the statement – Payout policy cannot affect firm value...............................6
c. Difference between ex-dividend and cum-dividend stocks............................................6
Question 4..................................................................................................................................7
a. IPO is costly undertaking and thus IPO conducting shall be avoided............................7
b. Firms going private and funding of public-to-private transaction..................................7
c. Valuation of companies by financial analysts.................................................................9
Answer 6....................................................................................................................................9
a. Dividend payout policies.................................................................................................9
b. Possible link between payout policy.............................................................................10
b. Main findings of the Lintner’s 1956 study on dividend policy of the US corporations
10
c. Long-run underperformance of IPOs............................................................................11
Reference..................................................................................................................................13

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Question 1
a. Difference among residual payout policy and managed payout policy
Residual policy – the residual dividend policy is used by the management of any company
for funding the capital expenditures with the available earnings before the payment of
dividend to the shareholders and the policy generates more volatility with respect to the dollar
amount of the dividends that is paid to the investors in each year (Farre-Mensa, Michaely and
Schmalz 2014). The main objective is to use the earnings to the capital expenditure with
regard to the cash flows and the dividends are paid with the remaining earnings created by the
company, if any.
Example – suppose the earning of the company is $ 1,000 and has the debt/equity ratio of 0.5.
Now if the company requires $ 900, for maintaining the debt/equity ratio, the company will
require paying $ 300 through debt and $ 600 through equity. Therefore, the amount of ($
1000 - $ 600) will be left for payment of dividend. Therefore, if the company requires the
equity for any project that is more than the available levels with the company, the company
will have to issue new stock.
Managed policy – managed dividend distribution policy is the commitment of the issuer to
make the fixed periodic payment of dividend. It states that the investors have the option to
buy the shares of any security along with the confidence that the investor will receive the
reliable distribution rather than the constant changes in payment (Kanwal and Hameed 2017).
Example – the company can choose to pay a fixed rate of dividend like $ 1 per share
irrespective of the profit level. Suppose the company earned huge profits during the quarter,
the shareholders may still get dividend at the rate of $ 1 per share. In the same way when the
profits will be low, then also the shareholders will get the dividend at the same rate.

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b. Findings of Lintern published during 1956 with regard to dividend policy
The behavioural models for the dividend policy supposes that changes in the dividend
policy can be stated by last period’s dividend and target dividend that can be expressed as
fraction of the period’s earning. Lintner John (1956) conducted and surveyed the interview of
the CFO of the firms in USA and recommended that past year dividend and current earnings
are related with the behaviour of dividend payment (Andres et al. 2015).
Dividend policy chosen by a firm determines the profitability of the dividend
payments for the investors and the stability of their income. However, in practice, the Us
companies use the residual policies for payment of dividend.
c. Academics meaning while it says companies cater to particular “payout
clientele”
The effect of clientele states that the investors will hold the stocks whose policy for
dividend is most preferable. It means to say, the investors prefer specific dividends over the
unknown earnings of the future or others will prefer to have the current income rather the
capital gains (Murphy and Thirumalai 2016). Therefore, the particular dividend policy will
encourage particular clientele to the stock. Therefore, while the academic say that the
companies cater to the particular clientele for payout, it means that the companies will apply
the dividend policy that will be more stable with respect to the effect of clientele.
Question 2
a. Main issues while making the initial public offering (IPO)
Going public means the entrepreneur sells the ownership of her or his company under
the public market like stock exchange. Selling of the shares under the IPO is the elaborate

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procedure that takes into consideration months of planning. After selling the shares by the
entrepreneur, they do not work for themselves rather they works towards the shareholders
(Hahn, Ligon and Rhodes 2013). Further, going public is not always right strategy for the
Small Medium Enterprises (SMEs) or the middle sized companies. However, when the
entrepreneur decides to go public as the right strategy the following issues shall be taken into
consideration –
 There shall be strong network for the major shareholders of company. These involve
the industry allies, loyal customers and community. The pools of the institutions and
individuals are most potential shareholder of the company.
 The company shall have excellent team for management that will boost the
confidence. Further, the managers shall have remarkable track record with regard to
the strategic management particularly the financial management, exceptional
marketing strategies and the expertise with regard to operation management.
 Entrepreneur shall protect the services and goods of the company with regard to the
patents and trademarks (Brooks 2015).
 The entrepreneur shall standardize the key business procedure. For instance,
implementing the sole structure for price that will be applicable to all the suppliers
and customers.
 The entrepreneur shall have well created structure for the employment rather than
banking on the independent contractors.
 Finally, if entrepreneur makes cut, she or he shall select the underwriter who will
assist the entrepreneur for finding initial buyers for shares. It is essential to note that
the creation of the new market, development of the product and the all round
developments are considerable in the grooming period of IPO.

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b. Main issues while considering whether to take the company private
Recent incidents like precipitous crashing of stock market, the euphoria related to
going public is replaced by the delisting act. Various US companies those were delisting were
counted to 188 during 2004. However, before going to private some issues shall be taken into
consideration.
Going private has the chance of buying time for the company as it avoids public
display of the event of collapse. However, the CEOs shall know the fact that going private
needs sufficient money for buying out the current shareholders. This is very expensive
proposition even under the depressed market (Grinblatt and Titman 2016). Further, the CEOs
shall know the fact that going to private reduces the confidence of the investors in the same
way as it saves the cost and the company is not required to comply with the Sarbanes - Oxley
act. Moreover, the companies that are not experiencing any organic growth shall go private.
Question 3
a. Description of repurchase method
(i) Open market repurchase – it is another term of buyback. The buyback of stock
that is also known as the share repurchase is the process of buying back the
company’s own shares from the open market. Buyback can be treated as the
company is using its fund or investing in itself for buying own shares (Pham et al.
2014).
(ii) Fixed – price self – tender offers – this is one time offer by any company looking
for acquiring any other company that involves desire for purchasing certain shares
at the fixed price. However, the fixed price is generally set at the premium that is
above the present price in the market.

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(iii) Dutch-auction self-tender offers – it operates like auction and the company offers
for repurchasing particular number of shares within the given range for price. Te
shareholders are invited for tendering shares over the period of 35 calendar day
and they do this through specifying lowest price within the acceptable range
(Huang, Su and Wang 2015).
b. Analysis of the statement – Payout policy cannot affect firm value
In US and various other jurisdictions, the retained earnings are subject to the dividend
taxes on the distribution, however, the contributed equity may be returned to the shareholders
that will be free from the taxation. Thus, the variations are exploited in relative proportions
for contributed capital and retained earnings for examining direct prediction that the retained
earnings are valued at the lower amount as compared to the dollar-for-dollar with respect to
the firm value (Bodie, Kane and Marcus 2014). It is also examined that the prediction
regarding the low predicted valuation for the retained earnings reduces the required return of
the shareholders on the equity component which in turn increase the reported earnings
valuation. Therefore, with regard to the differences among the taxes on capital gain and taxes
on dividends, it can be stated that the payout policy cannot affect the value of the firm.
c. Difference between ex-dividend and cum-dividend stocks
Cum dividend is a situation where the company prepares for paying out the dividend
in near future. It is like a notice to the investors and the company will announce the amount
of dividend that is to be paid out. However, if the shareholders sell the stock on cum-
dividend, she or he will not be entitled to dividend.
A date of cut-off shall be there that the company must set on which or after which
they may confirm the shareholder’s list for receiving the dividend. Once that list gets
finalized, then the stocks are called as to go for SD (ex-dividend). Once the XD status

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declared, the sellers of the shares will be still entitled to the dividends and the new owner will
not be entitled (Daunfeldt, Selander and Wikström 2015).
Once the company prepares the list of the recipient for dividend and the list gets
finalized, the stocks go for ex-dividend.
Question 4
a. IPO is costly undertaking and thus IPO conducting shall be avoided
Though the IPO has various advantages, owing to various advantages, conducting
IPO shall be avoided and it requires careful consideration for the downsides that can be
associated with the public company undertaking IPO. These are –
 Associated cost – conducting IPO itself as well as the outgoing costs associated with
that is at higher level. These costs includes the costs related to management and
company board teams main training, listing fees, costs associated with ongoing
obligation for reporting, cost of auditors, cost for general compliances and the cost of
legal advisors (Bessembinder, Hao and Zheng 2015).
 Loss of the control by the existing owner – the accommodation of potential divergent
interests of the other shareholders, complying with the new regulations and rules,
meeting the transparency requirements and susceptible to the market conditions that
includes disclosures related to beneficial shareholders and transactions related to
related party enhances the chances of losing the control by the existing owners.
 Exposures to the potential activism and scrutiny by the public shareholders.
b. Firms going private and funding of public-to-private transaction
Going private is the transaction or the series of transaction that converts the publicly
traded company to private company. Once the company becomes private, the shareholders of

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the company will no longer be able for trading the stocks in open market. The private equity
companies will purchase the struggling company then make it a private company and
recognize the capital structure, issue the stocks once the profit is realized.
Public to private (PTP) transactions are funded by –
 Loan notes or share capital from the venture capitalist and the management team that
generally comprised of director’s targets.
 Bank debt by the third party lender that is secured over target assets and bidders.
These transactions are also known as the PTPs, P2Ps or can take the private as the
asset of the target that are taken back into the private ownership.
a. Direct and indirect cost of conducting IPO – underwriter usually charges 7% fee on
the basis of offer price. Apart from that it involves other direct costs like costs to
lawyer, printers and accountants. On the other hand, indirect cost includes the
difference between the offer price and closing price of 1st day multiplied by number of
shares (Gao, Hsu and Li 2017).
C. Long term under performance of SEOs and IPOs – Long term underperformance of
SEOs and IPOs experiences substantial deterioration in post-issue period. The issuers
generally have significantly high level of sales revenue as well as earnings as
compared to the industry peers before the year 0.
D. Motives of companies for going private – public company may goes private due to
various reasons like it can generate considerable financial gain for the CEOs and
shareholders and the reduced reporting and regulatory requirements that are faced by
the private companies can free up the money and time to focus on the long-term goals.

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c. Valuation of companies by financial analysts
Various different methods for valuation can be adopted by the financial analysts that
can be categorised into 2 separate macro-classes. These are –
 Single-period method of valuation that is the market multiplies
 Multi-period method of valuation that is the method of residual income and
discounted cash flow method.
Answer 6
a. Dividend payout policies
As per the empirical evidence, importance for the cash dividends as part of the
investor’s total returns has been reduced over the period of time. Further, the share
repurchase play an important role in the payout policy in the countries that permits stock
buyback. The well known view is that the dividend policy is crucial as per the evidence of
large amount of the money’s involvement and attention of the firms, investors and security
analysts paid to the dividends. Therefore, the firms tend to follow the managed dividend
policy and not the residual dividend policy that involves the payment on dividend based on
the earnings of the company. Certain determinants with regard to the cash dividends are
important over the time period for shaping the actual dividend policies that includes past
dividend stabilities and the anticipated and current earnings (Li, Zhuang and Shapiro 2014).
However, no universal factors are appropriate for all the firms as the dividend policy is very
sensitive to various factors that include the characteristics of firms as well as the market and
the substitute forms of the dividend. The one size or universal explanations or theories for
determining the reasons of companies paying dividends are too much simplistic.

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b. Possible link between payout policy
The payout policy includes the guidelines and rules for paying out the proportion of
the earning to the investors, managers and shareholders as dividend. The agency conflict
arises due to asymmetry of information among the management and the shareholders when
the corporate governance entails the legal mechanism through which the organizational
business are controlled and directed (Abor and Fiador 2013). The payout policy may lead to
the agency conflict as the financial commitments and interest of the agents may at times
conflict with the interest of the principle. Generally, managers of the company may prefer
earnings to be retained to meet the company’s requirements for the purpose of growth and
takes the advantages of the opportunities related to the emerging investments when most of
the owners or shareholders will prefer to receive the dividends. In case of most of the large
publicly traded corporate companies, the agency conflicts are significant as they play crucial
role with regard to the corporate decisions that includes the dividend payout. Shareholders
hire the individuals with management expertise for running corporation on behalf of them as
they lack the expertise and time for carrying out the operation of the firm and assure that the
company provides the return on the investment (Byrne and O’Connor 2017). There is usually
substantially unmitigated conflict with regard to the agency among the agent and the
principle. For example, the managers have fundamental objective for maximizing the firm’s
size through creation of rapidly growing firms.
b. Main findings of the Lintner’s 1956 study on dividend policy of the US
corporations
Lintner model is the model that states that the dividend policy has 2 parameters – (1)
payout ratio (2) speed at which the current dividend is adjusted to target. Lintner’s John
(1956) conducted and surveyed the interview of the CFO of the firms in USA and
recommended that past year dividend and current earnings are related with the behaviour of

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dividend payment. The behavioural models for the dividend policy supposes that changes in
the dividend policy can be stated by last period’s dividend and target dividend that can be
expressed as fraction of the period’s earning. Further, Lintner developed the theory on the
basis of 2 crucial things that were observed by him. These are –
 Increases in the earnings always are not sustainable. Owing to this, the dividend
policy does not change until the managers can experience that the new levels of
earnings are sustainable.
 Companies generally tend to set the target dividend to earnings ratio for long-term
period as per the positive amount of net present value projects available with them.
He also wrote the 1st quantitative model for the payout policy. He prepared the model
based on the interviews with 16 manufacturing companies and the formula was –
ΔDIVt = Constant + SOA(Target DIVt – DIVt‐1)
Where, DIVt and DIVt‐1 are payment of cash in periods t and t − 1,
ΔDIVt is expected change in dividend from date t – 1
SOA is adjustment speed.
c. Long-run underperformance of IPOs
Initial public offerings being risky; underperform indices typically for initial few
years after the offerings. As per the research in the US market, it is recognized that the IPO
underperforms in the initial period while the return is measured from start of the trading and
continues till 3 to 5 years. Likewise the underperformance in the long-run over the other
markets are also been identified (Perera and Kulendran 2016). This impact is distinguished
from well known tendency of IPO to be underpriced and therefore, undergo sharp rise in the
initial period. Further, the long-term underperformance is stated by the difference in opinion

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regarding the value of IPO that declines over the period of time. This results into stock price
decline as compared to the fair price. However, this impact is augmented by large difference
in the opinion that raise price and lower the return rate itself. The extent of long-run
underperformance is estimated by different variables that act as the surrogates for divergence
in the opinion. It is strongest for firms with short histories of operating, low capitalization,
low sales, underwritten by the underwriters with low prestige, very volatile and firms that is
avoided by the institutional buyers (Shimizu and Takei 2016).

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Reference
Abor, J. and Fiador, V., 2013. Corporate Governance and Dividend Payout Policy: Evidence
from Selected African Countries.
Andres, C., Doumet, M., Fernau, E. and Theissen, E., 2015. The Lintner model revisited:
Dividends versus total payouts. Journal of Banking & Finance, 55, pp.56-69.
Bessembinder, H., Hao, J. and Zheng, K., 2015. Market making contracts, firm value, and the
IPO decision. The Journal of Finance, 70(5), pp.1997-2028.
Bodie, Z., Kane, A. and Marcus, A.J., 2014. Investments, 10e. McGraw-Hill Education.
Brooks, R., 2015. Financial management: core concepts. Pearson.
Byrne, J. and O’Connor, T., 2017. Creditor rights, culture and dividend payout
policy. Journal of Multinational Financial Management, 39, pp.60-77.
Daunfeldt, S.O., Selander, C. and Wikström, M., 2015. Taxation, dividend payments and ex-
day price-changes.
Farre-Mensa, J., Michaely, R. and Schmalz, M., 2014. Payout policy. Annu. Rev. Financ.
Econ., 6(1), pp.75-134.
Gao, H., Hsu, P.H. and Li, K., 2017. Innovation strategy of private firms. Journal of
Financial and Quantitative Analysis.
Grinblatt, M. and Titman, S., 2016. Financial markets & corporate strategy.
Hahn, T., Ligon, J.A. and Rhodes, H., 2013. Liquidity and initial public offering
underpricing. Journal of Banking & Finance, 37(12), pp.4973-4988.

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Huang, H.C., Su, Y.C. and Wang, H.Y., 2015. Market Efficiency around the Announcement
Day of Self-Tender Offers. The International Journal of Business and Finance
Research, 9(1), pp.121-128.
Kanwal, M. and Hameed, S., 2017. The Relationship between Dividend Payout And Firm
Financial Performance. Research in Business and Management, 4(1), pp.5-13.
Li, S., Zhuang, A. and Shapiro, D., 2014. Dividend Payout Policy and Institutional Investors
Ownership: Theory and Empirical Evidence. Working Paper, Belk College of Business.
Murphy, D. and Thirumalai, R.S., 2016. Retail Clientele and Dividend Policy.
Perera, W. and Kulendran, N., 2016. Why Dose underperformance of IPOs in the long-run
become debatable? A theoretical review.
Pham, V.H., Balachandran, B., Henry, D. and Nguyen, L.H., 2014. Open Market Repurchase
Program, Dividend Payment Status, Information Asymmetry, and Institutional Ownership.
Shimizu, Y. and Takei, H., 2016. Examining the Existence of Long-run Initial Public
Offering (IPO) Underperformance at Three Different Stock Exchange Markets in
Japan. Business Management and Strategy, 7(2), pp.190-206.