Hello again and welcome back to Corporate Finance Essentials 2. We're now in the last session, which is the dividend policy. Then when we finish the dividend policy session, we're going to go back very, very quickly and make a wrap-up of all the sessions that we have and all the topics that we discussed in this course. I will do it right after, without interruption of this session. The last topic that we have to discuss is something that again, like capital structure every company needs to consider, and that is, companies not in every year, but they typically make money and they need to decide whether they keep all that money or they send part of that money to their shareholders and that's what we call dividends. Therefore, they need to decide their dividend policy, and when you look around, you see companies that don't pay dividends and never did. Amazon for example, and companies that have paid dividends for many, many years, General Electric for example, and companies that for a while didn't pay, but then they started paying, like Microsoft and Apple. You have the full spectrum of companies that they pay a large proportion of earnings out as dividends, and the other limit you have companies that have never paid and have no intention in the foreseeable future of paying dividends. This is what we need to discuss today. How do companies make that decision? I should warn you about one thing, in most of the other topics that we can deal with in corporate finance, we can always run numbers, we can always run calculations and say, well, this is a number, this is what we should do, not here. A dividend policy is not a numerical topic. We know some of the variables that we can use to come up with that decision. But that decision is going to be arguable, mostly because again, we don't have those raw numbers to which we can go back and fall back and say, hey, because of this number, I'm going to do this or I'm going to do that. So those are the downside and the upside, if you will, of dividend policy. Let me start by introducing the topic and highlighting that it tends to be a confusing topic. I'm not sure I'm right about this, but I usually say this is of all the topics that we deal with in corporate finance. This is the one that we know the least. We know some things, but there's a lot that we don't know, and part of that comes because if you think about from the point of view of companies paying dividends or not paying dividends, those two things which are opposite, may be interpreted as a good thing. From the side of the investors. Receiving dividends or not receiving dividends. Both of those two things can be interpreted as a good thing. You have to put everything into contexts, that's one of the variables that we will actually either that will be the environment in which the decision needs to be taken. But what may be good and there are some circumstances may be bad and some others, while may be good for some people, may be bad for some other people, and that's one of the reasons this topic, it's a little bit, if not controversial, is a little bit difficult to assess. As we said before, this is not really a number crunching topic. We could crunch some numbers. We need to know obviously whether we can pay, whether we have the ability to pay, whether if we pay a dividend today, we'll be able to keep it up in the future. Of course, we need to run some numbers, but typically this is not consider one of those numerical topics as could be estimating cost of capital or estimating an optimal capital structure or many other, most other topics that we deal with in finance. Now, let's think of an ideal hypothetical, and that the ideal is what we would like to know, is basically of the earnings that we have. What proportion we should pay out so that investors are willing to pay the most for our shares? That would be the ideal. I'm not saying that we can implement that. I'm not saying that we have a model for that, but that would be the ideal. That's what is called an optimal dividend payout ratio. The dividend payout ratio is simply the proportion of dividends to earnings. What proportion of earnings we pay out as dividends. Of course that number could be zero for companies that don't pay any dividends, but it could be one for companies that pay all their earnings out as dividends, which of course there are none of those. The truth is typically somewhere in between with some companies on the zero and then some companies on the positive side, you have some extreme cases. Actually we are in these times, in some of those cases we're seeing some of those which are basically companies that even borrow money in order to pay dividends or in order to pay more dividends than the earnings they generated. But those cases are few and are far between, so we're not going to worry too much about those, but at least know what would be the ideal. The ideal would be to find the proportion of earnings that we need to pay out so that investors are willing to pay the most for our shares. Now, with all that said, there are some things we know when some things we don't quite know. What we do know is that the optimal is a trade-off more than the optimal. The trade-off is every dollar that a company has. It can pay it out to shareholders, or it can actually keep it and reinvest it back in the company. That gives you a basic trade-off I can pay out or I can reinvest, and if I reinvest more, maybe that's a maybe and we'll get back to that a little bit later, maybe I'll grow more. So if you have a good management and they reinvest the money at a good rate, then you have the trade-off that shareholders would like to keep that money in their pockets, but t at the same time they would like to have the company grow at an aggressive rate, but you cannot get these two things at the same time. So it's a trade-off that you have to deal with. We also know some empirical regularities, meaning that one of those things that we know is what is called dividends smoothing. Dividends smoothing basically means two things. Number 1, if you plot earnings-per-share and dividends per share for just about all the companies, you'll see that dividends tend to fluctuate a lot less than earnings due, and that's what is called dividend smoothing; earnings can go like that while dividends tend to go like that, they tend to fluctuate less than earnings. The second idea of dividends smoothing is that what you pay today depends not only on the earnings that you have today, but also on the dividends that you had in the past. You do take into account what dividends you've been paying to determine what dividends you're going to pay today. We're going to go back to this issue a few minutes from now. But we do know that, we do know the empirical regularity that dividends tend to be smoother than earnings and that managers tend to smooth a dividends over time.