Elco Electric Corporation has a stock price of $150 per share and is contemplating the payment of a large one-time cash dividend of $40 per share. The underlying motivation for the large payout comes from management’s belief that the firm has more cash than it can profitably reinvest and to keep the cash would adversely affect the incentives of the workforce to strive to create shareholder value. Consequently, the firm’s management decided to pay out the large cash dividend. What do you think the ex-dividend-date price of the company’s shares will be?
If the firm’s management is right about the stimulating effect of disgorging cash, do you think that the drop in stock price after the ex-dividend date will be smaller than otherwise expected? Why or why not?