Leverage Effect and Tax Effect

Leverage effect and tax effect:1.

Dividends effectively are ongoing and stronger commitment compared with share buyback, because, according to Lintner managers prefer to increase dividend rather than decreasing them. On the other hand, share buyback does not commit the company to future pay-out. In other words, repurchasing reserves financial flexibility relative to dividend. In fact, the study of, company with higher operating cashflow are likely to increase dividend, while company with higher non operating cash flow are more likely to increase repurchase.

In our case, the G corporation had negative growth of annual cash flow in the last 5 years, which means, the follow the share repurchasing program, the firm needed to make an additional finance from outside share buyback reduces company equity -> increase financial leverage if share buyback is financed by borrowing. Higher leverage means higher risk for shareholders and reduce share price. Also, higher leverage will induce the creditor for higher interest rate on loans - tax on capital gain is less on dividend income.Signalling and Undervaluation:The manager usually uses any change in dividend to convey information to investors. Share repurchase is the similar purpose. According to textbook, share repurchase could provide new info that manager expects earnings and cash flow will be higher in the future.

Also, they disagree with the market valuation of the company stock based on the existing public info.According comment and jaroll (1991), they found that the negative abnormal return in the months before the announcement of the share repurchasing program, so this means the managers make the share repurchasing announcement at the time they are undervalued. owever, there some recent and comprehensive studies that are inconsistent with the first version: they disagree with the repurchase will signal the good news about future earnings. Theyfound that there is a significant decline in operating profit as percentage of total assets over 3 years following the announcement of the repurchase program.

Also, it found out that the financial analyst revises their forecast of earning per share downward after announcement of share buyback program In our case, the G manager believes that the share now is undervalued because they expect that earning must be higher