Which of the following dividend policies would a firm with temporary excess cash flows most likely use? A share repurchase program: A) and no payout of dividends. B) in conjunction with a residual dividend model. why would a firm choose B over A? if a firm issues a dividend, the stock price falls, even though the issuance of any dividends is a positive signal.
residual dividend policies allow the company to use the funds that they have temporarily in excess, to distribute that money among shareholders. Also by this approach - they are not “required” to continuously keep paying the higher dividend. Yes the stock price gets deflated on announcement of the dividend - which is why the share repurchases are done to immediately reduce the outstanding share balance - to bring the share prices back up.
ok. so it implies the price drops on announcement, the shares are repo’d, the EPS goes up and thus the stock price goes up.
but why issue dividends at all? what is the benefit of returning the capital over keeping the excess cash on hand? we can speculate the firm has no good projects to invest in, but it’s out of the scope of this q.
ok nevermind. the excess CFs refer to the excess R/E, determining the optimal capital structure.