Applied Game Theory or How to pay a dividend without paying a dividend
meissereconomics.com
meissereconomics.com
It's important to remember that the company's shares are traded on a public market.
The shares distributed by the company are valuable and can be sold for the same amount of money as the dividend you could have received.
The key fact that the article ignores is that the shareholders collectively own the company. So if they all decline the dividend, they are effectively electing for the company they own to hold the cash (that they own by owning the company).
1. Everyone takes cash and you get the expected share price
2. Everyone takes shares and the value expected is halved
Still the dynamics of both are different and usually depreciation of the dividends is factored out on the price of the stock. I wonder if they are pricing the stock just before dividend and if that's fair.
If the company is hoarding cash, distributing dividends usually increases the stock price, since cash value is not included in the stock price. This is actually very important to understand, cash DOES NOT change a company's valuation (there are some exceptions and edge cases).
And corporate cash is usually invested in low-risk, liquid securities, which return far less than the average cost of capital for the company.
In other words, shareholders will be happier with the cash in their hands than in the company's bank account.
How much money do you need to buy this company?
The answer is zero.
You borrow 1B.
Buy the company.
Use the cash to pay back the debt.
Cash has no influence (with exceptions and edge cases) on a company's enterprise value.
Your broken logic could be applied to literally anything.
> Imagine company A, which has no significant cash, only a $1B tire manufacturing business.
> How much money do you need to buy this company?
> The answer is zero.
> You borrow 1B.
> Buy the company.
> Sell the time manufacturing business to pay back the debt.
> Manufacturing capacity has no influence (with exceptions and edge cases) on a company's enterprise value.
Or how about this?
> Imagine a used Honda Civic, which is a car that costs $10k.
> How much money do you need to buy this car?
> The answer is zero.
> You borrow $10k.
> Buy the car.
> Sell the car in parts on eBay to pay back the debt.
> Car parts have no influence (with exceptions and edge cases) on a car's value.
The fact that you can take out a loan to buy something, and turn around and liquidate the parts of that thing to pay back the loan does not mean the thing has no value.
Buying a Honda Civic is buying an asset which has intrinsic value, and can be used to generate value beyond the $ price.
Buying cash gives you no additional value.
So trust me, the amount of cash does not change Enterprise Value.
If you don't believe me, read any valuation materials, such as Damodaran's.
If you want to argue that there is no value in taking over a company for its cash, sure. If you want to argue that the market sees no value in cash, no.
Now, let us say the business issues a special Dividend of $10B. Can we all agree that a rational investor, on the ex-date, would now only spend $1B on this company, instead of $11B?
Maybe what you are suggesting is that a company with no history of issuing dividends, that starts to issue dividends, will see an increase in the stock price?
Exactly!
What might be confusing is that one dollar of cash at a company doesn't neatly translate into one dollar of value in the stock price. At a poorly run company with a history of bad acquisitions $1 of cash might be worth 50 cents because investors think that the company will waste the money rather than give it back as dividends. But a growing company might borrow money and have the stock price go up, if investors think it will be invested well.
Under certain conditions, the same is valid for debt. Capital structure of a company (under certain conditions) has no impact on the value of the company.
This is the Modigliani-Miller theorem, it got Modigliani (but sadly, not Miller) a nobel prize.
Fine print: there are a bunch of conditions in the case of debt, due to tax, and so on.
That's wrong. As you say later, the Enterprise Value (= Market Cap - Cash + Debt) doesn't change when the company accumulates cash. But the Market Cap increases. Otherwise, how do you balance the equation to keep the Enterprise Value unchanged?
Go look at a MSFT, PG or any other stocks that pay regular dividends on Google Finance. You'll see their stock is obviously not influenced by the value of the dividend payment at all. It's impossible to tell when dividends are distributed by looking at the stock price change alone.
If what I was saying was false, then the ex-date of the dividend should always close at a lower price than the previous day. However, it's a coin flip as to whether or not the ex date stock price closes above or below the previous day. This suggests that regular dividends are factored into the price of a stock.
You're trying to claim that the ex-date of the stock should close at $previous_close - $dividend every time. But that doesn't happen. When reality and theory disagree, trust reality.
For most companies the dividend distribution is less than average daily variance of stock prices. Which is why your strategy won't necessarily yield great results. A 3% yield distributed four times a year is only 0.75% of the stock value.
The SEC also has special rules for extremely large dividends so that the ex-date is after the distribution date.
Yes - it's true that if you are just looking at a stock chart, it might be hard to eyeball the date of the dividend if there is a lot of volatility, but, presuming that volatility is evenly distributed over various stocks dividend dates, there is no way to avoid having the stock drop down by the value of the dividend. I guarantee you there is a pretty large number of investment bankers who have all sorts of models that arbitrage that kind of variance, pretty much eliminating any gap, should it exist for more than a few seconds after opening.
I don't understand how the ex-date could occur after the distribution date. The whole idea behind the ex-date, is that is the date on which the dividend belongs to the seller, not the buyer. I.E. If I buy the stock on (or after) the ex-date, I do not get the dividend, it belongs to the seller. Depending on the exchange, it's usually two business days prior to the date of record set by the board of directors. (At least on the SGX, the exchange I'm familiar with). So how could you place the ex-date after the distribution date? What would the date of record be in that case?
Here is my favorite resource on this topic - http://www.spdrs.com.sg/education/files/SPDRU%20Dividend%20D...
library(quantmod)
getSymbols(c("MSFT","PG","SPY"))
msft.ex=index(quantmod::getDividends("MSFT")["2007::"])
pg.ex=index(quantmod::getDividends("PG")["2007::"])
msft.rets=as.data.frame(merge(dailyReturn(MSFT$MSFT.Close)[msft.ex],dailyReturn(SPY$SPY.Close)[msft.ex]))
colnames(msft.rets)=c("MSFT","SPY")
msft.fit=lm(MSFT~SPY,msft.rets)
summary(msft.fit)
confint(msft.fit)
pg.rets=as.data.frame(merge(dailyReturn(PG$PG.Close)[pg.ex],dailyReturn(SPY$SPY.Close)[pg.ex]))
colnames(pg.rets)=c("PG","SPY")
pg.fit=lm(PG~SPY,pg.rets)
summary(pg.fit)
confint(pg.fit)
par(mfrow=c(1,2))
plot(msft.rets$SPY,msft.rets$MSFT,xlim=c(-0.08,0.08),ylim=c(-0.08,0.08))
abline(msft.fit,col="red")
grid()
plot(pg.rets$SPY,pg.rets$PG,xlim=c(-0.08,0.08),ylim=c(-0.08,0.08))
abline(pg.fit,col="red")
grid()Maybe this helps: http://r4ds.had.co.nz But note it's a blind recommendation, I didn't know about this particular book before.
I found a long list of books here: http://blog.revolutionanalytics.com/2015/11/r-recommended-re...
A simple thought experiment should make it clear why that is - Let's say a $100 stock has a $2 dividend, if the stock didn't drop by the amount of the dividend on the ex-dividend date, then I could simply purchase the stock, be the owner of record on the ex-dividend date, receive the dividend, and then just sell the stock immediately. I get a 2% return for holding the stock for a week or less. Clearly that doesn't happen.
This theory holds up in terms of maximizing returns, though not in a cash crunch.
The one thing I would add is that taxes complicate the calculation if dividends are taxed differently than capital gains.
The other thing that they can do is use the cash for stock buybacks. And it's all (theoretically) equivalent: the company and its cash pile are worth the same amount of money either way.
Of course, questions arise in practice like tax treatment, and the fact that people who own businesses in practice don't want to own as much cash - that's what bank accounts are for, no need to glue them together - or whether companies systematically overpay for stock buybacks because they do it while the company feels prosperous as opposed to times when the stock is affordable.
This is so misleading.
When the company in not giving $10 of dividend, the whole company has $10 more on its bank account, so it's worth $10 more overall, distributed across all shares. Now if one share (worth $10 at current valuation) is created, all the shares are back to their original value, and if that share is given to a shareholder, he is effectively owning $10 worth more of the company than before. He didn't get less. And if everyone does it (or everyone but one shareholder, or any other combination) everything is still valid.
Your example cannot work because a company worth $100, cannot create new shares worth $100 ($50 per share). (It could theoretically distribute a cash dividend of $50 per share, but then the value of the outstanding shares would be $0).
If it were to distribute say 50% per share. Then it would create two new shares (in addition to the existing two). This would mean the new value per share would be $25.
So investor A has one share worth $25 and a cash dividend of $25 (he owns 1/4 of the company) Investor B has one share worth $25 and one (dividend) share worth $25 (in total 1/2 of the company).
Also depending on how the company operates, there is another element of game theory because the controlling shareholder could elect to cancel all future dividends. if you're the newly minted majority shareholder, it's probably in your favor to do this immediately. In that case, the Nash equilibrium seems to be both parties choosing the stock dividend (and effectively getting nothing).
While the 2 shareholder example is an oversimplification in this example, after enough plays of the game (i.e. dividends) a large shareholder could take control of the company if the other shareholders always choose cash.
For a cash dividend that's not true. Something real happens: the company has less cash afterwards (and the shareholder more).
There's a school of thought that says that the value of share should be the discounted sum of all future _cash_ dividends. According to it a company that only does share dividends should be worth nothing.
Koninklijke Boskalis Westminster lets its shareholders choose whether they want to receive their yearly dividend in cash or in the form of newly created shares, creating a paradox in which everyone gets less by choosing more.
This is not necessarily true. It depends on the current and future value of the company. If you get a cash dividend now and the value of the company rises in a month, then you've lost out on that upward movement.
A stock split leaves shareholders with exactly the same share of the company they had before, it's just divided into smaller increments. It also leaves the company's balance sheet exactly the same.
What's actually equivalent to a cash dividend is a stock buyback. That gives each shareholder a larger portion of the company, and removes cash from the balance sheet.
Companies will often do stock buybacks in place of cash dividends. They never do stock splits in place of cash dividends, because splits have no effect on shareholders' wealth.
If a company awards new shares to one specific person, that's different. And you're right, it has the same effect on all the other shareholders as if the company paid that person cash. That person gets more and it comes out of everybody else's pocket. But when everybody gets new shares it's just a split.
They are not equivalent, no. That's what I was trying to emphasize with the difference in choice available to the investor.
> They never do stock splits in place of cash dividends, because splits have no effect on shareholders' wealth.
Neither do cash dividends. You own $100 of a company worth $1000. The company issues a 5% dividend. The company is now worth $950. You now own $95 of the company and got a $5 dividend. Wealth unimpacted (disregarding tax and future changes in the company's valuation of course).
1. Not if you use the cash dividend to buy more shares.
2. The same thing would happen if you sold the "dividend" shares as soon as you received them.
That is so very wrong. While the overall picture seems the same, the tangible difference is in what each investor actually has at the end of each transaction:
Option 1: Dividends as cash, which means cash leaving the company. Money is transferred from one entity (the company) to another (a group of shareholders). While shareholders are regarded as owners of the company, the nature of their ownership doesn't always work quite the same as say ownership of one's personal effects. Being a shareholder mostly means having certain rights regarding how one gets part of the company's profits and the right to vote on how the company is controlled. Payout of dividends means an immediate reduction of capital for the company, and an increase of income to the shareholders. So at the end the shareholders have the same number of shares and a certain amount of cash. The market value of their shares may drop at first as a reflection of the dividend payments (because technically the company's book value does drop immediately). But let's be honest here, the whole point of shares is the profit potential, so the pricing of shares needn't be in strict alignment with the book value.
Option 2: Dividends as new shares means the company holds on to capital. At the end, shareholders get more shares, which may suit them just fine if they're not in any situation that compels them to liquidate. Extra shares means having more to sell. Let's not hyper-focus on book value, since a share price needn't be constrained by that. If there's a good chance that the price per share will rise over time, then getting shares may be more profitable to an investor than getting immediate cash.
As the old adage goes, you pays your money you takes your choice. Also, it takes money to make money. But let's not get too hung-up on book value vs. share price, or on whether money truly is a "store of value". There's an awful lot of human desires and human efforts at play here, and in the end it's that interplay of desires and efforts (i.e. what efforts must one undertake to satisfy one's own temporal desires) that brings value to anything.
Over a long period of time, Option 2 results in a company with huge cash reserves that aren't generating extra returns (see: apple). This could lead to a situation where the market value of the stock becomes much less than its intrinsic value and a hedge fund (or similar) could acquire a significant holding in the company and compel the board to accept a complete buyout at a discount. Forcing shareholders to accept 20-30% less and leaving them to sue for the difference.
Dividends are the end-game for every company. It doesn't matter if they distribute cash or buy back stock -- eventually they need to put money in the hands of investors.
I get your point, and did not mean to oversell "Option 2". But then the shareholders do get to vote on how they'd like it.
BTW, a truer example of "no dividends" is Amazon (http://www.nasdaq.com/symbol/amzn/dividend-history) - Apple does have a history of dividends (http://www.nasdaq.com/symbol/aapl/dividend-history), certainly with some regularity since 2012.
Once a company stops expanding at a double-digit pace, it makes sense for them to start paying dividends.
Do voting and non-voting shares typically receive the same amount of dividends?
The only differences I can see between cash and stock dividends is
1) For cash dividends I pay taxes now, for stock I typically pay upon the sale of said stock.*
2) A company issuing cash dividends has less liquid cash in the bank (also applies to the shareholders who get liquid cash).
*both are taxed as capital gains here, might be different tax wise in other countries which could complicate things
Stocks is not cash and needs to be liquified. Your million dollar portfolio could theoretically be worth $0 any day.
Interestingly enough this generalization is contradicted by several large US tech companies who have accumulated unprecedented cash hordes. It's interesting to think about why this might be happening.
The apartment example makes this a little more clear. Your options for extracting wealth are basically, earn a dividend or sell a portion of the holdings. Since only 100% of the company can be sold, you lose value each time you liquidate holdings and eventually you no longer have anything to sell. Dividends can continue as long as the company is earning a profit.
With large companies, the bulk of investors reinvest dividends, so it makes sense for them to have a scheme in place that just grants the shareholder more shares. However, they need to eventually buyback the stock for a stock distribution scheme to be the same as a dividend distribution scheme.
Also, this scheme leads to an exponential increase of shares, aren't there some laws against it ? It seems a bit suspiscious to me.
Complete noob in finance/market rules, don't hesitate to correct me.
If they hand out cash, that means the company is now worth $1B, and each shareholder has $100k more in cash. But their shares are now only worth $1k each, instead of the $1.1k they were worth before. The shareholder's net worth is unchanged.
If they hand out shares, there are now 1.1M shares in the company, and each is worth $1k, the same value per share as with the cash dividend. Each shareholder has an extra 100 shares, and their net worth is still unchanged from before the dividend.
So the key thing is that if they paid the dividend in cash, the overall net worth of the company goes down -- so everything balances out between shares and cash.
Of course, for a publicly-traded company the value of the stock doesn't necessarily match the current net worth of the company, and the share price fluctuates. So you'll need to work out for yourself whether you'd prefer to have the stock (with the capital gains liability) or the dividend (with its tax liability), possibly based on how long you intend to hold the stock.
So this would lead to an exponential growth to the number of shares? It really looks like a geometric progression. And, at the end, a huge amount of shares, each worth nothing.
Also, the company can buy-back shares to keep the number in circulation lower and to increase the stock price, or it can consolidate its shares by merging them, so each shareholder receives one new share for each two old shares.
Lastly, if you're looking at stock charts, the data provider will usually adjust historical values to take into account dividends and splits, giving you an accurate view of what the price would have looked like if the number of shares issued had never changed.
Stock buybacks are effectively same as dividends. If company buys stocks from the market , it increases the value for the shareholders.