WHY DO FIRMS PAY DIVIDENDS?
INTERNATIONAL EVIDENCE ON THE
DETERMINANTS OF DIVIDEND POLICY
David Denis, Igor Osobov
9/19/2011
OUTLINE

I. Background: Existing theories for dividend policy

II. Sample selection a data description

III. Determinants of the propensity to pay dividends

IV. Changes in the propensity to pay dividends

V. Concentration of dividends and earnings

VI. Catering incentives & Propensity to pay dividends

VII. Conclusions
2
I. BACKGROUND: WHY DO FIRMS PAY DIVIDENDS?
 Existing
 1.
 2.
 3.
 4.
Theories:
Signaling
Clientele
Catering the investors
Lifecycle
3
SIGNALING THEORY
 Due
to information asymmetry, investors
look for information that may provide a
clue as to the firm's future prospects
 Dividend announcements convey
information to investors regarding the
firm's future prospects
4
CLIENTELE THEORY
 Firms
set dividend policy to satisfy the
demand for payouts from heterogeneous
dividend clienteles
 Similar idea as “product differentiation”
in economics
 The set of assets available to investors
allows them to build sufficiently welldiversified portfolios with the desired
dividend level and risk characteristics
5
CATERING THEORY
 Investors
may have preference for
dividend payers (dividend premium)
 Firms pay dividends when investors have
dividend premium, not paying when there
is no such premium
6
LIFE-CYCLE THEORY
 Driven
by the need to distribute the firm’s
free cash flow, in order to control agency
cost
 Trade-off between the flotation cost
savings and the agency costs of cash
retention
 Firms optimally alter dividends through
time in response to the evolution of their
opportunity set.
7
II. SAMPLE SELECTION A DATA
DESCRIPTION
Worldscope data
 All firms with information on total asset,
common equity, net income, interest expense;
 Nonmissing information for common dividends,
method of reporting long-term investments
having interest in excess of 50%
 Exclude utilities, financial firms and firms with
negative book equity
 Over the time period of 1989~2002

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III. DETERMINANTS OF THE
PROPENSITY TO PAY DIVIDENDS

Explanatory variables:





Size (percent of firms with smaller market
capitalization)
Growth opportunities (Vt/At),
Change in total asset (dAt/At),
Profitability (Et/At)
Earned/contributed equity mix (REt/BEt), proxy for
lifecycle stage
10
Table 1 Characteristics of payers and nonpayers
11
Table 2 The proportion of payers as a function of
earned and total equity
12
III. DETERMINANTS OF THE
PROPENSITY TO PAY DIVIDENDS
 To
quantify the marginal effects of the
explanatory variables in explaining
dividend payout decisions, run logit
regressions (multivariate analysis)
13
Table 4 Logit regressions to explain dividend payout
decision
14
III. DETERMINANTS OF THE
PROPENSITY TO PAY DIVIDENDS

Conclusion 1
Determinants are similar across countries: larger
size, greater profitability, greater
earned/contributed equity make the firms more
likely to pay dividends; the effect of growth
opportunities is ambiguous
15
IV. CHANGES IN THE PROPENSITY TO
PAY DIVIDENDS
How to measure the propensity?
 Baseline estimate: run regression using data of
the period 1989-1993 (base period), then
calculate the probability of dividend payments for
each firm in subsequent years based on their
characteristics in that year
 Changes in the propensity to pay dividends
(changes in the unexpected proportion of payers)
can be measured as the difference between the
expected and the actual proportion of payers

18
Table 5 Out-of-sample estimates from logit regressions
of the percent of firms paying dividends
19
Table 6 Unexpected reductions in the propensity to
pay dividends in 2002 by retained earnings/total
equity (RE/BE)
20
IV. CHANGES IN THE PROPENSITY TO
PAY DIVIDENDS


If there are reductions in the propensity to pay
dividends, they appear to be concentrated
among those firms most likely to be at the
margin for paying dividends
Can the reduction happen just because of
Wordscope coverage biases?
21
IV. CHANGES IN THE PROPENSITY TO
PAY DIVIDENDS
What is the primary cause for the shortfalls?
 Abandonment by existing payers
OR
 Unexpected failure to initiate by newly listed
firms


No material chagnes in the dividend policies of
firms that were listed prior to 1993
Table 8 Dividend abandonment versus failure to initiate
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V. CONCENTRATION OF DIVIDENDS AND
EARNINGS
 Propensity
to pay dividends declined (in
the US), but the aggregate real dividends
increase
 Strong correlation exists between the
concentration of dividends and
concentration of earnings and market
capitalization
25
Table 9 Aggregate real and nominal dividend payments
26
Table 10 The concentration of dividends, market
capitalization and earnings
27
V. CONCENTRATION OF DIVIDENDS AND
EARNINGS
 Dividend
signaling and clientele
consideration cannot be first-order
determinants of dividend policies
28
SIGNALING
 Not
supported by data
 Firms with low earned/contributed
equity seem more likely for dividend
signaling, but these are the ones that do
not pay dividends
 In recent years, dividends are becoming
more concentrated among the largest,
most profitable payers
29
CLIENTELE
 Not
supported by data
 Dividend payers account for more than
90% of the aggregate market
capitalization in most countries
 Top 20% of dividend payers account for
virtually all of the market capitalization
of dividend payers => not diverse
enough so satisfy investor demand
30
WHY DO FIRMS PAY DIVIDENDS?
 Existing
 1.
 2.
 3.
 4.
Theories:
Signaling
Clientele
Catering the investors
Agency cost-based lifecycle
31
VI. CATERING INCENTIVES IN EXPLAINED
THE PROPENSITY TO PAY DIVIDENDS
 If
catering theory is important in explaining
the propensity to pay dividends, then
(a). The percentage of unexpected dividend
payers should be highly correlated to dividend
premium
 (b). Dividend “switchers” would start and stop
paying dividends in response to the market’s
dividend premium


Dividend premium is defined as the difference between the log of
the weighted-average market-to-book ratio of payers and that of
nonpayers
32
Table 11 Dividend premiums and the unexpected proportion of dividend payers
33
VI. CATERING INCENTIVES IN EXPLAINED
THE PROPENSITY TO PAY DIVIDENDS
 (a).
The percentage of unexpected dividend
payers is correlated to dividend premium?
 NO!
 (b). Do dividend “switchers” start and stop
paying dividends in response to the market’s
dividend premium?
34
Table 12 Dividend premiums and the frequency of initiations and
omissions by dividend switchers
35
VI. CATERING INCENTIVES IN EXPLAINED
THE PROPENSITY TO PAY DIVIDENDS
 (a).
The percentage of unexpected dividend
payers is correlated to dividend premium?
 NO!
 (b). Do dividend “switchers” start and stop
paying dividends in response to the market’s
dividend premium?
 NO!
36
WHY DO FIRMS PAY DIVIDENDS?
 Existing
 1.
 2.
 3.
 4.
Theories:
Signaling
Clientele
Catering the investors
Agency cost-based lifecycle
37
VII. MAIN CONCLUSIONS
1. Larger, more profitable, greater retained
earnings/total equity ratio=> propensity to pay
dividends (the effect of growth opportunities is
ambiguous)
 2. In the period of 1994~2002, there is a
reduction in the propensity to pay dividends
(though the propensity declines are fairly small
and not always robust), driven by a failure of
newly listed firms to initiate dividends when
expected to
 3. Aggregate dividends not declined, and
concentrated among largest, most profitable firm

38
SUMMARY


Main Contribution: The first to provide
international evidence on the importance of
the earned/contributed equity mix in
dividend policies
Potential Future Research Area: Why newly
listed firms are less likely to initiate dividends in
recent years? Whether characteristics that are
not considered in the regression model caused
this?
39