Question

1. Why do firms choose to make large increases in their dividends or start a stock repurchase program?2. Why do firms choose to cut or eliminate their dividends? What usually happens to the stock price of a company that does this?

Answer 1

Answer with Explanation:

Requirement 1:

The companies whose products are in growth phase or the company is cash cow which has a well diversified products does not have to invest in adding a new product line because their earnings are already stable enough or that they don't have to invest much because sufficient profits are left after extracting for investments. Increase in dividends has two meanings that either the management is confident enough that they think that the company will be able to earn more in the future and they will achieve better position in future which is a good news in the stock exchange and for investors as well and investor invest more in the company's ordinary stock.

Company start Stock repurchase program which is to buyback its previously issued ordinary shares which is because the management thinks that the stock is undervalued and thus they repurchase their ordinary shares so that the stock will go up in near future and this will benefit the company and the existing shareholders as well. This also helps in increasing earnings per share, return on equity, etc because the equity is reduced by share repurchase program.

Stock repurchase program is also run by the organization because they don't find any attractive opportunities. This means that the company does not have any large investment opportunities which means growth in revenue and profit can not be expected in the future years. Thus when the company starts repurchasing of stock the investor starts selling their stocks.

Requirement 2:

If the company thinks that they can increase the worth of shareholders beyond their shareholder's expectation then they don't pay dividend and invest in projects to increase the sales growth, profits and market share significantly in the coming future.

Some long term shareholders think this is a great news whereas short term investors who are looking for dividends will sell the stock which means that the stock value may fall in near future but in long run the company stock value increase when the investment will start showing its results.