The Dividend Decision_Final

The Dividend DecisionAnuj GoenkaChintan BhandariSiddharth Shah

IntroductionBlack (1976) in his study on dividend wrote, The harder we look at the dividend picture the more it seems like a puzzle, with pieces that just dont fit together.Foundational theoretical research proves that in efficient markets, dividends are deemed irrelevant for firm value.In case of inefficiency, standard finance theory has reintroduced justifications for paying dividends.

IntroductionTheories of dividend payments include :Dividends are simply a residual paid after setting investment policyDividends are a signal of valueDividend payments discipline managers from empire building, losing money on projects, etc.Dividends reflects the attribute s of investors they serve

Certain reasons why dividends is puzzling is due to high tax rates imposed on them by most countries

Factors Influencing Dividend DecisionStability of earnings Financing policy of the firmLiquidity of fundsDividend policy of competing firmsPast dividend ratesDebt obligationAbility to borrow

Growth needs of the companyProfit ratesLegal requirementsPolicy of controlCorporate taxation policyTax position of shareholdersEffect of trade policyAttitude of the investor group

Literature Review

Literature ReviewJensen (1986) argues that paying dividend forces managers to disgorge cash flow and leads to poor stewardship of the shareholders money in general.Miller (1986) noticed that dividends were taxed at twice the rate of capital gains on shares.Blume (1980) concluded that investors seem to shun extreme dividend policies but not high dividend yielding stocks.Shefrin & Statman (1984) presented a justification of the payment of dividends which invokes the Kahneman and Tverskys prospect theory.

Literature ReviewDeAngelo & Stulz (2006) stated that US companies with a high ratio of retained earnings to total shareholders equity, book value, pay dividends while those with low, or negative, retained earnings relative to shareholders equity do not.DeAngelo et al.(2006) studied US non-financial firms in the years 1973-2002 and recorded a steep decline in the number of firm paying dividends.Brav et al. (2005) found that managers feel share repurchase is better than initiating dividends.

Literature ReviewDhanani(2005) finds that it is hard to support any particular theory of what determines dividends, but also concludes:No relation exists between investment policy, capital structure and dividendsDividend is seen as a signal of value and sustained improvement in company performanceDividends are rarely raised to discipline managers Tax status seem to have little impact on dividend policy

Behavioral Corporate FinanceBaker and Wurgler (2011)Agents: Manager and InvestorResponses to securities mispricing and managerial decisionsApproaches: Catering Approach

Behavioral Signaling

Catering ApproachAssumptions

Imperfect arbitrage; markets are inefficient and rational investors have limited ability to correct mispricingManagers are smart; can distinguish market prices and fundamental valueManagers perceive these mispricing and make decisions to boost share prices above fundamental value known as catering

Catering ApproachLong (1978): Investors view cash dividends as a salient characteristicBaker and Wurgler (2004): Firms initiate dividends when shares of payers are at a premium and omit dividends when payers are at a discountBaker and Wurgler (2004): Premium reflects sentiment for safe dividend payers versus risky nonpaying growth firmsThis sentiment leads to investors flocking to the perceived safety of payers in gloomy periods and bid up their prices

Catering ApproachFocuses on managers understanding and actionsLimitations

No clear answer to why investor demand for payers vary overtime; tax code changes, changes in behavioral biases affecting such demand like loss aversion, reference dependenceOnly categorizes payers and non-payers and does not focus on quantum of payment

Behavioral SignalingAssumption

Investors are quasi-rational; have standard preferences and rational expectationsInvestors are loss-averse over the level of dividends; upward revision of dividends today signal that managers can meet or exceed that level tomorrowFocuses on quantum of payment and investor expectations

Behavioral SignalingBased on

Reference Dependence: judging utility derived by a reference point level of dividendsLoss aversion: tendency to perceive more disutility from decrease in dividends than utility from an equal-size increaseGoals

Why firms pay dividends at all; some sort of signalProve that dividend cuts are greeted very negatively

Research Gaps

Research GapsFrom the managements perspectiveFrom the investors perspective

Dividend Policy- Managements Perspective

Dividend Policy- Investors Perspective

Methodology

MethodologyThe investors' perspective is different for the different sectors

Event studyLintner modelFactor analysis By administering the survey

No empirical study has been done to establish a link between the event study and the behavioral aspect. Take an example from the paper. 2. Lintner- overconfidence, optimism, desired expectations*

thank you

No empirical study has been done to establish a link between the event study and the behavioral aspect. Take an example from the paper. 2. Lintner- overconfidence, optimism, desired expectations*