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Companies uses of Dividends and Stock Repurchase Programs
This paper seeks to determine if companies can offset the negative signals of dropping their dividend levels
by initiating a stock repurchase program. The impetus for this study is the often-cited case of Florida Power and
Light Company (FPL). While the FPL case is instinctive, it is difficult to make an inference on an entire
population from a study of one company. It is possible that FPL is a special case because it was a healthy
company that cut its dividend. If this were true, then the rest of the companies that cut dividends and
announced stock repurchase may have very different results. Lets look at the specific situation of FPL.
It is instinctive to consider revisiting the FPL experience. The two reasons that led FPL to cut its dividend were:
the recent speed of deregulation in the utilities industry that forced FPL to start thinking about the impact of
not being a regulated company, and the fact that the dividend payout had grown to a higher than normal level on
a historical basis. The reason for this is that the dividends recently had been growing faster than the
company's earnings (1). After these issues were taken into account, there were four major factors that led FPL
to simultaneously cut the dividend level and announce a stock repurchase program. First, FPL believed that
the negative signal from lowering the dividend would be somewhat offset by the positive signal from a
stock repurchase program. Second, there was a tax benefit to a stock repurchase because dividend income is
taxed more heavily than capital gains income. Third, a repurchase program provided flexibility in distributing
capital to investors in case earnings were not as high as expected, which stemmed from deregulation within
the utility industry increasing FPL's business risk. Fourth, switching to more repurchases and fewer dividends
would strengthen the flexibility in the level of cash reserves (2).
There are two theories about dividends that are worth explaining in more detail in this paper. Those theories are
the Signaling Hypothesis and the Clientele Effect. The Signaling Theory is based off the idea that managers
have better information about a firm's future prospects than public stockholders do. Since future dividends are
paid out of future profits, and given that managers are reluctant to cut dividends, any change in dividends to be
paid is often viewed as a signal of future profits. Thus, increases in dividends generally result in stock price
increases and cuts in dividends generally result in stock price declines (3).
The other relevant theory is the Clientele Effect. The basic idea is that different clienteles of stockholders
prefer different dividend payout ratios. Firms have different payouts based on their own internal business
needs. Thus, when a firm switches its payout ratio, perhaps due to business imperatives, the current clientele
leaves and another clientele must come in to take its place. If more investors leave or if they leave quicker than
the new clientele enters, this could lead to a temporarily depressed share price (4).
To see why FPL considered stock repurchases as an alternative means to pay cash out to investors, lets look at
the economics of a share repurchase. When a firm's stock is repurchased and management refrains from selling
their holdings as it generally does, the managers are effectively increasing their portion of ownership in the firm.
This willingness to "buy out" other shareholders shows the public that management feels the firm's stock
UP jounial of Undergraduate Research University of Florida
is undervalued. Thus, investors view the announcement of a stock repurchase program as a bullish signal. There
is also a tax advantage to stock repurchases versus dividends. When a stock repurchase is initiated the investor
has the choice to sell the stock back or not. Regardless of the choice, as long as the investor has the stock for over
a year, the capital gains tax liability is small compared to dividends. Also, if the investor decides not to sell he
defers the tax liability until the stock is sold.
Now lets revisit the FPL case to see whether coupling the positive stock repurchase signal with the dividend cut
had any impact on investor opinion. There were interesting market events surrounding the FPL announcement of
the change in dividend policy. On March 3rd, 1994 FPL suggested that it would be difficult to increase the
dividend. Then on May 9th, 1994 FPL announced the dividend cut with the stock repurchase program and the
stock price fell $4.375 to $27.50 (5). Then on May 31st, FPL's stock closed at $32.17, or about 30 cents higher
than the pre-announcement price. One year later, FPL's stock price closed at $37.75, giving stockholders a return
of 23.8%. Finally, almost two years later on April 1, 1996 FPL's stock was trading at $45.25, which
provided stockholders with a post-announcement return of 52.9% (6).
These results support the fact that FPL adapted itself to become more of a growth company in an
unregulated environment from an income company with a monopoly in its market. The significance of this case is
that FPL was the first company to drop the dividend payout without the typical negative reasons, but for
strategic reasons. Also, FPL supplemented the dividend cut with a stock repurchase in order to boost
investors' confidence in the company. Finally, FPL's stock had increased over a long period after the
announcement, and has more than offset the temporary price decline from the dividend cut.
The FPL case has been analyzed and explained in order to have a base to discuss other companies
that simultaneously dropped the dividend and announced a stock repurchase program. The first question to
address: Can a firm adjust its dividend policy for valid business reasons and avoid a significant temporary or
semi-permanent decline in the firm's value with a one time stock repurchase announcement. If the answer is no,
the other question is what reason is there for the drop in the stock price. One explanation would be that the
market effectively over punished the stocks of companies when they announced both a stock repurchase
program and a dividend cut as they did with FPL. Then once they realized that the company made a strategic
move, and signaled to the public that the company's basic earning power was still strong the stock
rebounded. Another possible explanation is that when the company cut the dividend, the clientele of investors
who desire a high dividend payout left and the stock dropped. Soon after the old clientele left, a new clientele
that desired a lower dividend payout replaced them, and the stock rebounded. Another question is
whether companies added an announcement for stock repurchases as they cut the dividend level to appear as if
they were making a strategic move as FPL did. In reality however, perhaps the companies were facing problems
and the management was trying to appear strong to the public in order to protect their firm's stock price.
In this study, a sample of twenty-four American companies that simultaneously announced both a dividends cut
and a stock repurchase program were collected. To begin the research, the daily returns 100 days before and
100 days after the announcement date for each company was recorded. The data was gathered by using the
CRSP database, Yahoo! Finance, and the Bloomberg database. The returns for each stock were compared to
the returns of a proxy for the market index. The difference of the two was calculated to be the net returns of
the stock for any particular day.
The first step was to find the sample's average net return for each day. The average net cumulative returns were
also found, starting with the average net return of the companies' 100 days before the announcement. The
resulting graph is shown in figure 1. The cumulative net returns were also calculated for FPL and shown in figure
2. Notice the downward trend in the sample leading up to the announcement date with a -18.17% cumulative
return is stronger than FPL's negative cumulative return during that period of -14.68%. Also, the drop at the time
of the announcement date for the sample is not as sharp as the FPL's case, -3.26% vs. -12.52% respectively.
In addition, unlike the FPL case where the stock returned to its pre-announcement value, the sample firms'
stock prices did not bounce back at all.
Cum dative Average Return Vs. Market Index
-110 -8S -W -40 -2 20 40 o0 80 110
Numbbe of DaysA~aeyfrM nounCemerl
Figure 1. Cumulative Average Return Vs. Market Index.
Number of Days Av ay from Announcement
Figure 2. Cumulative Return of FPL vs. Market index.
In addition to the graphical representation, statistical T-Tests were calculated on the data. The first T-Test
was conducted on the average return of the sample for each day. An 11-day range of T-Tests are shown in figure
3. Not much can be concluded from this test, since the only significant results are found in the announcement
date and 3 days after the announcement date. This lack of significance is probably due to the difficulty in
getting conclusive results from such a small sample. Next there was a T-Test conducted on the cumulative
net returns for an eleven-day range that include five days before and five days after the announcement date.
The results are shown in figure 4. This test shows very strong significance of negative cumulative returns within
Cumulative Return of FPL vs. Market Index
Days from T-Test Results For
Announcement Daily Average Returns
Figure 3. T-Test Results for Average Daily Returns.
11 day range -2.1151 Between 95% and 98%
surrounding the (2.069 - 2.500)
Figure 4. 11 day range surrounding the announcement date.
In some of the qualitative research conducted on the sample, I found that there were many motives for the firms
to give a stock repurchase and dividend cut simultaneously. A table that gives a basic summary of each company
can be seen at figure 5. These motives include: a competitive environment causing the target payout ratio
to change, bringing the payout ratio in line with the rest of the industry, changing the financial capitalization of
the firm, propping up an undervalued stock price, to have financial flexibility for acquisitions and volatile cash
flows, stock option accretion, and of course there may have been other motives such as those discussed earlier
in this paper.
Figure 5. Basic Company Summary.
Company Name Dividend Cut Share Repurchase
Companies stated reason
Sempra Energy from $1 56 to $1 00
$ 2750 to $ 1375
$1 60 to $1
Cavalier Homes Inc $ 01 to $0 00
Dutch Auction of $17 50 to $20 for 36
MM shares to buy $700 MM or 15% of
Plans to buyback 15 mm shares when
it spins off compuserve
less than 10% of shares
additional 20 MM to total of 30 MM
authorized by 6/01 Already
repurchased 9 6 MM in last 6 months
25 4% of outstanding
authorize 1 4 mm
90 5 MM at 12/31/99
7 06/21/00 Equity Inns Inc $ 31 to $ 25
Compuserve wll be spun off and
profits wll not be as high as before
Reduce cost of Capital
wth lower projected n I The
company wants to reallign its payout
ratio and to fund share repurchase
Downturn in industry
a cushion for anticipated and
unanticipated problems in the future
Late 1/00 and
$5 MM in stock in 2000 and 20001
09/15/99 Allegheny Teledyne $ 16 to $10
$1 46 to $ 75
13 15 penceto 11 43
already 8 5 MM shares and consider
launch program - 6 6 MM shares or
up to 4 MM shares
asking for 400 MM shares including
1 8 MM shares - 17% of s/o
company being split up- restructuring Conglomerate
Merging with Unisource and
lots of cash before possible
free up cash to invest in
nonregulated businesses in a
33% dividend cut 12 MM shares
Ryland Group Inc $ 15 to $ 04 16 MM shares
LucasVarity 7 pence to 4 5 pence 3% of company stock
Pacific Gas and
$ 49 to $ 30 plans to initiate program
$ 36 to $ 25 1 MM shares
WR Grace & Co $ 35 to$ 125 up to 10 MM
New York State
Electric and Gas $ 55 to $ 35 plan repurchase
new strategy for retail competition Utility
undervalued stock homebuilding
tax efficient payout automotive
move into retail sector REIT
manage balance sheet with growth specialty-chemical
strategies in core businesses business
Florida Power and
$62to $ 42
Light Group Inc
Ametek Inc $ 17 to $ 06
$1 to $ 40
Whittaker Corp $ 40 to $15
and Fragrances Inc
Wisconsin Energy cut by 49%
Rank Group PLC 12 75 pence to 8
Connectiv Inc $1 54 to $ 88
Ethyl Corp $ 50 to $ 25
Texas Utilities Co $ 77 to $ 50
plan to repurchase 10 MM
$150 MM or 25% of s/o
up to 25 MM shares
up to 3 MM shares
179 3 MM
14 5 MM
increase from $200 MM to $400 MM
buyback 15% of capital on top of 10%
$350 MM or 14 MM
increased competition and
large writedown motor part
use cash to buy oil reserves oil
nearterm impact of Saudi healthcare, energy,
cancellation on earnings chemical, etc
food flavors and
needs cash for new plants energy
free cash to focus on core divisions leisure
free up cash to become more
wave of future and a possible
fuel and lubricant
CTG Resources Inc $ 38 to $ 25
$180 to $1 6 4 MM shares 107 MM
One conclusion from this study is that FPL was a special case in terms of the results when it announced a dividend
cut and a stock repurchase program. FPL was a company that was very strong, and changed its dividends not due
to hurt earnings, but an anticipation of the change in the industry. Comparing the cumulative net returns of FPL
and the sample shows this. The results show that FPL's returns were stronger than the sample up to
announcement, weaker on the day of the announcement, and recovered more than the sample after
the announcement. This information lead me to believe that FPL was a strong company that had a clientele
switch hurting the stock price on the announcement date. Perhaps investors initially overreacted, but with
the positive signal from the stock repurchase, ultimately investors realized that FPL was still a strong
firm. Subsequently, a new clientele of investors came in to restore the stock price to its pre-announcement level.
The sample had different results as shown by the statistically significant negative return present around
the announcement that was not recovered. This shows that the market did not take the announcement for the
stock repurchase seriously, and that the effect of the dividend drop was a permanent share revaluation.
This concludes that on average, the announcement of a dividend drop and a stock repurchase program results in
a permanent drop in the stock price. Also, since the drop in stock price is permanent, the explanation is that
the signal of the dividend overpowers the signal from the stock repurchase and not the switch of the clientele.
The results also indicate that the rest of the companies in this study were financially weak and may have been
trying to appear to be in the same situation as FPL. In my opinion, another study with many companies in the
sample should be conducted to generalize the expected results of companies that simultaneously announce
a dividend cut and a stock repurchase program. Also, companies who do take on these actions should be looked at
on a case by case basis to estimate the effects on the stock price.
1. Soter, Dennis, Eugene Brigham, and Paul Evanson. "The Dividend Cut "Heard 'Round the World": The Case of
FPL." Journal of Applied Corporate Finance 9.1 (1996): 7-8.
2. Soter, Brigham, and Evanson 8, 13-4.
3. Brigham, Eugene F, and Joel F. Houston. Fundamentals of Financial Management. 2nd ed. Fort Worth: The
Dryden Press, 1999. 502.
4. Brigham, and Houston 502-3.
5. Esty, Benjamin C. "Dividend Policy at FPL Group, Inc. (A) and (B) Teaching Note." Harvard Business School Case
5-296-072 (1996): 17-20.
6. Soter, Brigham, and Evanson 5.
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