Employee Compensation: Higher Expected Dividend Yield Lower Compensation Expense?

J

JamesPage

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Hi Everyone,
This question is regarding Employee Compensation: Post-Employment and Share-Based Reading 18.h
How does a higher dividend yield decrease the estimated fair value and thus decrease compensation expense (in the income statement) using options pricing models? Does a higher expected div yield decrease expected stock value?
J
 
Higher dividend yield means increasing dividends while keeping price the same, or lower price for the same amount of dividends. So in order to do that, you need to decrease growth or increase the discount rate in a DDM, thus a higher dividends yield means either one of these. The formula is D/P = (r-g)
 
Higher the dividend yield lower the future expected stock value ceteris paribus. At an extreme, if the company sells all its assets and pays one massive dividend, the value of the stock post that dividend will be a big whopping zero. Think about dividends as cash paid out and hence is not compounding in the price of the stock.
 
Just think of dividend as a benefit paid. Benefits paid reduce the compensation expense. Hope this helps.
 
Where did you come across dividend yield in the chapter?? I read it from the Schweser notes and dont remember anything about dividend yields being mentioned. Is it in the CFA text??
 
Think of it as the safer the stock is the lower the price of the option will be. If there is a dividend then you know you are going to earn income the uncertainty of the prince increases/decreases decreases thus lowering your option value.
Options are insurance on an asset, if you are the individual selling the option, and options are based off of uncertainty, the more uncertain something is the higher you will charge because you don’t know what you are going to lose. That is why volatilty increase, risk-rate increase, time-frame increase will all result in higher compensation expense and dividend will result in lower expense.
 
Thanks everyone! Salam, to answer your question it is in Schweser. Read the Key Concepts section LOS 18.h
 
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