Financial Strategy, Second Edition

CASE STUDY 6

Death of the Dividend?

Adrian Wood

AIMS, OBJECTIVES AND THEORETICAL SETTING

Our aim was to investigate whether or not European companies are changing the way they return cash to their shareholders. Traditionally, European firms have distributed cash via the payment of a stream of dividends. We wanted to see if that was changing and, specifically, if dividends were losing ground in favour of share repurchase programmes.

The survey didn't aim to investigate when companies distribute cash to shareholders – which should only happen if they have truly excess capital and no positive net-present-value (NPV) projects to invest in. We were only interested in the distribution technique, i.e., dividends versus share buy-backs.

Of course, classic corporate finance theory maintains that, when a company does decide to return cash to shareholders, how it does so is irrelevant (under assumptions of efficient capital markets and the absence of transaction costs). Investors are no better or worse off if the company pays a dividend or carries out a share buyback. For evidence of this, consider the following:

A company has 100 m shares, each worth E1, giving a market capitalisation of E100 m. The company also has E10 m of excess cash to give back to shareholders. The company can either pay a dividend or carry out a share buy-back:

a) If it pays the E10 m of cash as a dividend – equal to a dividend of E0.1 per share – then after the distribution has taken place, the market capitalisation ...