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Linear Technology Essay

1. Describe Linear Technologies payout policy.

Linear Technology announced its first dividend on October 13, 1992 in order to portray Linear Technology as a less risky firm than other technology companies that did not pay dividends and to gain access to new investors interested in earning income in addition to investing in growth. Linear Technology initially planned to begin with a relatively low dividend of $0.05 per share which amounted to a 15% earnings payout ratio – mindful of the fact that investors abhorred firms that reduced or stopped their dividend payment schedule. Beginning more conservatively than their original estimates, Linear Technology began with a $0.00625 dividend per share.

Linear Technology has steadily increased it’s dividend per share increasing the payout approximately every four quarters by $0.00125. This pattern was maintained from Q2 1993 to Q3 2000. Beginning in Q4 2000, Linear Technology began increasing its dividend per share by a new pattern of $0.01 increases per four quarters. The current dividend per share is $0.05 during Q3 2003. Its current dividend yield of 1% is relatively higher than the average dividend yield rate for Information Technology firms in the S&P 500, around 0.3%.

2. What are Linear’s financing needs? Should Linear return cash to tis shareholders? What are the tax consequences of keeping cash inside the firm?

Linear Technology’s financing needs are to optimize its cash flow, investments, and cash balances in order to maximize its shareholder values. Linear’s cash balance in March 2003 stood at around $1.5 billion, which was being conservatively invested in short-term debt securities. The cash flow from these investments, the interest income, was around $52 million.

Due to the tax cuts implemented by the Bush administration, the tax rate on dividends and capital gains were greatly reduced. The dividend tax rate dropped from an approximate 38% and the capital gains tax dropped from an approximate 20%. More important that the magnitude of the tax cuts, however, is that the capital gains tax was equalized with the dividends tax. When the dividends tax is higher than the capital gains tax, the optimal dividend policy is to pay no dividends. In this situation, the firm will use share repurchases instead in order to take advantage of tax savings. Before the tax cuts, the firm has less incentive to raise funds for dividend payouts due to the higher tax rate on dividends and the negative effect on shareholders. However, with the equalized tax rate of 15%, the firm is no longer discouraged from raising dividends.

3. IF Linear were to pay out its entire cash balance as a special dividend, what would be the effect on value? On the share price? On earnings? On earnings per share? What if Linear repurchased shares instead? Assume a 3% rate of interest.

4. Why do firms pay dividends? Why has the rate of dividend initiations changed over time?

Firms pay dividends for several reasons despite the MM proposition that characterizes dividend policy as irrelevant. One main reason for dividend policy is based on the manager’s belief that investors prefer stable dividends with sustained growth. This kind of dividend signals to the investor the firm has reached a steady state growth i.e. a mature market position. A company usually only begins to consider releasing dividends once it has established regular and predictable operations cash flows. However, dividends can also act as a negative signal telling investors that the firm’s growth rate is slowing. Increasing the dividend can, on one hand, signal the manager’s perspective for future growth and optimism over future cash flows; on the other hand, increasing the dividend can also signal a lack of investment opportunities. The use of dividend payouts has steadily decreased over the last 30 years. This trend is in part related to the changes in dividend tax rate, however, I believe the majority of this trend or trends can be attributed to changes in investor preferences. The dividend payout decision is ultimately chosen by a manager, whose main objective is to satisfy shareholder preferences.

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