Why Do Firms Pay Stock Dividends: Is it Just a Stock Split? by Xi He, Mingsheng Li, Jing Shi, Garry Twite :: SSRN

Why Do Firms Pay Stock Dividends: Is it Just a Stock Split? by Xi He, Mingsheng Li, Jing Shi, Garry Twite :: SSRN:

Abstract:

"This paper examines why firms choose to pay stock dividends. Using a sample of listed Chinese firms, we find that younger, more profitable firms, with lower leverage, high levels of retained earnings, private ownership prior to listing, investing more in fixed assets and operating in regions with lower shareholder protection are more likely to pay stock dividends. Consistent with stock dividends substituting for stock splits, our evidence indicates that the initiation of a stock dividend is associated with a significant positive market reaction and increased analyst following, suggesting that firms use stock dividends to attract analysts’ attention. In addition, the positive announcement effect for stock dividends increases with the size of the split factor, suggesting that management making use of stock dividends to keep the firm’s stock price within its acceptable trading range."

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• Colgate plans stock split, hikes dividend
• How the S&P's Top Dividend Stocks Have Fared in 2013

Silent Combat: Do Managers Use Share Repurchases to Trade Against Short Sellers? by Harrison Liu, Edward Swanson :: SSRN

Silent Combat: Do Managers Use Share Repurchases to Trade Against Short Sellers? by Harrison Liu, Edward Swanson :: SSRN:

I caught myself literally saying "Wow" when I read this....

Liu and Swanson look at the timing of stock repurchases. Past literature had shown that managers prefer share repurchases to dividends. One reason often given for this preference is the flexibility that buybacks have as opposed to dividends which, once set, are rarely lowered. We have known that this flexibility results in some market timing but what had only been speculated on, was that managers use buybacks to counter act short selling.

The Abstract: (emphasis is my own)

Abstract:
Motivated by the substantial capital used to repurchase stock and its potential to affect price discovery, we develop an empirical model of changes in corporate share repurchases. We find that several accounting measures of capital availability and firm performance influence repurchases, but our novel discovery is that corporate managers trade against shorts by increasing share repurchases in response to an increase in short sales. Trading against shorts appears to violate SEC regulations that price be set by “independent market forces without undue influence by the issuer.” We also examine how managers trade with their personal capital. In general, they trade with short sellers (i.e., selling when shorts sell); however, managers change their behavior and do not sell when the company is repurchasing shares. By not selling their personal stock holdings, managers maintain the credibility of the buy signal from the corporate share repurchases.

Two "Look-ins":

"We estimate that quarterly share repurchases increase by an average of $1,140,000 for each one percentage point increase in short interest. This trading is unlikely to result from reverse causation, whereby short sellers react to corporate repurchases (i.e., endogeneity), because (1) short sellers have no incentive to increase their position when a company is buying back its shares, and (2) the amount of corporate share repurchases is reported quarterly, so it is not readily available to shorts in a timely manner."

and

"Managers can easily monitor the aggregate short position in their company’s stock since short interest is publicly reported....managers’ could adjust share repurchases to counteract changes in short sales. International Bancshares Corporation (IBC) is one of the few companies to publicly admit to this practice. In a press release on March 25, 2009, IBC states that it “is particularly vulnerable to the harmful practices of short-traders because under CPP, the Company is prohibited from repurchasing its common stock. (CCP refers to the U.S. Treasury Department’s Capital Purchase Program.) The Treasury, which held stock warrants as part of TARP funding, responded by granting IBC permission to repurchase stock. "

Fascinating stuff! I^3 (Interesting, important, and informative!)



Cite:
Liu, Harrison and Swanson, Edward P., Silent Combat: Do Managers Use Share Repurchases to Trade Against Short Sellers? (January 16, 2012). Available at SSRN: http://ssrn.com/abstract=1986396

Related articles

• Questioning the Evil of Short Sales (nytimes.com)

Will dividend increase be short-lived?

First of all, we should note that dividend yields are still quiet low from a historical perspective (i.e. long term).  That said, they have come back somewhat and are more prevalent now than a decade ago (when even Fama and French were writing on the Demise of the Dividend) and this year we are seeing more firms both initiate as well as increase dividends.

So what happened? Several things. The Internet bubble burst and investors (at least temporarily) remembered that stocks do not just go up. Then came Enron and the governance crisis of the early 2000s. As investors were painfully reminded that accounting numbers could not always be trusted, the signaling aspect of dividends came to the forefront (it is harder to play games with cash than it is with accounting numbers). And in the last, but definitely not least, in the US there was a reduction of taxes on dividends (remember dividends come out of corporate earnings and hence the double taxation problem).

In the following piece, the WSJ points out that this year firms are paying more than last year (when they conserved more cash during the "great recession". But the article also reminds us that the lower tax rate on dividends is up next year. It will be interesting to see whether it is reapproved.

Dividends Are Back - WSJ.com:

"Corporate balance sheets, which were squeezed during the recession, are once again brimming with cash. S&P 500 nonfinancial companies had a record $837 billion in cash at the end of the first quarter, up from $665 billion a year earlier, according to S&P.

Of course, there are plenty of headwinds. The tax rate on qualified dividend payments, capped in 2003 at 15%, is set to expire at the end of this year along with some other Bush-era tax cuts. Absent congressional action, the top dividend tax rate will jump to 39.6% next year."

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• National Fuel Announces 108 Years of Uninterrupted Dividend Payments and 40 Consecutive Years of Increases (eon.businesswire.com)
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Dividend lecture: "Dividends are like getting married, stock buybacks are like hooking-up"

Aswath Damodaran from NYU is truly one of the best professors I have ever seen--a true genius. He is one of a handful of financeprofessors I will drop everything to see his presentation at any conference.


YouTube - Damodaran on Dividends:

"Professor Aswath Damodaran, Professor of Finance from the New York University Stern School of Business, lectures about stock buybacks and dividends. See http://pages.stern.nyu.edu/... for more. ."

Quote of the video?

"Dividends are like getting married, stock buybacks are like hooking up."

This class video is from 2007 but it so well done I will include it.






BTW I found this when I was deciding on a new idea for class. I want to do 5 minute (preview/summary) for the most important things in class. (The same video can serve as both preview to help create the mental architecture on which to "hang" the class material and a summary to help students reinforce the key points of the class. (Any thoughts, from either students or professors would be appreciated.)

Stock Repurchases: Theory and Evidence by Jim Hsieh, Qinghai Wang

SSRN-Stock Repurchases: Theory and Evidence by Jim Hsieh, Qinghai Wang:

From the abstract:

"...article surveys the theoretical and empirical studies on share repurchases. Share repurchases have surpassed cash dividends and become the dominant form of corporate payouts since the last decade. This study provides a brief description of five major types of share repurchases and considers the motives that influence firms’ repurchase decisions. Specifically, we examine regulatory and tax considerations, agency costs of free cash flows, signaling and undervaluation, capital structure, takeover deterrence, and employee stock options. The review indicates that the existing literature provides ample support for several of these motivations while others merit further investigation."

and a fast look-in from the paper:

"Firms can buy back their shares through five different mechanisms: (1) fixed-price tender offers, (2) Dutch-auction tender offers, (3) open-market share repurchases, (4) transferable put-rights distributions, and (5) targeted stock repurchases."

Cite: Hsieh, Jim and Wang, Qinghai,Stock Repurchases: Theory and Evidence(April 2009). Available at SSRN: http://ssrn.com/abstract=1395943

This one will fit perfectly into any corporate finance class! It will be required reading for next semester in my classes.

Bigger Bang Better but Dividends better signal?

Bigger Bang - Investor Relations - CFO.com:

"When it comes to buying back shares, it pays to think big. Two recent reports — one from Morgan Stanley, the other from Citigroup — find that companies executing the biggest buybacks relative to market capitalisation see their shares rise more than the rest subsequently."

Which is interesting enough, but the real reason for inclusion are these two nuggets found late in the article. First:

"..there is an important geographical caveat. The share prices of British companies with the highest buyback yields have underperformed the market in the past three years, in contrast to their continental European peers with identical repurchasing characteristics. UK companies are traditionally perceived as "more shareholder focused than their European peers," Morgan Stanley's analysts note. So, when continental European firms embark on "what is perceived to be a value creating exercise...the potential upside is more significant."

and then secondly:

"Over the past ten years, the share prices of companies that consistently boost dividends have outperformed the market — including companies with buyback programmes — regardless of the relative size of the dividend or buyback. "Dividends are rightly perceived to be a much better indicator of management's long-term view of the health of their company..."

Three "take aways"

1. Unlike some earlier research, this European-based study by two investment firms finds bigger buybacks are a better signal than small buybacks.
2. The buybacks seem to be more important where governance is not as good.
   
3. Buybacks have a positive effect, but dividends may be a better signal.
   

For more on buybacks, see some past articles.

Dividends and Capital Structure

Hold on to your seats folks, this one gets exciting! Definitely I^3!

It starts off so easy: Are dividend policy and capital structure related? And if so how?

Surprisingly for two topics that have been central to corporate finance for decades, we still really do not have very good explanations to either. A new paper by Faulkender, Milbourn, and Thackor attempts to solve both problems with a new theory that suggests not only are dividends and debt related, and tied to investor uncertainty. Moreover, it appears the theory actually fits the data!

Super short version: When managers and shareholders agree on the things stock prices rise. Moreover, debt levels and dividend payout ratios drop. This key insight is shown both theoretically and empirically.

Longer version: While often studied, capital structure and dividend policy have many unanswered questions and none of our models fit the evidence very well.Hence the need to new thinking on the matter and that is what by Faulkender, Milbourn, and Thackor have brought to the table (computer screen?) in Does Corporate Performance Determine Capital Structure and Dividend Policy?

A few quick look-ins:

“..troubling is the fact that existing theories also do not explain why some firms never pay dividends whereas others consistently do, why the payment of dividends seems dependent on the firm’s stock price, and why there seem to be correlations between firms’ capital structure and dividend policy...We are thus left without a theory of dividends that squares well with these stylized facts. The evidence on capital structure is even more troubling.”

“In this paper, we address this question by developing a fresh approach with a simple model that departs from the usual agency and signaling stories. We assume that the manager wishes to maximize a weighted average of the stock prices at the initial and terminal points in time. At the initial point in time he raises the funds needed for a future project with either debt or equity, and thereby determines the firm’s capital structure. Moreover, he also decides how large a dividend to promise to pay at the next point in time. At the time that the manager makes his financial policy choices, he is aware that investors may not agree with his future project choice… project-choice disagreement arises solely from potentially different beliefs about project value rather than agency or private information problems.

* Their main point:

“higher agreement between the manager and the investors implies a higher stock price, so the model predicts leverage and dividend payout ratios to be inversely related to the firm’s stock price.

After theoretically modeling the problems, the authors empirically test their predictions and find strong support. Again in their words:

"We find that firms for which there is greater agreement (i.e., lower analyst forecast dispersion and greater performance-based compensation) have significantly less debt in their capital structure – as measured by either market or book leverage, or interest coverage – and pay out a significantly smaller fraction of the earnings in the form of dividends, measured using both the dividend payout ratio and the dividend yield.”

Good stuff!!

You probably do want to read the whole thing on this one (indeed the literature review (disguised in the introduction) is excellent and is definitely understandable for even undergraduates!)

Cite: Faulkender, Michael W., Milbourn, Todd T. and Thakor, Anjan V., "Does Corporate Performance Determine Capital Structure and Dividend Policy?" (March 9, 2006). Available at SSRN: http://ssrn.com/abstract=686865

Dividend Policy, Agency Costs, and Earned Equity by DeAngelo, DeAngelo, and Stulz

In a well done and interesting work, DeAngelo, DeAngelo, and Stulz tie dividend policy and agency costs (particularly the free cash flow problem) together. Their main point is that if firms did not pay dividends, managers would have too much cash at their disposal.

The authors begin by asking the question "why do firms pay dividends." To answer the question they examine what would happen if firms didn't pay dividends. Specifically they "conservatively estimate that, had the 25 largest long-standing dividend-paying industrial firms in 2002 not paid dividends, they would have cash holdings of $1.8 trillion (51% of total assets), up from $160 billion (6% of assets), and $1.2 trillion in excess of their
collective $600 billion in long term debt. Absent dividends , these firms would have huge cash balances
and little or no leverage, vastly increasing managers' opportunities to adopt policies that benefit
themselves at stockholders' expense."

Moreover, the paper makes the important distinction (made before by Jensen & Meckling 1976 and Easterbrook 1984) that earned equity is in someways different than contributed equity (external financing). Notably, contributed equity comes with investor imposed monitoring and the so-called market discipline that is provided when firms must raise new money. Therefore, firms with higher levels of earned equity should pay out larger dividends since these firms have (ceteris paribus) a greater likelihood of a free cash flow problem.

Sure enough, the authors find that "For the 25 longstanding dividend payers discussed above, the median ratio of earned to total equity is 97%, suggesting that this measure does in fact identify historically profitable firms with potentially large agency problems. Our evidence is uniformly and strongly consistent with the prediction that the probability of paying dividends increases with the amount of earned equity in the capital structure."
Which really should not surprise anyone.

This importance of earned equity is important even after controlling for growth, cash on hands, and other factors thus "indicating that the impact of earned equity on the decision to pay dividends that we document here is an empirically distinct phenomenon from other factors that have previously been shown to affect the dividend decision."

VERY interesting!


BTW Jensen's 1986 free cash flow problem paper is one of my favorite papers of all time. So much so that I did my dissertation on firms with high cash--finding that investors believe that firms that build up cash reserves do in fact tend to waste them as measured by lower Q values. Thus, this paper by DeAngelo, DeAngelo, and Stulz fits perfectly into my semantic network of managers, excess cash, and dividends. Here is a bad version of a paper based on my dissertation in case anyone is interested. Yeah right!

Proof of a clientele effect: evidence from Taiwan

Taxes and Dividend Clientele: Evidence from Trading and Ownership Structure By Lee, Liu, Roll, and Subrahmanyam



Lee, Liu, Roll, and Subrahmanyam (LLRS) provide convincing evidence that a dividend clientele effect does exist. While previous researchers (for example Scholz-1992, Dhaliwal, Erickson, and Trezevant-1999, and Graham and Kumar-2003) have also found the existence of a clientele effect, the current paper is different in that it is based on cleaner data and does not rely on complex modeling. Rather the authors examine trading, ownership, and tax rate data from Taiwan. As they state "Taiwan offers an excellent laboratory for studying clientele because the capital gains tax is zero and share repurchases were prohibited for most of our sample period."

Before getting to the findings, some background is necessary. Taiwan does not tax capital gains, but does tax dividend income. Data include all trades as well as approximations to the traders' marginal tax rate. Additionally the rules on stock buybacks changed in September 2000 which enabled the authors to "study the behavior of firms as they became able to evade dividend taxes."

And the findings? "Individuals appear to respond in the direction predicted by the clientele hypothesis." Wealthy individuals decrease their net buying after dividend increases and increase net buying after dividend decreases. Those in lower tax brackets "do just the opposite."

"Institutions as a group display an insignificant response to dividend changes."

LLSR further examine this using regression analysis. Consistent with the above findings, "there is a strong negative relation between dividend increases and the proportion of shares held by wealthy individuals."

Further examination of the institutional ownership suggests that "Among institutional types, both tax exempts and corporations significantly prefer higher dividends per share. They also prefer higher payout ratios and are joined in this preference by financial institutions."

Finally, the authors also look at changes in behavior after the legalization of share repurchases. They find that "firms with higher concentrations of highly taxed shareholders were significantly more likely to commence repurchase programs. More than forty percent of Taiwan firms actually engaged in share repurchasing after it became possible. A significant fraction (23%) of firms that had previously been paying dividends ceased paying them entirely and 21% reduced dividends and began repurchasing. The tendency to engage in these practices is significantly related to the proportion of a firm’s shareholders in higher tax brackets."

http://www.anderson.ucla.edu/acad_unit/finance/wp/2004/5-04.pdf


I am convinced. Are you? Definitely an interesting paper and it will make it to my class notes!

BTW How can there be so many interesting articles? I just do not understand. It seems like everywhere I look there are articles that are really really good! This is no exception.