Linear technology is an American-based company that produces, among other things, semiconductors and analog circuits. The company was formed in 1992 and has been profitable. In its first year, linear technology announced a quarterly payout of $0.05 per share, which was 15% of its earnings (Baker & Wagonfeld, 2004). The management of linear technology has had a dividend policy of increasing the dividends paid to its shareholders by 1% from the year it was formed. As Yusra et al. (2019) argue, the company’s policy of paying exponentially compounded dividends each year demonstrates that linear technology is not risky for investors, thus attracting income-seeking shareholders. The first announced dividend payout in the first year was too low and ensured that the company would have positive cashflows on its initial incomes. Despite adopting this policy of dividend payout as well as a share buyback, linear has managed to survive fairly and remain liquid over the years because of its conservative cash maintenance policy.
Reasons Organizations Pay Dividends
There are many reasons why companies choose to pay dividends to their shareholders. The first and main reason is to attract income-seeking shareholders (Pattiruhu & Paais, 2020). These investors usually buy shares with more focus on earning dividend payouts regularly, either quarterly or semi-annually (Saeed & Zamir, 2020). Additionally, firms pay dividends to project a positive image that the companies are stable, profitable and can provide an acceptable return on investment to their shareholders. This image projection is arguably the reason why linear has been paying increased dividends each year. Companies also pay dividends to reward their shareholders for having faith in the company and its management. This dividend reward system is popular since the executive team profits if it keeps the owners happy.
Another major reason organizations, especially the profitable ones, choose to pay dividends is to manage their capital structure. When a company has excess cash and does not wish to expand its operations, it may pay dividends. This strategy helps an organization reduce its cash balance reserves and increase shareholder equity. Baker and Wagonfeld (2004) argue that organizations could also pay dividends to ensure that the organizations maintain financial flexibility. Financial flexibility to a business refers to a situation where an organization can respond to internal or external changes without a negative financial impact. This flexibility would demonstrate that the firm’s investments are not too risky (Yusra et al., 2019). If investors realize that a company is financially stable, the company enjoys to benefits of raising equity capital easily in future.
Reasons for Changing Dividend Initiation Rates
A dividend initiation gives a positive projection to an external stakeholder that it is stable and confident toward its future growth. The increase in the rates of dividends over time by a company is due to various factors. First, companies may lower their dividend rates when they want to change the focus of the shareholders from dividend income to capital gains. Secondly, a firm may raise or lower its dividend rate to adapt and ensure they make the most out of the constantly changing tax policies. Some companies also vary the dividend initiation rates because of their nature and industries. For instance, technology companies operate in a highly volatile market with constant booms and busts. Changing the dividend policy rates is expected for these companies since the market largely influences their policies.
Cash Return to Its Shareholders
Linear should return cash to investors since it would be a prudent way to reward them and signal confidence in the company’s financial strength. However, giving these cash rewards should be prudent (Kollmann et al., 2019). In deciding whether to return cash to shareholders, the management should consider the impact on the company’s financial flexibility, strategic options, and shareholder value. While returning cash may be attractive to some investors, it may limit the company’s ability to pursue growth opportunities or weather economic downturns (Saługa et al., 2020). Linear’s management should also ensure that the dividend payout ratio is sustainable and aligned with the firm’s long-term growth prospects.
Effects of Paying the Entire Cash Balance as A Special Dividend
If linear technology were to pay out its entire cash balance as a special dividend, the effect on the value, share price, earnings, and earnings per share would depend on various factors, including the market’s expectations and the company’s prospects. Paying out a special dividend in the short term would likely increase the firm’s share price as shareholders receive cash and become more willing to buy and hold the stock. However, the effect on value would be more complex. The payment of a special dividend would reduce the company’s cash balance, which could make investors perceive the company as having fewer resources to invest in future growth opportunities or weather economic downturns. This could, in turn, reduce the organization’s overall value.
Paying a special dividend would not directly affect earnings or earnings per share, as it does not impact the company’s underlying operations. However, the reduction in cash could affect future earnings, as the firm would need more financial resources to invest in growth opportunities or make strategic acquisitions. This could, in turn, impact future earnings per share. It is worth noting that linear technology had accumulated a large cash balance over the years and had no plans to make acquisitions. Thus, if the company were to pay out its entire cash balance as a special dividend, it might not significantly impact its future growth prospects or financial flexibility. Nonetheless, considering the organization’s future capital needs and growth prospects, the decision to pay a special dividend should be carefully considered.
Outcomes of Repurchasing Shares Instead of Providing a Payout
If linear technology chose to repurchase shares instead of providing a payout, the effect on the value, share price, earnings, and earnings per share would depend on the specific circumstances of the repurchase. On the one hand, share repurchases can increase the value of a company by reducing the number of shares outstanding, which increases the earnings per share and makes each remaining share more valuable. This could also result in a higher share price, especially if the market perceives the share repurchases as a positive signal about the company’s prospects. On the other hand, share repurchases could also negatively affect a firm’s financial position. For example, if linear used all of its cash to repurchase shares, it would no longer have that cash available to fund future investments or to weather any unexpected downturns. Additionally, repurchasing shares at inflated prices could lead to a company’s overall value decline over the long term.
Paul Coghlan Recommendation
Based on Linear technology’s financial statements, which show that the company has enormous growth prospects, Paul Coghlan should encourage the board to continue the company’s current strategy of paying out regular dividends while increasing the number of share repurchases. This aspect would allow the firm to return more value to its shareholders while taking advantage of the low-interest rates and maintaining a conservative cash balance. Additionally, he could recommend that the company consider a special dividend or a larger share buyback program, depending on the company’s future cash flow and growth prospects. While the firm’s performance has been strong relative to the S&P 500, evaluating opportunities to create value for shareholders and maintain a competitive position in the market is essential.
References
Baker, M. P., & Wagonfeld, A. B. (2004). Dividend policy at linear technology. Harvard Business School.
Kollmann, T., Stöckmann, C., Kensbock, J. M., & Peschl, A. (2019). What satisfies younger versus older employees, and why? An ageing perspective on equity theory to explain interactive effects of employee age, monetary rewards, and task contributions on job satisfaction. Human Resource Management, 59(1), 101–115. Web.
Saeed, A., & Zamir, F. (2020). How does CSR disclosure affect dividend payments in emerging markets? Emerging Markets Review, 100747. Web.
Saługa, P. W., Szczepańska-Woszczyna, K., Miśkiewicz, R., & Chłąd, M. (2020). Cost of equity of coal-fired power generation projects in Poland: Its importance for the management of decision-making process. Energies, 13(18), 4833. Web.
Yusra, I., Hadya, R., & Fatmasari, R. (2019). The effect of retained earnings on dividend policy from the perspective of life cycle. Proceedings of the 1st International Conference on Life, Innovation, Change and Knowledge (ICLICK 2018). Web.