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A paper on corporate dividend policy in the context of business corporate finance taking into account relevant theory as appropriate.
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Jason Cates Dividend Policy Ravi Patel
0
Dividend Policy
Written by
Jason Cates Ravi Patel
09200538 08206396
Jason Cates Dividend Policy Ravi Patel
1
© Jason Cates and Ravi Patel, 2013
Reproduction for the following uses is authorised provided the source is acknowledged in
line with the Copyright, Designs and Patents Act 1988;
Private and research study purposes, performance, copies or lending for educational
purposes, criticism and news reporting, incidental inclusion and copies and lending by
librarians. Further details of authorised use under the above Act is available from the UK
Copyright Service.
This publication may be made available online at SlideShare.net/AdrJasonCates for public
use no earlier than 09:00hrs (GMT) on 21 April 2013 as deemed appropriate by the
acknowledged sources.
This paper has referenced appropriate sources in line with Harvard Referencing.
Any queries regarding this publication should be sent to:
LinkedIn.com/in/AdrJasonCates
To be delivered to the University of Hertfordshire on or by
8 March 2013
Ordered by Jason Cates and Ravi Patel to be printed
8 March 2013
Printed in the United Kingdom
Jason Cates Dividend Policy Ravi Patel
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Part I: With reference to appropriate theory, critically evaluate the dividend and share
buyback policies of Debenhams plc. Your discussion should include an evaluation of share
buybacks as an alternative to dividends.
Word count: 2000
Jason Cates Dividend Policy Ravi Patel
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Table of Contents Introduction ...................................................................................................................................... 4
Dividend Policy .............................................................................................................................. 4
Share Buyback ............................................................................................................................... 5
Theories ............................................................................................................................................ 6
Modigliani & Miller ........................................................................................................................ 6
Signalling Effect ............................................................................................................................. 6
Clientele Effect .............................................................................................................................. 7
Management Incentives ................................................................................................................ 8
Performance Indicators ................................................................................................................. 8
Business Life Cycle ......................................................................................................................... 8
Conclusion ....................................................................................................................................... 10
Signatories ...................................................................................................................................... 11
Referencing ..................................................................................................................................... 11
Appendix ......................................................................................................................................... 13
Appendix 1 – Debenhams Ownership Summary ........................................................................... 13
Jason Cates Dividend Policy Ravi Patel
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Introduction This paper evaluates Debenhams share buyback and dividend policies and considers their
implications on shareholder return. This will be carried out by considering such policies in relation to
relevant theory and conclude by considering the appropriateness of these policies in returning
shareholder investment.
Dividend Policy The graphs below show Debenhams level and costs of dividend since 2008.
(Debenhams, 2008-2012)
(Debenhams, 2008-2012)
Debenhams reduced its dividend to 0.5p a share in 2009 and went on to cancel its dividend
in 2010. This was in order to refinance its debt and improve upon its cash position which, in 2008,
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1.5
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2.5
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2008 2009 2010 2011 2012
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Dividend Per Share
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60
2008 2009 2010 2011 2012
Tota
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£M)
Total Cost of Dividend
Jason Cates Dividend Policy Ravi Patel
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fell to -£2.9M. Cancelling its dividend allowed Debenhams to increase its cash level by £191.1M
between 2008 and 2009 and to repay 25% during the financial year 2011.These investments reduced
Debenhams bankruptcy and financial risk by lowering its interest payable and improving its short-
term liquidity. (Debenhams, 2008-2011)(Watson & Head, 2010)
(Debenhams, 2008-2012)
(Debenhams, 2008-2012)
Share Buyback In 2011, Debenhams reinstated its dividend and announced a share buyback scheme worth
£40M. Share buybacks are seen as an efficient way of returning cash to shareholders in addition to a
dividend. Companies are generally reluctant to issue increases in dividend in which they may have to
reverse. Share buybacks are a way avoiding this problem and increasing cash pay-outs without
having to reverse the decision in following years. A share buyback will also enhance the value of the
remaining shares further contributing to shareholder return. (Barrett, 2011)(Brav et al, 2005)
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2008 2009 2010 2011 2012
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Cash Level
Jason Cates Dividend Policy Ravi Patel
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Theories Modigliani & Miller
Modigliani and Millers proposal incorporating both tax and bankruptcy risk concluded that
increasing use of debt capital reduces a company’s overall weighted average cost of capital (WACC).
This is due to debt finance generally being a cheaper source of finance than shareholder equity in
addition to interest payments acting as a tax shield against profits. However, when gearing reaches a
critical point, the associated increase in bankruptcy risk will drive up this WACC and eventually
outweigh the cost and tax benefits of financing by debt. (Watson & Head, 2010)
An underlying assumption of this proposal is that shareholders are indifferent between
returns being in the form of dividend payments or capital growth. However, this ignores the
signalling and clientele effects, both of which will have an effect on a company’s cost of equity based
on the expectations of different shareholder clientele. (Brav et al, 2005)
Relating to Debenhams dividend policy, the key issue of relevance is that of high debt and
the resulting bankruptcy risk. Debenhams dividend was reduced to 0.5p a share in 2009 and
cancelled in 2010, this capital was then reinvested in improving Debenhams cash level and repaying
its liabilities. In 2008, Debenhams net cash position stood at minus £2.9M; by 2010 this had reached
positive £188.2M. Furthermore, total liabilities fell from £1.86Bn in 2008 to £1.39bn by 2011. During
this time, Debenhams saw its share price double from 39.75p per share in August 2008 to 79.5p per
share by August 2009. This level of share price growth implies that share price and therefore total
shareholder return are affected by other factors beyond simply dividend payments. (Debenhams,
2008-2011)(LSE, 2013)
Signalling Effect Specific dividend and share buyback policies will signal specific information to shareholders
and other investors.
The cut in dividend in 2009 and 2010 can signal two things. The first of these is that
Debenhams may be entering a phase of declining performance and thus, can no longer afford to pay
a dividend to shareholders. However, the second category involves the company prioritising
investment in NPV’s over paying out a dividend, thus leading to greater capital growth in the future.
Therefore, the circumstances’ surrounding a decrease in dividends needs to be considered when
discussing the signalling effect. This relates in part to the business life cycle which will be discussed
later on in this paper. (Debenhams, 2009-2010)(Brav et al, 2005)
In this case, by Debenhams tying its cut in dividend to reinvestment in cash and the
refinancing of its debt, it managed to convince its shareholders that it came under this second
category involving investment in NPV’s. Moreover, this change in dividend policy attracted more
investors leading to an increase in share price as shown in the graph below. This implies that
investors have other considerations beyond simply the level of dividends which will be discussed in
the clientele effect. (Debenhams, 2012)
Jason Cates Dividend Policy Ravi Patel
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(Debenhams, 2012)
In relation to Debenhams share buyback policy of 2011-2012, Debenhams saw an increase in
share price occurring around the same time period it implemented this policy. Although there may
be other factors causing this share price increase, it may be partly due to the signals such a policy
sends investors. In this case, investors have taken it to mean the company has surplus capital due in
part from savings from lower interest payments after its debt refinance programme. In summary,
investors have taken these changes in dividend and share buyback policy as positive signals
regarding future company performance. (Debenhams, 2012)
Clientele Effect The effects these policies had on company share price may be due in part to the clientele
effect. This is due to different types of investor preferring different forms of income. Generally, long-
term investors such as pension funds prefer a more stable and regular income, typically in the form
of dividends. This is compared to short-term investors who prefer high capital growth in the short-
term. (Watson & Head, 2010)
As seen in appendix 1, mutual funds which generally prefer safer long-term investments
hold only a minority shareholding in Debenhams. This is compared to Debenhams top ten
shareholders that mainly consist of investment and asset management companies and together hold
a 57.9% shareholding. These investment funds generally, but not always, prefer capital growth over
high dividends. This is due in part to the different tax considerations of these two clienteles. Simply,
as high earners pay a higher rate of income tax, they will naturally be drawn to the lower rate of
capital gains tax and therefore, would prefer high capital growth over dividends. As such, by
cancelling its dividend in 2010 and issuing a share buyback in 2011, Debenhams is appealing to this
specific clientele. (Debenhams, 2013) (Grullon & Michaely, 2002)
This theory is supported by the increase in Debenhams share price as mentioned earlier
after it announced these changes in policy. This suggests that variations in dividend and share
buyback may have an impact on shareholder return in the short-term. As such, the clientele effect is
a significant factor when deciding upon share buyback and dividend policies. This is due to each of
the two polices appealing to different types of clientele. However, research has found that
alternating between these two policies has no effect on long-term shareholder return and they
simply act as “substitutes”. (Skinner, 2008)
Jason Cates Dividend Policy Ravi Patel
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Management Incentives In regards to management incentives, Debenhams CEO Michael Sharpe currently owns
2.46M shares/share options in the company alongside CFO Simon Herrick’s 647,127 shares/share
options. This share ownership means the company’s two executives have a personnel interest in
maintaining or improving upon Debenhams share price. In regards to Debenhams share buyback
policy, if total “corporate value” is to remain stable, having fewer shares on the market should lead
to a higher share price. In regards to Debenhams, after implementing its £40M share buyback, its
share price had grown to 96.05p per share, up from 55.35p a year before. As stated, this may be due
in part in the reduction in the overall number of shares. However, it may also be due in part to the
signalling and clientele effects which will be discussed later on in this paper. (Debenhams, 2013)(LSE,
2013)
Performance Indicators From a corporate reporting perspective, having fewer shares can contribute to improving
key performance indicators. The first of these is earnings per share (EPS). Prior to the share buyback
in 2011/2012, Debenhams EPS was 9.1p with profits of £160.3M. After the share buyback, EPS had
increased to 9.8p, even though profits had declined to £158.3M. This increase in EPS despite
declining profits shows the impact a share buyback can have on a companies reported performance.
(Debenhams, 2011-2012)(Watson & Head, 2010)
Furthermore, issuing a share buyback also reduces the costs of maintaining or improving
upon the company’s current dividend. In 2011, Debenhams paid dividends of 3p a share with a total
cost of £38.6M. This is compared to 3.3 pence a share in 2012 which a cost £38.5M. This shows that,
by issuing a share buyback, Debenhams was able to improve its dividends per share figure without
incurring the cost of such an increase. Therefore, although issuing a share buyback reduces company
capital in the short-term, the lower costs of maintaining or improving the company dividend will
likely offset this in the longer term. (Debenhams, 2011-2012)(Grullon & Michaely, 2002)
Business Life Cycle In regards to the business life cycle, Debenhams share buyback policy implies the company is
entering a stage of decline. Firstly, by returning capital to shareholders rather than reinvesting it in
the business may suggest the company lacks positive NPV’s to invest in. If a company fails to invest
in new NPV’s, the company will enter a stage of decline when it’s current NPV’s start to reach the
end of their lifespans. Secondly, issuing a share buyback reduces the number of shares in the
company and helps to improve the company’s share price. This suggests the company believes their
shares are likely to underperform in the near future. This need to maintain share price further
implies the company may be entering a stage of decline. (Brav et al, 2005)(Vernon, 1966)
In regards to dividend policy, Debenhams cut in dividend in 2009 and 2010 could imply two
things. Firstly, it could mean the company does not have the capital to pay out a dividend due to
heavy investment in new NPV’s, leading to higher capital growth in the future. This may suggest the
company is entering a new growth or “rebirth” stage. However, having insufficient capital to pay a
dividend might also suggest a decline in company performance, further implying that Debenhams
Jason Cates Dividend Policy Ravi Patel
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might have entered the decline phase. Using the savings from reduced dividends in 2009 and 2010
to invest in cash and lower debt suggests Debenhams comes under this first category. This is further
supported by the reinstatement of its dividend in 2011. (Debenhams, 2009-2011)(Barrett, 2011)
In conclusion, a share buyback may be more appropriate for declining companies when
there is a need to return capital to shareholders over a short period of time. In contrast, dividend
payments may be more suitable for more stable mature companies who can afford to maintain this
dividend over the longer term. (Watson & Head, 2010)
Jason Cates Dividend Policy Ravi Patel
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Conclusion As stated earlier, research has found that differences in dividend and share buyback policy
have no real impact on long-term shareholder return. Furthermore, this research has found that
these two policies simply act as substitutes when returning capital to shareholders. (Skinner, 2008)
However, two issues to consider are the clientele effect and the business lifecycle which
hold significant influence on the suitability of these policies. Share buybacks may be more
appropriate for declining companies who wish to return capital to shareholders over a short period
of time. Whereas dividends may be more appropriate for mature stable companies with the
profitability to maintain such a dividend in the long-term.
Regarding the clientele effect, companies largely owned by short-term investors would be
encouraged to implement a policy of buying back shares and improving share price. Conversely,
companies largely owned by long-term investors would be encouraged to implement a policy
focused around paying regular dividends. Both these policies appeal to different types of investor
and should be implemented as appropriate.
Relating to Debenhams, issuing a share buyback appeals to its main shareholder clientele of
investment funds whose timeframes are generally in the short-to-medium term. The reduction in its
dividend in 2009 might imply that it was on the verges of decline. However, the reintroduction of its
dividend in 2011 suggests it has entered the “rebirth” stage of the business lifecycle.
Jason Cates Dividend Policy Ravi Patel
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Signatories We commend this paper to the University of Hertfordshire to be delivered on or by 8 March 2013.
Jason Cates
Ravi Patel
___________
Mail: [email protected]
Portfolio: SlideShare.net/AdrJasonCates
LinkedIn: LinkedIn.com/in/AdrJasonCates
Jason Cates Dividend Policy Ravi Patel
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Referencing Barrett C., (2011) ‘Debenhams rises 7% over buy-back plan’, Financial Times, 21st October 2011
Brav et al A., Graham J.R, Harvey C.R. and Michaely R. (2005), ‘Payout policy in the 21st century’,
Journal of Financial Economics, 77, pp. 483 – 527
Debenhams (2008) Annual report 2008. [Online] Available at: http://media.corporate-
ir.net/media_files/IROL/19/196805/reports/ar2008_new.pdf [Accessed: 11th February 2013]
Debenhams (2009) Annual report 2009. [Online] Available at: http://media.corporate-
ir.net/media_files/IROL/19/196805/reports/ar2009_new.pdf [Accessed: 11th February 2013]
Debenhams (2010) Annual report 2010. [Online] Available at: http://media.corporate-
ir.net/media_files/IROL/19/196805/agm2010/ar2010.pdf [Accessed: 11th February 2013]
Debenhams (2011) Annual report 2011. [Online] Available at: http://media.corporate-
ir.net/media_files/IROL/19/196805/agm2011/ar2011.pdf [Accessed: 11th February 2013]
Debenhams (2012) Annual report 2012. [Online] Available at: http://media.corporate-
ir.net/media_files/IROL/19/196805/agm2012/ar2012.pdf [Accessed: 11th February 2013]
Debenhams (2013) Ownership Summary. Available at:
http://www.debenhamsplc.com/phoenix.zhtml?c=196805&p=irol-ownershipSummary [Accessed:
13th February 2013]
Grullon G. and Michaely R. (2002) Dividends, Share Repurchases, and the Substitution Hypothesis.
The Journal of Finance, Volume 57, Issue 4, pp1649 – 1684
LSE (2013) Debenhams 2013. Available at: http://www.londonstockexchange.com/exchange/prices-
and-markets/stocks/summary/company-summary-
chart.html?fourWayKey=GB00B126KH97GBGBXSTMM [Accessed: 21st February 2013]
Skinner D. J. (2008),’The evolving relation between earnings, dividends, and stock repurchases’,
Journal of Financial Economics, Vol ume87, Issue 3, pp. 535 - 740
Vernon (1966) cited in Proxim Group, (2013) The Business Life Cycle. Available at:
http://www.proximgroup.com.au/Understanding-The-Business-Life-Cycle-Is-Important-To-
Improving-Your-Small-Business-Success.php [Accessed: 23rd February 2013]
Watson, D. & Head, A. (2010) Corporate Finance: Principles and Practice. 5th edn. Harlow: Prentice
Hall.
Jason Cates Dividend Policy Ravi Patel
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Appendix
Appendix 1 – Debenhams Ownership Summary
Top 10 Shareholders Shares % O/S
Share Change
Schroder Investment Management Ltd. (SIM) 202,969,928 16.2% -5,908,364
Milestone Resources Group, Ltd. 89,183,155 7.1% 0
Majedie Asset Management Limited 66,480,510 5.3% 55,719,596
Artemis Investment Management LLP 63,855,868 5.1% 0
Standard Life Investments Ltd. 63,332,751 5.0% -13,492,714
Bestinver Gestión S.G.I.I.C. S.A. 61,554,348 4.9% -52,588,229
AXA Rosenberg Investment Management Ltd. 60,803,116 4.8% 0
Legal & General Investment Management Ltd. (UK) 42,075,474 3.4% 0
Norges Bank Investment Management (NBIM) 38,491,542 3.1% -333,675
LSV Asset Management 37,668,430 3.0% -790,500
Mutual Funds Shares % O/S
Share Change
Bestinver Internacional FI 57,284,726 4.6% -4,406,677
Bestinfond FI 37,751,534 3.0% -2,826,268
Statens Pensjonsfond Utland 35,340,709 2.8% 14,752,863
Delta Lloyd Select Dividend Fonds NV 20,100,000 1.6% 350,000
Old Mutual UK Select Mid Cap Fund 18,981,000 1.5% 1,555,000
CIS UK Growth Trust 18,000,000 1.4% 7,500,000
Aberforth Smaller Companies Trust plc 13,952,178 1.1% 2,307,436
Bestvalue FI 11,059,184 0.9% 11,046,913
St. James's Place Balanced Managed 9,502,150 0.8% 0
Old Mutual UK Select Smaller Companies Fund 9,315,000 0.7% 609,000