The company’s payout policy comprises dividend payout and repurchase of stocks. The dividend policy of the organization tends to follow the growth model of dividends. According to the model, organizations start to pay dividends after moving from a period of high growth (in terms of profitability) to a period of maturity where the company experiences dismal growth, and finally to maturity where the organization does not experience revenue growth.
The company paid its first dividend in the year 1992. It amounted to 15% of the earnings. The rate was quite low and conservative. The management expected good performance and that organic growth of the payout rate was feasible. It is for this reason that the management started with a low rate that would be sustainable in the long run. As of the year 2003, the dividend payout ratio was 25%. However, as the business entered its maturity stage, management of the company was concerned about the ability of the company to sustain the dividend payout ratio. The CFO was confident that the cost structure and the business outlook could support the payout ratio. The Chief Financial Officer was of the view that payment of dividends despite declining sales would indicate a robust position in the risky industry.
The other element of dividend policy was the repurchase of shares. This was meant to offset the employee stock options. Further, it was instigated by a poor market condition which was characterized by low market interest rates. Thus, the company received low returns from various investments. Finally, the company did not have an acquisition plan with the large cash balances that they held. Therefore, buying back the shares was a viable option. The use of the two methods enabled the management of the company to meet all requirements of the shareholders.
The financing needs of Linear technology
The income statement of the company between 1992 and 2002 shows a stable revenue even during periods of economic recession. This can be attributed to the company’s favorable cost structure and lower financing needs. The major costs incurred by the company are in research and development, retention of qualified staff and machinery, and equipment. From the financial statements, it is evident that the company explores avenues of spending on these key expenses that require low financing needs. For instance, the company makes use of a bonus scheme for paying salaries of key staff members so that they earn more when revenues are high. This helps in keeping the staffing cost low during low peaks. Further, management focuses on acquiring plants and machinery that are durable and have a considerable warranty. This aids in reducing the cost of maintaining and frequently replacing the machines. Finally, the company makes investments conservatively. They rely on available cash balances. This reduces the financing needs required by the organization to invest.
Repurchase of shares
The relationship between shareholders and management is an example of the principle-agent relationship. This relationship has several problems such as conflict of interest. Even though the move to repurchase shares is not welcomed by all shareholders, it is beneficial to the company since it reduces agency problems. This reduces the cost of equity. Further, the repurchase of shares may provide positive signals to the market about the future outlook of the company. This is paramount in considering the dynamism of the industry. On the other hand, buying back shares would interfere with the liquidity levels of the organization. This can hinder future investments thus, curtailing prospects of the future increased dividend payout ratio. Even though the financial performance of the organization is stable, it is still responsive to market reactions as seen with robust sales in 2002. Stock repurchase occurs in two instances, that is, to reduce agency problems and to reduce investment. The company’s goal is to reduce the cash level. It is consistent with under-investing. Therefore, buying back the shares would be a viable venture for the organization. Further, repurchases reduce the number of outstanding shares thus, increasing the earnings per share and the market share price (Brealey et al. 67).
Repurchase of shares is carried out using after-tax payments. Under the double taxation system existing, shareholders pay more tax than upon the repurchase of shares because dividends attract double taxation. This implies that holding cash and using it to pay dividends attracts double taxation and thus, repurchase of shares provides more value than payment of dividends irrespective of the prevailing tax rates.
The effect of paying the entire cash balance as a special dividend
The essence of paying dividends is to boost investor confidence in the performance of the company thus, reducing the required rate of return. The amount of dividend paid is often added to the market price of shares. For instance, if the price per share is $46 and the dividends declared are $3.5, the new market price per share will be $49.5. This also increases the value of the firm. However, this depends on the time of announcement. To obtain the current market price of the shares, only the net present value of the shares will be added to obtain the market price thus, not the whole amount of the dividend will be added to the market price per share. Apart from increasing the value of the firm, the payment of the special dividend reduces interest income that arises from holding cash. This reduces earnings before tax and tax expenses (Eugene and Michael 98).
Brealey, Richard, Stewart Myers and Franklin Allen. Principles of corporate finance. USA: McGraw-Hill Irwin, 2005. Print.
Eugene, Brigham and J. Michael. Financial management theory and practice, USA: South-Western Cengage Learning, 2009. Print.