payout policy in the 21 st century
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Payout Policy in the 21 st Century. Alon Brav Duke University, Durham, NC USA John R. Graham Duke University, Durham, NC USA Campbell R. Harvey Duke University, Durham, NC USA National Bureau of Economic Research, Cambridge, MA USA Roni Michaely Cornell University, Ithaca, NY USA - PowerPoint PPT PresentationTRANSCRIPT
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Payout Policy in the 21Payout Policy in the 21stst Century CenturyAlon Brav
Duke University, Durham, NC USA
John R. GrahamDuke University, Durham, NC USA
Campbell R. HarveyDuke University, Durham, NC USA
National Bureau of Economic Research, Cambridge, MA USA
Roni MichaelyCornell University, Ithaca, NY USA
IDC, Israel
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Brav/Graham/Harvey/Michaely: Payout Policy
Introduction
• In 1956, John Lintner laid the foundation for the modern understanding of dividend policy
• He conducted detailed interviews with 28 companies• His research helped set the agenda for theoretical and empirical
research on dividend policy
• Much has changed in the last 50 years. – Possibly different payout policy goals– Repurchases– More insights from theory that may help direct the spotlight in the right
direction
• We revisit this path-breaking study at the beginning of the 21st century
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Brav/Graham/Harvey/Michaely: Payout Policy
Introduction
• We survey 384 financial executives with an instrument that focuses on both dividends and repurchases– 256 public, 128 private
– Most presented results are based on the public firms
• We conduct one-on-one interviews with 23 CFOs or Treasurers of prominent corporations– Interviews last between 40 minutes and two hours
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Brav/Graham/Harvey/Michaely: Payout Policy
Methodology
Survey and Interview Design• Draft survey instrument “refereed” by both finance
researchers and experts in survey design• Interviewed structured to adhere to best scientific
practices of interviews, e.g. Sudman and Bradburn (1983)
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Brav/Graham/Harvey/Michaely: Payout Policy
Methodology
Survey Delivery• Survey CFOs, Treasurers, Finance VPs• Primarily members of Financial Executives
International• Two $500 random winners• Three surveys
– FEI CFO Forum (April 23, 2002, Co. Springs CO)– Dave Ikenberry NFCF (May 1, 2002, Houston TX)– Mass emailing to 2200 FEI members– Overall ~16% response rate
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Goals of Treasury department:• Fund investment
– M&M
• Liquidity and possible contingencies• Payout decisions are second-order
Except...• DO NOT CUT DIVIDENDS ranks equal to or
above all of these items
Brav/Graham/Harvey/Michaely: Payout Policy
How are payout decisions made?
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Brav/Graham/Harvey/Michaely: Payout Policy Payout vs. Investment Decisions
0% 10% 20% 30% 40% 50% 60% 70% 80%
Percent of CFO's who rate choice as +1 or +2 (on scale of -2 to +2)
6j: M&A strategy
7j: M&A strategy
6h: Good alternative investments
7h: Good alternative investments
3a: Investment decision made 1st
4a: Investment decision made 1st
3e: Fund externally, rather than cut
4e: Fund externally, rather than cut
Repurchases Dividends
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Brav/Graham/Harvey/Michaely: Payout Policy
Dividends vs. Repurchases (Fig. 2)
0% 10% 20% 30% 40% 50% 60% 70% 80%
Other
Retain as cash
Invest more
Mergers/Acquisitions
Repurchase shares
Pay down debt
Fig. 2A: Of funds that are used to pay dividends, what is their most likely alternative use? (Current dividendpayers only). For each response we report the percentage of respondents who answer 1 or 2 on a scale from -2 to+2.
0% 10% 20% 30% 40% 50% 60% 70% 80%
Other
Pay more dividends
Retain as cash
Invest more
Mergers/Acquisitions
Pay down debt
Fig. 2B: Of funds that are used to repurchase shares, what is their most likely alternative use? (Current sharerepurchasers only). For each response we report the percentage of respondents who answer 1 or 2 on a scalefrom -2 to +2.
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Brav/Graham/Harvey/Michaely: Payout Policy
Complements or Substitutes?
• Level of dividend fixed
• Substitute repurchases for change in dividends– One way substitution
• Would use even more repurchases if they were free of constraint of dividend history
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Brav/Graham/Harvey/Michaely: Payout Policy
Lintner (1956)
Three main points• Target payout ratio (dividend/earnings)• Dividend policy set conservatively
– “partial adjustment” to target payout– smooth through time– sticky (history important)
• Level given, focus on changes
– tied to long-run sustainable earnings– do not increase now if you might have to cut later
• No repurchases
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Brav/Graham/Harvey/Michaely: Payout Policy
Compare to Lintner (1956)
Dividend policy still “conservative”?• Yes• Perceived big penalty for cut, small reward for
increase– So, smooth, to avoid future cuts
• Path dependence of dividend policy• BUT
– stealth dividend cut if possible
– holding dividend constant OK
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Brav/Graham/Harvey/Michaely: Payout Policy Payout Decisions Still Made Conservatively? vs. Lintner (1956)
Repurchases: No, flexible Dividends: Yes, still conservative
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Percent of CFO's who rate choice as +1 or +2 (on scale of -2 to +2)
5c: smooth from year to year
5j: not want to cut in future
5b: change in div what matters
6L: Maintain historic policy
7L: Maintain historic policy
3d: Neg. consequence to cutting
4d: Neg. consequence to cutting
5d: Try to avoid cutting
6d: Try to avoid cutting
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Brav/Graham/Harvey/Michaely: Payout Policy Conservatively increase payout? Similar to Lintner (1956)?
0% 10% 20% 30% 40% 50% 60% 70% 80%
Percent of CFO's who rate choice as +1 or +2 (on scale of -2 to +2)
6a: Temporary increase in earnings
7a: Temporary increase in earnings
6d: Excess cash on balance sheet
7d: Excess cash on balance sheet
6b: Sustainable change in earnings
7b: Sustainable change in earnings
6c: Stability of future earnings
7c: Stability of future earnings
RepurchasesDividends
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Brav/Graham/Harvey/Michaely: Payout Policy
Payout ratio still target? vs. Lintner (1956)
0% 10% 20% 30% 40% 50% 60%
Other
Do not target at all
Dividend yield
Growth in dividends per share
Dividend as a % of earnings
Level of dividends per share
For those that paid dividends within the past 3 years, what do you target when you make your dividend decisions?
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Brav/Graham/Harvey/Michaely: Payout Policy
Payout ratio still target? vs. Lintner (1956)
0% 10% 20% 30% 40% 50% 60%
A strict goal
Not really a goal
A somewhat strict goal
A flexible goal
For those that paid dividends within the past 3 years, is the target part of a strict goal or a flexible goal?
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Brav/Graham/Harvey/Michaely: Payout Policy
Payout ratio still target? vs. Lintner (1956)
Extension of Fama-Babiak (1968), Choe (1990)
• The SOA= and TP= . • Both SOA and TP have declined through time using
both matching sample to our survey and broader Compustat sample
.21,1, uEDD ititiiiti
1̂ 12 ˆ/ˆ
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Brav/Graham/Harvey/Michaely: Payout Policy
Summary vs. Lintner (1956)
• Dividend policy still very conservative• Modern cash cows live in (close to) Lintner
world• Repurchase policy is not (i.e., it is more flexible)
• Payout ratio no longer target• Targets very flexible
• Repurchases now very important
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Brav/Graham/Harvey/Michaely: Payout Policy
Miller and Modigliani (1961)
• Payout Policy irrelevant if capital markets perfect
• Imperfections that could explain payout policy– Taxes– Managerial agency conflict– Information/signaling – Other factors (EPS, float, credit ratings, etc)
• Clienteles could result from imperfections
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Brav/Graham/Harvey/Michaely: Payout Policy
A. Taxes
• Theory: At least for individual investors, dividends are taxed move heavily than capital gains.
• Therefore:– Firms should consider investors’ taxation when
deciding about payout policy – Relative taxation should affect the amount of
dividends they pay
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Brav/Graham/Harvey/Michaely: Payout Policy
A. Taxes• Interviews: repurchases are “efficient way to return capital”
– taxes (2nd order) important
• Surveys: modest support
0% 10% 20% 30% 40% 50% 60% 70% 80%
Percent of CFO's who rate choice as +1 or +2 (on scale of -2 to +2)
8a: Investor taxes lower vs. dividends
6g: Investor taxes
7g: Investor taxes
Repurchases Dividends
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Brav/Graham/Harvey/Michaely: Payout Policy
B. Clienteles• Investors that pay (relatively) more taxes on
dividends should hold stocks that pay out through repurchases.– Translation: Individual investors should have
an aversion to dividend paying stocks. By implications, institutions should be more attracted to such stocks.
• Prudent man• Institutions as monitors
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Brav/Graham/Harvey/Michaely: Payout Policy
B. Clienteles
• Retail investors– Prefer dividends, in spite of tax disadvantage
– Firms like because loyal
• Institutions– If anything, prefer repurchases
– Some can not invest in zero dividend stocks
• 42% say pay dividends because of prudent man rules
– Tax advantage not an issue to institutions
– Firms like because they “have the money”
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Brav/Graham/Harvey/Michaely: Payout Policy
B. Clienteles• Companies do not think that dividends attract institutions more so than do
repurchases• Companies do not use dividends or repurchases attract institutions to
monitor• Inconsistent with Allen, Bernardo, and Welch (2000) idea that firms use
dividends to attract institutional investors
0% 10% 20% 30% 40% 50% 60% 70% 80% 90%
Percent of CFO's who rate choice as +1 or +2 (on scale of -2 to +2)
6n: Attract retail investors7n: Attract retail investors
6i: Influence of institutions7i: Influence of institutions
6p: Attract inst. bc they monitor7p: Attract inst. bc they monitor
6o: Attract institutions7o: Attract institutions
Repurchases Dividends
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Brav/Graham/Harvey/Michaely: Payout Policy
C. Agency Stories
• Firms pay dividends to impose discipline on managers
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Brav/Graham/Harvey/Michaely: Payout Policy
C: Free Cash Flow
• Interviews: some say: “money can burn hole in pocket”
– But payout not the way to fix the problem
• Surveys: (1) no support in general, (2) repurchases work as well as dividends but (3) Cash cows are much more likely to pay; more reluctant to cut; more likely to keep dividend growth as earnings growth
0% 10% 20% 30% 40% 50% 60% 70% 80%
Percent of CFO's who rate choice as +1 or +2 (on scale of -2 to +2)
6f: Disciplinary role
7f: Disciplinary role
Repurchases Dividends
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Brav/Graham/Harvey/Michaely: Payout Policy
D. Asymmetric Information
• Conveying information
• Costly self-imposed action—Signaling
• Adverse selection – Do informed investors benefit from repurchase programs,
at expense of uninformed?
• Stock undervaluation
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Brav/Graham/Harvey/Michaely: Payout Policy
D: Do payout decisions convey information? • Interviews: Yes, punctuation mark at end of sentence
– Need to be consistent with other forms of communication– Repurchases convey as much as dividends
• Surveys: Yes, convey info in general
0% 10% 20% 30% 40% 50% 60% 70% 80% 90%
Percent of CFO's who rate choice as +1 or +2 (on scale of -2 to +2)
6m: Running low on investments?
7m: Running low on investments?
3b: Convey information?
4b: Convey information?
Repurchases Dividends
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Brav/Graham/Harvey/Michaely: Payout Policy Information: Signaling
0% 10% 20% 30% 40% 50% 60% 70% 80%
Percent of CFO's who rate choice as +1 or +2 (on scale of -2 to +2)
5g: bear external financing cost
5h: investor bear dividend tax
5i: pass up good investments
3i: Show we can bear costs
4i: Show we can bear costs
3h: Look better than competitors?
4h: Look better than competitors?
Repurchases Dividends
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Brav/Graham/Harvey/Michaely: Payout Policy
D. Information: Signaling• Surveys
– No supporting evidence – Scores are even lower for growth/risky firms– 39% (16%) say keep div (repurchase) policy of peers
• Interviews– Spent hours on this issue– Generally try to group selves with peers (not separate)– No evidence of
• increasing dividend to show market that firm is strong• viewing dividend as self-imposed cost
– Avoiding dividend cut• Possibly a signal (costly for bad firms, separate from bad)• Cuts are rare – can’t explain dividend policy for most firms• Does not explain why firms pay dividends in the first place
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Brav/Graham/Harvey/Michaely: Payout Policy
D. Information: Stock Price• Interviews: Would like to buy when price low, but
– often want to maintain liquidity at this time– do not want credit rating downgrade– So, it’s a conditional objective
• Surveys: repurchases, stock good investment
0% 10% 20% 30% 40% 50% 60% 70% 80%
Percent of CFO's who rate choice as +1 or +2 (on scale of -2 to +2)
6q: Stock price low
7q: Stock price low
Repurchases Dividends
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Brav/Graham/Harvey/Michaely: Payout Policy
E. Other factors: EPS• Interviews: managers are concerned about EPS
– Some think it’s automatic that repurchases increase EPS– Other believe that it depends on alternative use of funds
• Surveys: EPS important
0% 10% 20% 30% 40% 50% 60% 70% 80% 90%
Percent of CFO's who rate choice as +1 or +2 (on scale of -2 to +2)
8g: Options not dividend protected
8f: Offset stock option dilution
8b: Increase EPS
Repurchase questions
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Brav/Graham/Harvey/Michaely: Payout Policy
E. Other factors: Float and credit ratings• Interviews: Float very important
– Execs think they need to have a large number of shareholders
• Interviews: credit rating important– Hoard cash to improve rating– Especially for financial firms or firms with financial divisions
Repurchases Dividends
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Brav/Graham/Harvey/Michaely: Payout Policy
Initiate with repurchases or dividends?
0% 10% 20% 30% 40% 50% 60% 70%
some combination ofdividends andrepurchases
dividends only
share repurchases only
Fig. 6D: What would your first payout be if you were hypothetically deciding to pay out capital for the first time. (For
neither dividend payers nor share repurchasers only.)
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Brav/Graham/Harvey/Michaely: Payout Policy Why initiate payout?
0% 10% 20% 30% 40% 50% 60% 70% 80%
Percent of CFO's who rate choice as +1 or +2 (on scale of -2 to +2)
9L: Offset stock option dilution
9j: Increase EPS
9n: Float/liquidity improves
10c: Extra cash
9c: Extra cash
10L: convey info bc undervalued
9m: convey info bc undervalued
10i: stock undervalued
9i: stock undervalued
Repurchases Dividends
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Brav/Graham/Harvey/Michaely: Payout Policy
Conclusions
• Payout policy is not first-order important* (M&M)
• Repurchases: decided de novo
• Dividends: level very important
• Managers prefer repurchases over dividends because they are more flexible. – Not because of taxes.
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Brav/Graham/Harvey/Michaely: Payout Policy
Conclusions
• According to managers, payout– convey information – NOT being used as a costly signal– NOT being used to attract institutions
• Managers do not use dividends over repurchases to attract institutions
• Institutions do not push for more dividends
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Brav/Graham/Harvey/Michaely: Payout Policy
Conclusions
• Managers of cash cows believe more strongly that– Dividends should be stable– Keeping dividend growth rate with earnings
growth
• But all managers reject the notion that they need dividends so that they will not spend cash unwisely.
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Brav/Graham/Harvey/Michaely: Payout Policy
Rules of the Game: How payout policies are determined
• Make investment plans first*
• Take care of cash/liquidity needs
• *BUT, remember, level of dividends fixed• Only reduce dividends in extraordinary
circumstances• Severe penalty for cutting dividend because the market
believes that “cuts precede bad news”• So, don’t ever cut dividends
• unless you have an amazing investment opportunity• smaller penalty if competitors cut
• Think very carefully before initiating dividends
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Brav/Graham/Harvey/Michaely: Payout Policy
Rules of the Game
• Desire to maintain the level of dividend “at any cost” consistent with findings in Graham, Harvey and Rajgopal, 2004, “The Economic Implications of Corporate Financial Reporting”• Here managers desire to hit consensus EPS “at any cost”• 55% would knowingly sacrifice value (not pursue a very
positive NPV project) if it would cause the firm to miss next quarter’s target!
• 78% would knowingly sacrifice value to smooth earnings