dividend policies in an unregulated market: the london stock exchange, 1895-1905

Dividend Policies in an Dividend Policies in an Unregulated Market: Unregulated Market:

The London Stock Exchange, The London Stock Exchange, 1895-19051895-1905

Fabio Braggion Fabio Braggion (Tilburg University & (Tilburg University & CentER)CentER)

Lyndon Moore Lyndon Moore (Victoria University of (Victoria University of Wellington)Wellington)

A Study of Dividend Policies A Study of Dividend Policies at London Stock Exchange, at London Stock Exchange, 1895-19051895-1905


How much did companies pay? How much did companies pay?


How much did companies pay? How much did companies pay? Who were the payers?Who were the payers?


How much did companies pay? How much did companies pay? Who were the payers?Who were the payers? Why did they pay?Why did they pay?

Motivations:Motivations:History:History: very little knowledge of very little knowledge of dividend policies at the turn of the dividend policies at the turn of the Twentieth centuryTwentieth century

– On Britain: Church, Baldwin and Berry On Britain: Church, Baldwin and Berry (1994) on the Consett Iron Company(1994) on the Consett Iron Company

Motivations:Motivations:Finance:Finance: London Stock Exchange was London Stock Exchange was an interesting environmentan interesting environment

– Very Low Taxation on DividendsVery Low Taxation on Dividends

Very low taxation on Very low taxation on dividends…dividends…

Dividends were taxed only once… at a rate Dividends were taxed only once… at a rate of 5%of 5%

Capital gains were tax freeCapital gains were tax free

Corporate income was treated as Corporate income was treated as individual income…individual income…

……Companies just deducted the income tax Companies just deducted the income tax when paying dividends to shareholderswhen paying dividends to shareholders

Very low taxation of Very low taxation of dividends…dividends…

No different tax rates between retail investors No different tax rates between retail investors and institutionsand institutions– Friendly societies were an exception but their Friendly societies were an exception but their

activities appear limitedactivities appear limited

Less likely the existence of dividend clienteles Less likely the existence of dividend clienteles around dividend paying companiesaround dividend paying companies– Heavily taxed investors own low dividend sharesHeavily taxed investors own low dividend shares– Investors with low tax rates own high dividend Investors with low tax rates own high dividend

sharesshares(Michaely and Womack, 1995; Allen, Bernardo and Welch, 2000)(Michaely and Womack, 1995; Allen, Bernardo and Welch, 2000)

Motivations:Motivations:Finance:Finance: London Stock Exchange London Stock Exchange was an interesting environmentwas an interesting environment

– Also: No “Prudent Man” RegulationAlso: No “Prudent Man” Regulation

We can focus on the first We can focus on the first explanation:explanation:

– Asymmetric Information (Bhattacharya, Asymmetric Information (Bhattacharya, 1979; Miller and Rock, 1985; Jensen, 1986)1979; Miller and Rock, 1985; Jensen, 1986)

It is not clear whether a stock price reaction to a dividend increase or decrease is a response to

1. an asymmetric information problem 2. a reshuffling of clienteles

Our Work:Our Work: Collected information on dividend payments, Collected information on dividend payments,

accounting data and asset prices for about accounting data and asset prices for about 300 public companies between 1895 and 300 public companies between 1895 and 19051905

Identify dividend payers vs. non-payersIdentify dividend payers vs. non-payers

First attempt to evaluate different First attempt to evaluate different explanations of dividend policies… we will explanations of dividend policies… we will focus on asymmetric informationfocus on asymmetric information

We find:We find: More than 100 years ago companies paid More than 100 years ago companies paid

out as much as nowout as much as now

Profitable and more mature companies Profitable and more mature companies were more likely to pay dividendswere more likely to pay dividends

Dividends resolved an agency problem: Dividends resolved an agency problem: managers wanted to show they managers wanted to show they “behaved”“behaved”

The DataThe Data About 300 British Companies quoted at About 300 British Companies quoted at

the London Stock Exchangethe London Stock Exchange From Annual Reports Information From Annual Reports Information

about:about:– EarningsEarnings– Capital StructureCapital Structure– Dividend PaymentsDividend Payments– Book Value of the AssetsBook Value of the Assets– Dates of the Shareholders MeetingsDates of the Shareholders Meetings

The DataThe Data From the Times of London:From the Times of London:

– Weekly Asset Prices Weekly Asset Prices – Dividend Announcement datesDividend Announcement dates

Out of this data…Out of this data………we also construct:we also construct:

A Weekly Stock Price Index for the A Weekly Stock Price Index for the London Stock ExchangeLondon Stock Exchange

Market to Book Ratio (Tobin’s Q)Market to Book Ratio (Tobin’s Q)

How Much did they Pay?How Much did they Pay?

……. Now and Then….. Now and Then….

Allen and Michaely (1990s):Allen and Michaely (1990s):– 25 and 85%25 and 85%

Our Results:Our Results:– 73 and 92%73 and 92%

How Much did they Pay?How Much did they Pay?

Characteristics of Dividend Characteristics of Dividend Paying CompaniesPaying Companies

(Fama & French, 2001(Fama & French, 2001 DeAngelo, DeAngelo and Stultz, 2006)DeAngelo, DeAngelo and Stultz, 2006)

Logit regressionLogit regressionDependent Variable: Dependent Variable:

1 if the company paid an ordinary dividend in 1 if the company paid an ordinary dividend in 19011901

0 if it did not0 if it did not

We examine…We examine… … … 2643 Companies/years…2643 Companies/years…

– 573 (22%) Non-Payers573 (22%) Non-Payers– 2070 (78%) Payers2070 (78%) Payers

Regressors:Regressors: Contemporary and one year lagged Contemporary and one year lagged

profitabilityprofitability– Earnings after interest, depreciation and Earnings after interest, depreciation and

taxes. Reconstructed from the taxes. Reconstructed from the information provided in the balance information provided in the balance sheetssheets

Size: Total AssetsSize: Total Assets

Regressors: Growth Regressors: Growth Opportunities/ Life CyclesOpportunities/ Life Cycles

Idea: More mature companies should be Idea: More mature companies should be more likely to pay dividendsmore likely to pay dividends

Age of the Company:Age of the Company:– Proxied by year of incorporationProxied by year of incorporation

Earned Equity to Total Common EquityEarned Equity to Total Common Equity

Past Growth:Past Growth:

1-t

1-t1-tt

Assets TotalPaidoutAssets TotalAssets Total

Interpreting the Results:Interpreting the Results: Contemporaneous Earnings are the most Contemporaneous Earnings are the most

important determinant:important determinant:– increasing profitability from the first to the third increasing profitability from the first to the third

ROA quintile would increase firm’s probability of ROA quintile would increase firm’s probability of paying dividends from 60% to 80%paying dividends from 60% to 80%

The effect of Age is not very strongThe effect of Age is not very strong An standard deviation increase of Earned An standard deviation increase of Earned

Equity to Common Equity increases the Equity to Common Equity increases the probability of paying dividends of about 27%probability of paying dividends of about 27%

Cash to Total Assets has positive sign and it Cash to Total Assets has positive sign and it is marginally statistically significantis marginally statistically significant

Why did they pay?Why did they pay?Evaluating ExplanationsEvaluating Explanations

We focus on explanations based on We focus on explanations based on Asymmetric Information:Asymmetric Information:– Dividends as a Costly Signal:Dividends as a Costly Signal:

Dividends are signals for good investment Dividends are signals for good investment opportunities in the futureopportunities in the future

– Dividends and Agency TheoryDividends and Agency TheoryDividends are a way to discipline managers, Dividends are a way to discipline managers, especially in low growth/cash rich especially in low growth/cash rich companiescompanies

PredictionsPredictionsDividends as a Signal:Dividends as a Signal:– A dividend initiation or increase should A dividend initiation or increase should

be followed by a rise of stock returnsbe followed by a rise of stock returns– A dividend cut or omission should be A dividend cut or omission should be

followed by a decline of stock returnsfollowed by a decline of stock returns

PredictionsPredictionsDividends and Agency:Dividends and Agency:– A dividend initiation or increase should be followed A dividend initiation or increase should be followed

by a rise of stock returns for low q companiesby a rise of stock returns for low q companies– A dividend initiation or increase should have no A dividend initiation or increase should have no

effect (or generate of moderate rise) of stock effect (or generate of moderate rise) of stock returns for high q companiesreturns for high q companies

– A dividend omission or decrease should be A dividend omission or decrease should be followed by a decline of stock returns for low q followed by a decline of stock returns for low q companiescompanies

– A dividend omission or decrease should have no A dividend omission or decrease should have no effect (or generate of moderate declie) of stock effect (or generate of moderate declie) of stock returns for high q companiesreturns for high q companies

Again DataAgain Data Because of asset prices availability we focus Because of asset prices availability we focus

on 63 companieson 63 companies We observe 390 dividend announcements We observe 390 dividend announcements

over the period January 1901 through over the period January 1901 through December 1905December 1905

Out of 390 announcements we have:Out of 390 announcements we have:o 44 dividend omissions 44 dividend omissions o 13 dividend commencements (or 13 dividend commencements (or

recommencements)recommencements)o 115 dividend increases 115 dividend increases o 133 dividend decreases133 dividend decreaseso 87 dividends left unchanged87 dividends left unchanged

Summary of the ResultsSummary of the Results A dividend decrease or omission leads A dividend decrease or omission leads

to a decline of 1.4-2.4% of Stock to a decline of 1.4-2.4% of Stock ReturnsReturns

This effect is driven by low-Q This effect is driven by low-Q companiescompanies

No effects on High-Q companiesNo effects on High-Q companies

– There is support for the Agency Theory of There is support for the Agency Theory of DividendsDividends

Conclusions and Future Conclusions and Future DirectionsDirections

Solve the “liquidity problem”Solve the “liquidity problem”

Evaluation of Behavioral Evaluation of Behavioral Explanations and evidence of Explanations and evidence of “Catering”“Catering”

Longer run analysis and price driftLonger run analysis and price drift

dividend policies in an unregulated market: the london stock exchange, 1895-1905

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