Dividends have several positive attributes. They are a logistically simple way to distribute excess capital, provide low-cost investor monitoring, and deliver equity returns. In many industries, dividends are an important part of total shareholder return. Once the current and future capital position has been determined, we propose a holistic approach to determine the level and mix and execution of shareholder distributions. Dividend policy can be developed from three factors: capacity analysis, empirical evidence, and market expectations.

Dividends Versus Buybacks

Dividends plus share repurchases constitute the total shareholder yield of cash distributed from the company back to shareholders. The most appropriate mix of dividends versus share repurchases is a function of the quality of the cash flows, volatility, cyclicality, and the need for financial flexibility. Every company needs to strike its own optimal balance between dividends and share repurchases. The discretionary nature of share repurchases versus the fixed cost of dividends makes buybacks more appropriate for companies with more volatile, seasonal, cyclical, or uncertain cash flows. Share repurchases are less of a fixed charge commitment than dividends, which are difficult to change due to the signaling impact. A true residual shareholder distribution policy is best suited to uncertain distributions of excess cash.

For the same reason, ratings agencies should favor buybacks over ...

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