intermediate managerial finance discussion

Discussion

What typically happens to a firm’s value when it increases its dividend? What would you expect to happen for a high-tech firm such as Microsoft?

How do the high amounts of executive stock options often granted by high-tech firms complicate the dividend policy decision for these firms?

Student reply1

The economic benefits of the lower dividend tax rates will increase over time. When a company starts paying more dividend stock price of the company decreases. This is would be because when the payout ratio is high then growth rate on dividend payments become lower and therefore the stock price decreases with increases in the dividend payment. Even for a high tech firm like Microsoft, increasing its dividend payout will help increase the market stability of the company. Subsequently, it will also increase its market capitalization, shareholder base, and owing to an additional infusion of capital being expected. With the increased confidence of the shareholder due to the changed payout. A higher dividend would result in a higher market value and a better share price for a company such as Microsoft.

Student reply 2

When a firm increases its dividends, the value of the firm increases. Increasing dividends is a way to show how profitable the company is performing, and also a way to encourage additional investment from the firms shareholders by instilling them with confidence that the firm is performing well. For a high tech firm such as Microsoft, increasing dividends can help stabilize the firm. Because companies such as Microsoft have large sums of cash, a tax reduction towards dividends will help increase the company’s profitability and it can also lead to more investors wanting to buy shares of Microsoft stock. The high amount of executive stock options can complicate the dividend process because executive stock options can make it hard for the executives to make their decisions. Pay-to-performance incentive options can create problems because executives will try and increase the market values of their companies in order to increase their personal profits. Stock price performance can also affect the value of current and future stock prices. Executives will struggle to decide whether or not to increase the firms dividends because they will have many options to choose from and they will often choose the option that benefits them in the short-run instead of the company in the long-run.

Student reply 3

Typically when dividends increase the future projections for the company are viewed positively, this can create an influx in investment cash/capital. I would expect that to hold true with a company as large as Microsoft. When dividends are paid out the underlying stock price usually falls to account for the dividend payout but this can certainly be offset by the infusion of new investors interested to jump on board (or increasing their interest in the company if they are already investors) due to the increased dividends. The tax rates on dividends can play a factor in tempering or increasing the expectations that increased dividends can play in the market sector.

Companies with extensive stock options provided to executives can complicate dividend policy decisions for those firms. Stock values often fluctuate with the issuance of dividends (as the companies value depreciates by the dividend payout amount) in the short-run. This can create temptations for executives to try to exercise options while at a lower value, or sell while high, or try to restrict or expand dividend policy in an attempt to manipulate stock price while not being as focused on sustaining long-term growth.

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