Genron's Dividend Policy: Share Repurchase vs. High Dividend, Study notes of Economics

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Share price today:.

• By not paying a dividend today and repurchasing shares instead, Genron is able to raise its dividends per share in the future.

In perfect capital markets, an open market share repurchase has no effect on the stock price, and the stock price is the same as the cum-dividend price if a dividend were paid instead.

In the case of a share repurchase, by selling shares an investor can create a homemade dividend.

In perfect capital markets, investors are indifferent between the firm distributing funds via dividends or share repurchases. By reinvesting dividends or selling shares, they can replicate either payout method on their own.

Alternative Policy 3: High Dividend (Equity Issue)

Let’s look at a third possibility for Genron. Suppose the board wishes to pay an even larger dividend than $2 per share right now. Genron plans to pay $48 million in dividends starting next year. Suppose the firm wants to start paying that amount today. Genron needs an additional $28 million to pay the larger dividend now.

• (^) Raise $28 million by selling $28 million / $42 per share = 0.67 million shares
• Raises total number of shares outstanding to 10.67 million
• Amount of dividend per share each year will be
• Cum dividend share price:
• (^) initial share value is unchanged by this policy, and increasing dividend has no benefit to shareholders.

Modigliani-Miller and Dividend Policy Irrelevance Table 17.1 shows an important trade-off: If Genron pays a higher current dividend per share, it will pay lower future dividends per share. Regardless of the amount of cash the firm has on hand, it can pay a smaller dividend or a larger dividend. Because buying or selling shares is a zero-NPV transaction, such transactions have no effect on the initial share price. Furthermore, shareholders can create a homemade dividend of any size by buying or selling shares themselves. MM Dividend Irrelevance: In perfect capital markets, holding fixed the investment policy of a firm, the firm’s choice of dividend policy is irrelevant and does not affect the initial share price.