It can be very important for a firm to pay dividends in order to show profit and stability. Paying the dividends rather than repurchasing shares shows the company growing and making enough profits to have a positive future. Well-established companies pay dividends to stockholders on a regular basis. If both paying dividends and repurchasing shares are combined, then there could be a large increase in shareholders’ returns.
There would be a tax preference for share repurchasing because the taxes paid are deferred until the shares are sold. Dividends are taxed each time there is a dividend payment made. Dividend taxes can be better in certain areas. Managers would use buying back depending on the number of shares that the company has. “The biggest benefit of a share buyback is that it reduces the number of shares outstanding for a company. This usually increases per-share measures of profitability like earnings-per-share (EPS) and cash-flow-per-share and also improves performance measures like return on equity. These improved metrics will generally drive the share price higher over time, resulting in capital gains for the shareholders.” (Picardo, 2019). These profits will be taxed when the shareholders sell their shares. A manager would be inclined to buy back stocks if the stocks were undervalued. A manager would then be inclined to pay dividends in the stock was overvalued as the price would soon come back down depending on the market.
Picardo, E. (2019, March 12). Dividend vs. Buyback: Which Action Benefits Investors More? Retrieved March 16, 2019, from https://www.investopedia.com/articles/active-trading/073015/dividend- versus-buyback-which-better. asp
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In a “perfect world” capital market, how important is a firm’s decision to pay dividends versus repurchase shares?
Under what conditions would you have a tax preference for share repurchase rather than dividends? Would managers acting in the interests of long-term shareholders be more likely to repurchase shares if they believed the stock to be either undervalued or overvalued?
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