Regarding payout policy, select the correct statement:

Question

BlackTom AI · Accepted Answer

First, I restate the question and list the options so we can evaluate each in turn.
Question: Regarding payout policy, select the correct statement.
Options:
1) In the presence of information asymmetry between investors and managers, maintaining the same dividend per share every quarter is a generally a bad payout policy because it confuses investors.
2) According to securities regulation and insider trading laws, a firm is not allowed to issue debt and then use the cash to pay a dividend to shareholders instead of keeping the money to fund its operations.
3) After it pays out a large amount of excess cash to investors with a special dividend, a firm’s book value of equity can become negative and raise concerns among analysts focused on accounting numbers.
4) A firm’s market capitalization (value of equity outstanding) will generally increase significantly after it pays out a large amount of excess cash to investors by repurchasing shares.

Option 1 analysis:
- The claim is that maintaining a constant dividend per share (DPS) in the presence of information asymmetry is generally bad because it confuses investors. In practice, many firms favor a stable or slowly increasing dividend as a signal of reliability despite information asymmetry, and frequent changes in DPS can confuse investors but that does not make the policy universally bad. The assertion overstates the claim and disregards motives like signaling and smoothing. Therefore this option is not typically regarded as a definitive correct statement.

Option 2 analysis:
- Securities regulation and insider trading laws prohibit various improper uses of information or misallocation of funds, but there is no broad prohibition against a firm issuing debt and then paying a dividend from cash flow or cash reserves instead of funding operations. Some combinations may be questionable or trigger scrutiny (e.g., emergency financing used for dividends could raise concerns), but the blanket claim in this option is too strong and not accurate as a general rule. Thus this option is not correct.

Option 3 analysis:
- This statement aligns with accounting and corporate finance theory. If a firm pays out a very large excess cash dividend or a special dividend, its cash decreases and if it has little or no remaining equity capital or if liabilities rise relative to assets, the book value of equity can indeed become negative in some cases (e.g., if share repurchases or large payouts reduce equity below liabilities). Analysts focusing on accounting numbers would flag negative book value of equity as a concern since it indicates the balance sheet is distressed or highly leveraged relative to equity, even if market value or cash flows might still support operations. This option reflects a plausible accounting outcome under extreme payout actions.

Option 4 analysis:
- The claim is that market capitalization would increase significantly after paying out a large excess cash amount via share repurchases. In reality, large cash payouts to shareholders reduce cash and may reduce the number of shares outstanding, but market capitalization is determined by the stock price times shares outstanding. A large payout could lower stock price due to cash outflow and lower equity value, and while some signaling effects could support a price increase, the assertion that capitalization will generally increase significantly is too strong and not universally true.

Additional considerations:
- Across the options, we are assessing payout policy implications from accounting and market perspectives. The correct choice typically hinges on a financially consistent outcome that can occur under standard conditions, whereas the others rely on overstatements or incorrect regulatory interpretations.
- The evaluation emphasizes the relationship between payout actions and balance sheet metrics (like book value of equity) as well as market implications.

In summary, evaluating the accounting implications of a large excess cash payout points to a scenario where the book value of equity can become negative, which matches the described statement. The other options rely on assumptions that are not universally valid or contradict common regulatory or market behavior expectations.

COMM_V 370 101-108 2025W1 COMM 370 - 2025W1 - Final - Requires Respondus LockDown Browser

Regarding payout policy, select the correct statement:

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