Dividends vs. Share Repurchases
Dividends are segment of returns payable to shareholders of corporations. This form of payment is usually made when corporations generate surpluses or profits. In this case, corporation can either retain some returns or distribute them out. Any decision settled upon by the fund managers and which involves cash dividends can take either share repurchases or dividends. Notably, dividends are distributed on fixed rates per share. Therefore, shareholders receive their dividends based on their shareholding. Depending on the nature of cash dividends issue, it could accrue multiple benefits to the shareholders or the corporation. Essentially, share repurchases involve the decision admitted by a corporation to reacquire its stocks through buyback. For this reason, they distribute cash to their shareholders in return for outstanding shares. The process of share repurchase involves open market operations, private concession, use of put options and auctioning. In this regard, it is essential to depict whether dividends or share repurchases are convenient for both parties involved (Groppelli & Nikbakht, 2000).
Investors of most corporations can be classified into two categories based on their investment intentions. In this regard, investors could look for the appreciation of their portfolios over some time, while others could be interested in dividends paid out regularly. As a result, the benefits or demerits depend on the investors’ desires. For corporations that issue dividends, shareholders will be interested in because they can earn income on their input in the company. Despite the fact that these shares are taxable on the recipients, they supplement individuals’ disposable income. On the other hand, large shareholders despise this form of distribution because taxes take up large proportions and hence the net gains are minimal. In addition, this form of return payment drains the corporation earnings limiting the chances for its growth and expansion. In spite of this scenario, the retain earnings can be used in a number of beneficial ways after considering dividends distribution. They include settling debts, acquisitions of other corporations and expansion of production dimensions.
Another critical importance of cash dividends is the flexibility it provides to shareholders compared to share repurchase. Usually, when shareholders obtain dividends, they continue to hold their shareholding in the same proportions without changes. On the contrary, share repurchase necessitates shareholders to redeem their shares for the amounts issued by the corporations. As a result, their shareholding could decline or become exhausted. It implies that their future returns will decline despite the profitability of the corporation. Under this analysis, shareholders would prefer dividends over the share repurchase to reduce their exposure to future risks (Madura, 2003).
The distribution of dividends allows both shareholders and corporation management to portray psychological control and disciple. Since corporation managements should be delivered based on shareholders’ pressure, they put in significant efforts to enhance the shareholders’ wealth maximization. It is because shareholders have the right to hire and fire the management team based on their performance.
The process of share repurchase is intricate, but it has multiple benefits to shareholders and corporations. This form of return payment to shareholders is beneficial to corporations when shares are undervalued in the stock exchange compared to when they are overvalued. In this regard, corporations undertake share repurchase when they have excess profits in their books with few obligations. It implies that through the share repurchase, the number of outstanding shares in the market decreases. Subsequently, the earning per share would increase significantly. Based on this consideration, stock prices would shoot up improving the performance of the corporation.
Several countries’ tax capital gains at lower rates compared to the dividends attributable to shareholders. In this case, companies may opt for share repurchase to reduce tax outflows attributable to dividends and benefit shareholders. Therefore, capital gains would offer shareholders the chance to increase incomes and diversify their portfolios. Meanwhile, the corporation’s staff would benefit out of the employee stock ownership plans. It is because share repurchases lead to the increase in stock prices. As a result, they can generate income from capital gains or future dividends distribution.
The expectation of dividend payout by shareholders in a year affects a company. In the event that the company has adopted a culture of paying regular dividends, shareholders will always eagerly await the payments. Therefore, if the company does not meet its obligation, shareholders will criticize the management, which may affect their performance. On the contrary, share repurchases have the flexibility to undertake the process when it is convenient for them. Thus, the company can control the shareholders’ expectations. In addition, the management will stimulate business growth and expansion due to the available capital from earnings. Lastly, stock prices will increase considerably (Shim & Siegel, 2000).
In spite of share repurchases adding value to shareholders’ wealth, this phenomenon cannot always be applicable. With the anticipation of the stock price increase out of share repurchase, it could affect future market trends as the company might drain its financial base. In this case, the management could evaluate the best approach that they can use to improve the shareholders’ wealth without exposing themselves to risks. Therefore, the management of a company would choose the dividends and retain some returns to direct them in viable investments.
Despite the benefits accruing from the share repurchase, investors may not wish to expose themselves to it due to its undependable nature. This form of return is usually inconsistent and unpredictable. As a result, investors would opt for the dividend-paying companies since they are assured of some returns on yearly basis. In the event that the company underperforms before generating substantial returns, investors would be exposed to financial risks.
Similarly, the fact that companies allocate huge capital for share repurchases does not definitely imply that share prices will increase. In this regard, multiple factors in the stock exchange including economic circles will influence share prices. Hence, if the company has invested in share repurchase to improve its share prices, numerous factors could lead to its underperformance. It implies that companies expose themselves to detrimental risks during share repurchase.
The process of share repurchase is complicated and the company may be exposed to risks if it is not well informed of all details of the process. In this case, any inconveniences caused to the investors could force them to file lawsuits against the company. Therefore, the company would be at a risk of incurring additional costs to the repayment of capital gains to investors. On this note, companies could resort to other forms of return payments to shareholders.
The analysis of the two return payment methods indicates the advantages and disadvantages attributable to each method. Generally, share repurchase serves the interest of the shareholders with large shareholding. This is due to the capital gains attributable to fewer taxes. On the other hand, dividend payments are suitable for the small shareholders with the need to generate regular income. Meanwhile, companies have an added advantage on share repurchase since they can accumulate earnings until they can meet the cost. Based on this consideration, they can expand and grow before they can offer capital gains. On the other hand, dividends serve the company to reduce the risks exposure of share repurchase. This implies that fund managers have to strategize on the appropriate dividend policies that suit the company. In this regard, it is essential to establish appropriate dividend policies for the company.