More on the ExDividend Date

The ex-dividend date is important and is a common source of confusion. We examine what happens to the stock when it goes ex, meaning that the ex-dividend date arrives. To illustrate, suppose we have a stock that sells for \$10 per share. The board of directors declares a dividend of \$1 per share, and the record date is set to be Tuesday, June 12. Based on our previous discussion, we know that the ex date will be two business (not calendar) days earlier, on Friday, June 8.

If you buy the stock on Thursday, June 7, just as the market closes, you'll get the \$1 dividend because the stock is trading cum dividend. If you wait and buy it just as the market opens on Friday, you won't get the \$1 dividend. What happens to the value of the stock overnight?

If you think about it, you will see that the stock is worth about \$1 less on Friday morning, so its price will drop by this amount between close of business on Thursday and the Friday opening. In general, we expect that the value of a share of stock will go down by about the dividend amount when the stock goes ex dividend. The key word here is about. Because dividends are taxed, the actual price drop might be closer to some measure of the aftertax value of the dividend. Determining this value is complicated because of the different tax rates and tax rules that apply for different buyers. The series of events described here is illustrated in Figure 18.2.

EXAMPLE 18.1 |

"Ex" Marks the Day

The board of directors of Divided Airlines has declared a dividend of \$2.50 per share payable on Tuesday, May 30, to shareholders of record as of Tuesday, May 9. Cal Icon buys 100 shares of Divided on Tuesday, May 2, for \$150 per share. What is the ex date? Describe the events that will occur with regard to the cash dividend and the stock price.

The ex date is two business days before the date of record, Tuesday, May 9, so the stock will go ex on Friday, May 5. Cal buys the stock on Tuesday, May 2, so Cal purchases the stock cum dividend. In other words, Cal will get \$2.50 X 100 = \$250 in dividends. The check will be mailed on Tuesday, May 30. Just before the stock does go ex on Friday, its value will drop overnight by about \$2.50 per share.

As a more concrete example, in the first quarter of 2001, McGraw-Hill, which we feel compelled to note is a very fine company,1 boosted its dividend by 4.3 percent. In fact, dividends have been paid by the company since 1937 and have increased without fail since 1974, growing at a compound rate of 10.9 percent over the following 27-year period. The dividend record date was February 26, with payment to be made on March 12. The new quarterly dividend was \$.245 a share.

The record date was February 26, a Monday, so the ex date was Thursday, the 22nd. When the market opened, McGraw-Hill's stock price dropped by \$0.11, or only about half of the dividend. However, the market was very active that day, so the dividend

'The reason we feel so compelled is that McGraw-Hill is the publisher of this textbook!

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

VI. Cost of Capital and Long-Term Financial Policy

18. Dividends and Dividend Policy

CHAPTER 18 Dividends and Dividend Policy

Ex date

\$1 is the ex-dividend price drop -Price = \$9

The stock price will fall by the amount of the dividend on the ex date (Time 0). If the dividend is \$1 per share, the price will be \$10 - 1 = \$9 on the ex date:

Before ex date (Time -1), dividend = \$0 Price = \$10 On ex date (Time 0), dividend = \$1 Price = \$9