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Editorial introduction to the special issue on dividends and dividend policy
Article Type: Guest editorial From: Managerial Finance, Volume 41, Issue 2
Welcome to this special issue on Dividends and Payout Policy. As co-editors of the issue, we present five noteworthy papers that contribute new insights to this timeless topic. Dividend policy refers to the payout policy that a firm follows in determining the size and pattern of distributions to shareholders over time. For academics, explaining why firms actually pay dividends has been a thorny issue without a simple or obvious solution. We are reminded of Black’s (1976, p. 5) comment that “The harder we look at the dividend picture, the more it seems like a puzzle, with pieces that just don’t fit together.” However, in a controversial paper, DeAngelo and DeAngelo (2006) claim that Black’s (1976) dividend puzzle is a non-puzzle. This is because the crux of the puzzle rests on the mistaken idea that Miller and Modigliani’s (1961) theorem applies to payout and retention decisions, which it does not. Whether a dividend puzzle exists is still subject to debate and hence is not resolved here.
Judging from the number of books and articles on this subject, dividend policy has both captivated and puzzled academic researchers for decades. Many have been preoccupied with academic issues that are of little interest to practicing financial managers or investors. Although corporate executives may wrestle with determining an appropriate dividend policy, they still must do so and typically act as though their firm’s dividend policy is relevant despite the controversial arguments set forth by Miller and Modigliani (1961) that dividends are irrelevant in determining firm value.
According to DeAngelo and DeAngelo (2006), the seminal work of Miller and Modigliani (1961) on dividend irrelevance sent researchers searching for frictions that would make dividend policy matter, when it mattered all along. Some are still searching. Researchers have tried and failed to develop an optimal dividend policy that uniformly fits all firms at all times. Modeling such a universal or macro-level policy is unlikely to be fully successful because directors and executives develop dividend policy at the firm or micro-level basis. Hence, dividend policy is sensitive to various factors such as market frictions, firm and market characteristics, corporate governance, and legal environments.
According to Lease et al. (2000, p. 179), “These researchers have ‘tortured’ the data, imploring a confession to support or reject the various theories. However, to a very large degree, the data have resisted providing definitive answers.” More recently, Baker (2009, p. 16) notes, “Despite much study, researchers still do not have all the answers to the dividend puzzle.” After decades of research, empirical evidence offers some general guidelines or stylized facts about dividends and dividend policy in the real world. Additionally, survey research provides a better understanding of how managers view dividends and how they make dividend policy decisions.
The issue begins by taking the unusual approach of providing a survey of literature reviews on dividends and payout policy in our article “Corporate payout policy revisited” (Baker and Weigand, 2015). We review not only the theoretical and empirical research pertaining to the various factors thought to affect payout policy, but also whether the academic research is corroborated by survey evidence regarding the mindsets of the directors and executives who actually determine an individual firm’s payout policy. Our review indicates that the importance of cash dividends as a component of investors’ total returns has declined over time, as share repurchases now constitute a substantial amount of the total cash disbursed to stockholders in most countries permitting buybacks. Although no singular set of factors can be applied to every firm, as dividend policy is shaped by many determinants, including both market- and firm-specific criteria, a subset of factors appears to be consistently important to many firms’ payout decisions. These factors include the stability of past dividends and the level of current and anticipated future earnings. Taking a bit of editorial license, if we were to give an award for the most prescient dividend paper ever written, we would bestow it on Lintner (1956), whose description of the way managers conservatively smooth past and current earnings changes into the level of the firm’s dividend remains remarkably accurate almost 60 years after it was first published. Several of the papers published in this issue present findings that are consistent with Lintner’s original insights.
The second paper in this issue, “Market power and dividend policy,” (Booth and Zhou, 2015) introduces a unique perspective on the dividend question by considering how a firm’s competitive position influences its propensity to pay dividends. Booth and Zhou assert that the twenty-first century has ushered in a wave of deregulation and Schumpeterian creative destruction that has permanently altered the competitive landscape in the USA, and that this higher level of competiveness has increased the business risk of the average firm. The essence of the authors’ argument is that the degree of financial risk a firm chooses is proportional to the business risk it faces, as financial risk generally magnifies basic business risk. Since firms are continually adjusting their financial policies based on changes in their competitive position, feedback must exist between business risk and payout policy, which is an important aspect of financial policy. Booth and Zhou reason that not only will younger, newly listed firms eschew dividends due to their higher business risk, but also older, more established companies that face increases in competition will be reluctant to either initiate dividends (if they have yet to begin paying) or increase dividends vigorously (if they have a track record as a dividend-payer). The key factor determining whether a firm’s dividend policy is hampered by competition is its “market power,” which includes the ability to pass the costs of competitive shocks onto the firm’s customers. The authors measure market power in various ways, including industry concentration, the degree of foreign competition, and a firm’s pricing power. They present convincing evidence that not all firms that are maturing and growing more slowly pay larger and more frequent dividends, but firms such as these do so only when their greater maturity and size have led to an increase in market power, which results in a more stable earnings stream that supports higher dividend payments.
The third paper in the issue, “Dividend yields and stock returns in Hong Kong” (Lemmon and Nguyen, 2015), revisits the positive relationship between stocks’ dividend yield and their risk-adjusted returns, known as the dividend yield effect. The research questions that Lemmon and Nguyen investigate pertain to dividend policy specifically, the well-known finding that stocks with higher dividend yields tend to earn higher risk-adjusted returns. The question is: Are these higher returns compensation for the extra tax burden of receiving a greater proportion of annual returns in the form of dividends, or simply an anomaly resulting from yet-to-be-identified firm-level factors that are omitted from the models used to analyze stock returns? Their study also implicitly addresses the “tax-capitalization” hypothesis, which is the larger question of whether asset prices and expected returns generally reflect investor-level tax burdens.
Lemmon and Nguyen (2015) study a sample of dividend-paying stocks listed in Hong Kong, which provides a natural laboratory for investigation of this issue, as this region imposes no taxes on dividend income or capital gains. Similar to the results of previous studies, they find that a 1 percent increase in dividend yield is accompanied by returns that are also 1 percent higher, on average. These results cast doubt on pure tax-based explanations of the dividend yield effect, and strongly suggest that additional non-tax factors are the primary determinant of this phenomenon. Their study also demonstrates the difficulty of conducting powerful tests of the dividend yield effect, thus reinforcing the need for researchers to exert great care when interpreting the results of their own and prior studies focussed on either the dividend yield or tax-capitalization hypotheses. Their conclusions also naturally suggest an agenda for future research into one or both of these topics to identify the elusive omitted factors.
The issue’s fourth paper, “Dividend policy in India: new survey evidence” (Baker and Kapoor, 2015), presents survey evidence on questions about dividend policy in India. This study reveals new information about the factors influencing Indian managers’ dividend decisions, how dividend policy in India might differ from the USA and Canada, and how Indian managers view the relationship between dividend policy and repurchases and the value of their firms.
The results of the survey reveal similarities with their managerial counterparts around the world. At least half of the respondents view past, current, and expected future earnings as relevant to their dividend decisions, along with the company’s previous commitment to maintaining dividends. Other factors that survey respondents view as important include liquidity constraints (availability of cash) and the desire to target a consistent payout ratio. One of the survey’s most striking findings is that out of 21 factors surveyed, using dividend policy to signal information about future earnings ranked last, which allows the authors to offer a clever insight: “[Perhaps] academics […] like signaling theory because it lends itself to complicated modeling.” Baker and Kapoor also find that Indian managers share similar attitudes toward old-school. Lintner’s (1956) perspectives on dividends with their US and Canadian counterparts, particularly about the need to target a consistent payout ratio and to avoid changes in dividends that might have to be reversed in the near future.
The fifth paper in the issue is a study entitled “The post-repurchase announcement drift: an anomaly in disguise?” (Ngyuen, 2015). The author investigates how much of the post-repurchase announcement drift in stock prices is actually due to price drift related to prior announcements of superior earnings. His work follows from previous research showing that the price drift observed following announcements of dividend reductions and omissions is mainly due to disappointing earnings announcements made earlier. Ngyuen eliminates firms from his sample that announce repurchases but fail to follow through, as studies report no price drift for firms that cry wolf (or in this case “repurchase”). He finds that the post-announcement price drift for firms actually repurchasing shares is not significantly different than the price drift observed for firms of similar size with comparable earnings performance that do not announce plans to repurchase shares. Therefore, he concludes that the post-repurchase announcement price drift is actually due to preceding earnings announcements, and not unique information conveyed by the decision to repurchase shares. Contrary to the predictions of the greatly beleaguered efficient markets hypothesis, evidence continues to mount that it can sometimes take years for information to be fully reflected in asset prices.
After reading these five articles, we trust that you will agree that dividends and dividend policy is an intriguing topic in corporate finance. The journey, however, is not over and many avenues of research still remain to be explored on this topic.
Professor H. Kent Baker, Kogod School of Business, American University, Washington, District of Columbia, USA, and
Dr Rob Weigand, School of Business, Washburn University, Topeka, Kansas, USA
Baker, H.K. (2009), Dividends and Dividend Policy, John Wiley & Sons, Hoboken, NJ
Baker, H.K. and Kapoor, S. (2015), “Dividend policy in India: new survey evidence”, Managerial Finance, Vol. 41 No. 2, pp. 182-204
Baker, H.K. and Weigand, R.A. (2015), “Dividends and dividend policy”, Managerial Finance, Vol. 41 No. 2, pp. 122-125
Black, F. (1976), “The dividend puzzle”, Journal of Portfolio Management, Vol. 2 No. 2, pp. 3-8
Booth, L. and Zhou, J. (2015), “Market power and dividend policy”, Managerial Finance, Vol. 41 No. 2, pp. 145-163
DeAngelo, H. and DeAngelo, L. (2006), “The irrelevance of the MM dividend irrelevance theory”, Journal of Financial Economics, Vol. 79 No. 2, pp. 293-315
Lease, R.C., John, K., Kalay, A., Loewenstein, U. and Sarig, O.D. (2000),Dividend Policy – Its Impact on Firm Value, Harvard Business School Press, Boston, MA
Lemmon, M. and Nguyen, T. (2015), “Dividend yields and stock returns in Hong Kong”, Managerial Finance, Vol. 41 No. 2, pp. 164-181
Lintner, J. (1956), “Distribution of incomes of corporations among dividends, retained earnings and taxes”, American Economic Review, Vol. 46 No. 2, pp. 97-113
Miller, M.H. and Modigliani, F. (1961), “Dividend policy, growth, and the valuation of shares”, Journal of Business, Vol. 34 No. 4, pp. 411-433
Ngyuen, T.T., Dung (June) Pham and Sutton, N.K. (2015), “The post-repurchase announcement drift: an anomaly in disguise?”, Managerial Finance, Vol. 41 No. 2, pp. 205-224