The Basics of Payout Policy

The term payout policy refers to the decisions that firms make about whether to distribute cash to shareholders, how much cash to distribute, and by what means the cash should be distributed. Although these decisions are probably less important than the investment decisions covered inChapters 10 through 12 and the financing choices discussed in Chapter 13, they are nonetheless decisions that managers and boards of directors face routinely. Investors monitor firms’ payout policies carefully, and unexpected changes in those policies can have significant effects on firms’ stock prices. The recent history of Whirlpool Corporation, briefly outlined in the chapter opener, demonstrates many of the important dimensions of payout policy.

payout policy

Decisions that a firm makes regarding whether to distribute cash to shareholders, how much cash to distribute, and the means by which cash should be distributed.

ELEMENTS OF PAYOUT POLICY

Dividends are not the only means by which firms can distribute cash to shareholders. Firms can also conduct share repurchases, in which they typically buy back some of their outstanding common stock through purchases in the open market. Whirlpool Corporation, like many other companies, uses both methods to put cash in the hands of their stockholders. In addition to increasing its dividend payout, Whirlpool also resumed its share repurchase program in 2013, which had been halted during the economic recession. At the time of resuming the share repurchase program, the company’s free cash flow was between $600 million and $650 million and expected to increase to between $650 million and $700 million. Whirlpool’s chief executive officier, Jeff Fettig, stated that “sales increased in every region of the world” as the company continued to expand its margins and that as the company continued to execute its “long-term growth strategy . . . [it would] continue to drive actions to further create value for . . . shareholders.”

If we generalize the lessons about payout policy, we may expect the following to be true:

1. Rapidly growing firms generally do not pay out cash to shareholders.
2. Slowing growth, positive cash flow generation, and favorable tax conditions can prompt firms to initiate cash payouts to investors. The ownership base of the company can also be an important factor in the decision to distribute cash.
3. Cash payouts can be made through dividends or share repurchases. Many companies use both methods. In some years, more cash is paid out via dividends, but sometimes share repurchases are larger than dividend payments.
4. When business conditions are weak, firms are more willing to reduce share buybacks than to cut dividends.