Pretend you are the CFO of a company that has paid a steady dividend for the pas

Question

Pretend you are the CFO of a company that has paid a steady dividend for the past forty years and your recently hired, brilliant, freshly minted UTA Finance graduate who managed to pass Advanced Business Financial Analysis sends you a text message on your mobile phone while you are in the middle of yoga class that reads: Dividends are irrelevant. Why don’t we quit paying them? On your way home from class and experiencing inner peace, you decide to prepare a response to your newest colleague, who many not know much about your company, but is well versed in theory. How would you reply? 2.) The new brilliant, freshly minted UTA Finance graduate, excited to have her text messages answered by a CFO who had experienced inner peace, follows her question with a suggestion that the company undertake to raise private equity for the purpose of purchasing all public shares. What reasons would she give for taking the company private?

Explanation / Answer

(I) Arguments for Dividend Payouts:

Dividend payout is important for investors because dividends provide certainty about the company's financial well-being. Dividends are also attractive for investors looking to secure current income. In addition, many examples indicate how the decrease and increase of a dividend distributions can affect the price of a security. Companies that have a long-standing history of stable dividend payouts would be negatively affected by lowering or omitting dividend distributions. These companies would be positively affected by increasing dividend payouts or making additional payouts of the same dividends.

It is based on Bird-in-the-Hand Theory.

Investors think dividends are less risky than potential future capital gains, hence they like dividends. So, investors view dividend increases as signals of management’s view of the future. Therefore, a stock price increase at time of a dividend increase could reflect higher expectations for future dividends themselves. Hence, dividend payouts are relevant.

(II) Reasons for taking the company private:

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