Microsoft announced at the annual shareholders meeting in November 2002 that, despite having $40 billion in cash on its balance sheet, the company would not be taking any substantive measures to distribute the cash to its roughly 4.2 billion shareholders. Microsoft stated that the cash was needed to satisfy judgments that could arise from ongoing corporate and private antitrust lawsuits.

While the company had a history of buying back its stock, Microsoft had never paid a dividend since going public in 1986. The no dividend policy made sense historically as high-tech, growth companies with highP/E's, typically don't issue dividends, butinstead elect to plow their profits back into the business. But as of the shareholdermeeting, Microsoft's growth had slowed to

Options

Management was under pressure to act. They could choose between a myriad of options including: 1) Doing nothing, 2) Using the cash to finance acquisitions and expansion, 3) Returning the cash to shareholders by beefing-up the ongoing stock repurchase program, a program that had the company buying back shares at the rate of up to $ 6 billion a quarter, or 4) Returning cash to shareholders by issuing

about 10 percent annually, from 30 percentor more in the company's early years, andthe stock, as evidenced by its inclusion in the Dow Jones Industrial Average, had begun to look more like a stable blue chip than a high-flying tech issue.

The announcement made at the 2002 meeting angered many shareholders. Growth had stagnated and the company was sitting on a pot of cash. It was an efficient business that was generating $1 billion a month in free cash. In a shrinking interest rate environment, Microsoft's returns on shortterm investments were insignificant andreduced the firm's return on equity. Thestate of affairs led one investor at themeeting to comment, "We need a reason tohold the stock. We need a dividend. Weneed something."

dividends. Given the company had virtually no debt (see below), share repurchase appeared to be an efficient way to solve the problem. Buybacks are tax efficient to individual investors and protect shares from dilution due to option exercise. Unlike repurchases, investors assume that dividends payments, once begun, will continue indefinitely.

CASE STUDY 2

Microsoft

Solving a Good Problem for a Company to Have (2004)

Bierman, H. (2017). Case studies for corporate finance: from A (Anheuser) to Z (Zyps) (Vol. 1). World Scientific.

Decision

In mid-January of 2003, three months after the November 2002 shareholder meeting, the company surprised the investment community by announcing its first-ever annual cash dividend of 8 cents per share (2 cents per quarter). The dividend represented a total outlay of more than $850 million which translated into just over a quarter of 1 percent of the share price. While the dividend made big news, it was met with criticism that the dollar amount was insignificant.

Following the announcement speculation immediately arose over Microsoft's changein philosophy. One suggested reason for the dividend was President Bush proposed tax reform plan which would exempt shareholders from income tax on dividends (later changed to a 0.15 tax rate). Another possible reason, and the one that Microsoft stated publicly, is that many of thecompany's legal risks are largely behindthem. The company settled with the Justice Department and many private antitrust claimants and has made progress with the European Union.

Shareholder Reaction and Company Update

Microsoft's stock price dropped about $4 or7% the day following the dividend announcement. This was partially attributable to the relatively weak outlook for the current quarters, but the falling price was likely an indication that some investors concluded that Microsoft had exhausted its growth options and the future looked uncertain.

Despite the dividend payments and despite continued stock buy back, Microsoft continued to increase its cash balance. In July of 2004, the company announced it

Questions

would issue a special cash dividend of $3 per share payable on December 2, 2004. With almost 11 billion shares outstanding, the special dividend would return almost $33 billion in cash to shareholders. In July the company also announced that it would begin to pay a regular quarterly dividend of $0.08 per quarter. The move represented a doubling of the dividend-the second time the dividend had doubled since the initial dividend issuance. But even with the latestdoubling, Microsoft's yield will still bebelow the 1.7% average yield for the S&P 500.

1. Was the decision to start paying a cash dividend of $0.02 per share per quarter a good decision?
2. Was the $3 per share special dividend desirable?
3. What, if anything, should Microsoft have done with its $64 billion of cash and short term
4. investments?