It says in LOS 47 f. that a cash dividend and a share repurchase of the same amount are equivalent in terms of the effect on shareholders wealth. I get that the same amount of cash is being paid out to the shareholders, but wouldn’t a shareholder be more well off being paid a cash dividend because they keep the ownership of the stock this way, with room for the price to grow, and at the same time still get the cash dividend paid to them? Or maybe I’m just not understanding the actual meaning of “shareholders wealth” here. Any ideas? Thanks.
Usually when shares are repurchased the remaining shares have values increased of the same amount as of the cash dividend paid. You can understand it in this way that when a stock dividend is announced the total wealth remains same but the individual stock’s value decrease. In the same way when shares are repurchased the individual stock’s value increases with the same effect as of paying the cash dividend (assuming tax treatment is same). Why companies opt for share repurchase is because in this way the shareholders do not ‘expect’ the companies to pay the dividend in upcoming years. Especially in US if a company pays a dividend it becomes a kind of a norm and shareholders and other people tracking the company start to expect. If expectations fall the result is evident in the price of the stock in the market. That’s why companies opt for stock repurchase.
Just found this thread and can’t quite agree with Mohammad. I can be wrong but AFAIR if shares are bought back at a market price, M&M hypothesis holds and no tax are assumed, there is NO impact on the share price. If there are corporate income taxes we have a slight increase in the price of shares due to decreased WACC (our equity decreased). The price can even decrease if the repurchase was at the price higher than the market. However the increase in shareholders wealth does not come from other shares appreciating. The former shareholders just get cash for their shares and can invest it wherever they want. In other words, if the share is properly valued by the market, there is no diference for the investor whether to hold a share for perpetuity and enjoy dividends, or sell it for the market price getting cash immidiately. Actual cash distributions (through dividends or repurchases) does not change any shareholders wealth. I mean before the ex-dividend date the share price is e.g. $80. After $2 dividend payment the price becomes $78. So the total wealth does not change. The wealth (share price) can be changed through dissemination of the new information, not the actual cash distribution. For the exam I beleive we should assume that share price does not change through repurchase. However I should better check this in the textbook.
I think i forgot to mention one thing… Paying the dividend and repurchasing the shares of the same amount have similar impacts only if tax treatments are similar.
tarik64 Wrote: ------------------------------------------------------- > It says in LOS 47 f. that a cash dividend and a > share repurchase of the same amount are equivalent > in terms of the effect on shareholders wealth. I > get that the same amount of cash is being paid out > to the shareholders, but wouldn’t a shareholder be > more well off being paid a cash dividend because > they keep the ownership of the stock this way, > with room for the price to grow, and at the same > time still get the cash dividend paid to them? Or > maybe I’m just not understanding the actual > meaning of “shareholders wealth” here. Any ideas? > Thanks. Tarik, this shareholders wealth refers to shareholders who continue to hold on to the stock, does not include shareholders who sold stock to the company, they probably lose out. Think about the effect of dividends and repurchases on shareholder’s equity.
share dividend vs cash …barring transaction cost u can easily convert from one to another based on your forecast