Topic outline

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  • 1. Introduction

    Welcome to "Payout Policy!" The purpose module is to present a systematic approach for managers to navigate the two key questions surrounding the payout policy: How much money should the firm return to its shareholders? And how should cash be returned? This introductory section motivates the topic and presents the logic of the module.


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    The main learning goals of this module are:
    • Understand the key questions surrounding the payout decision: How much to pay out, and how to return money to shareholders?
    • Know the various forms of payout, in particular dividends and share buybacks.
    • Know how and why payout matters.
    • See how a firm's financing policy, investment policy, and payout policy are related.
    • Know the relevant steps towards a sustainable payout policy.​
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  • 2. Payout Basics

    This section introduces the two main forms of corporate payout: Dividends and share buybacks. We present the key characteristics of these payout methods, discuss how firms can implement them, and take a look at important tax implications from the point of view of the shareholders.

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  • 3. The Irrelevance of Payouts

    Does it matter whether firms pay dividends or repurchase shares? This section studies the basic mechanics of dividend payments and share buybacks. We show that, in a very stylized world, payout decisions are actually irrelevant: How much cash the firm returns to shareholders and how that cash is distributed does, in principle, not matter. Moreover, if shareholders have different payout preferences, they can implement such "payout policies" on their own with homemade dividends.

    With these considerations, we lay an important building block to better understand how and why payout decisions do matter in the real world, where many of the strict assumptions that we make in this section do not hold.

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  • 4. The Relevance of Payouts

    Now that we understand the basic mechanics of dividends and share repurchases, it is time to drop some of the strict assumptions from the previous section and look at the relevance of payout decisions in reality. 

    The purpose of this section is to investigate under which scenarios payout decisions actually do matter. The key question here is whether a dollar of cash is more valuable inside the firm or outside the firm. We discuss the main elements of an answer to that question.

    • In principle, if the firm has investment opportunities that offer a higher return than the cost of capital, retaining cash (reducing payout) increases firm value, and vice versa. 
    • We look at the economic reality and see that (mature) firms, on average, do not have many investment opportunities that significantly enhance firm value. Reinvesting cash is therefore not necessarily a value-enhancing proposition.
    • We also look at the empirical evidence about the value of excess cash holdings inside the firm and some of the determining factors
    • Finally, we present a framework that allows us to assess the three main effects that payout decisions can have on firm value.

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  • 5. Dividends vs. Share Repurchases

    The previous section has shown that how much cash the firm distributes to shareholders is highly relevant in reality. The logical next step is to investigate whether it matters how the firm distributes cash, i.e., whether it pays dividends or repurchases shares

    This section focuses on the trade-off between dividends and share buybacks. We look at the advantages and disadvantages of the two forms of corporate payouts with respect to many important dimensions, especially:

    • The flexibility they grant the firm
    • Their impact on earnings per share (EPS)
    • The information they convey about the valuation of the firm's stock
    • Their relevance in the context of executive compensation
    • Their usefulness to offset ownership dilution
    • As well as important tax considerations.
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  • 6. Why do Firms Pay Dividends?

    The previous section has shown that buybacks offer many advantages over dividend payments. Yet the empirical reality is that dividends are still very popular. Why is it that firms pay dividends? The purpose of this section is to find answer to that question. These answers include:

    • It could be that shareholders have a desire for current income
    • It could be that regular dividend payments help shareholders to impose self-control
    • Dividends could contain valuable information and therefore firms could use them as signals
    • There could be managerial agency costs
    • There could be special shareholder clienteles for which dividends are favorable
    • The market could desire dividends because alternative investments have low yields.
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  • 7. Towards a Payout Policy

    By now, we have discussed the most important elements surrounding the questions of how much firms should pay out and how they should return money to their shareholders. The purpose of this section is to consolidate the main takeaways and to present a structured approach for managers to think through the payout decision:

    1. Funding needs: Does the firm have excess cash?
    2. Costs of excess cash: If yes: are there any adverse effects to keeping excess cash inside the firm?
    3. Distribution: If yes: How should that cash be returned to shareholders?


    The discussion highlights once again that the payout policy cannot be considered in isolation. It is an integral part of the firms broader financial policy and thereby strongly interplays with the investment policy as well as the financing policy. We conclude the section with some thoughts about the relevance of these policies for different types of firms.

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