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Corporate Finance. Corporate Payout. Fama and French (2001). The proportion of firms paying cash dividends falls from 66.5% in 1978 to 20.8% in 1999, due in part to the changing characteristics of publicly traded firms .
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Corporate Finance Corporate Payout
Fama and French (2001) • The proportion of firms paying cash dividends falls from 66.5% in 1978 to 20.8% in 1999, due in part to the changing characteristics of publicly traded firms. • Fed by new listings, the population of publicly traded firms tilts increasingly toward small firms with low profitability and strong growth opportunities- characteristics typical of firms that have never paid dividends. • More interesting, we also show that regardless of their characteristics, firms have become less likely to pay dividends. This lower propensity to pay is at least as important as changing characteristics in the declining incidence of dividend-paying firms.
Number of CRSP firms in different dividend groups The addition of NASDAQ firms (1973) The addition of Amex firms (1963)
What happens in year t to CRSP firms that do and do not pay dividends in year t-1 • Dividend payers are lost from the sample. Much of the lost is due to mergers. • There is no clear trend in the rate at which dividend payers terminate dividends.
Profitability • Dividend payers have higher measured profitability than non-payers.
Percent of newly listed firms with positive earnings on common stock • Until 1978, more than 90% of new lists are profitable. Thereafter, the fraction with positive earnings falls.
Investment opportunities • Firms that have never paid dividends have the best growth opportunities.
Size • Dividend payers are much larger than non-payers. • Thus, three fundamentals- profitability, investment opportunities, and size- are factors in the decision to pay dividends.
Propensity to pay • Next table shows estimates from logit regressions of the effect of changing characteristics and declining propensity to pay on the percent of firms paying dividends. • The explanatory variables are profitability (E /A ), the growth rate of assets (dA/A ), the market-to-book ratio (V/A ), and the percent of NYSE firms with the same or lower market capitalization (NYP).
DeAngelo, DeAngelo and Skinner (2004) • Aggregate real dividends paid by industrial firms increased over the past two decades even though, as Fama and French (2001) document, the number of dividend payers decreased by over 50%. • The reasons are • the reduction in payers occurs almost entirely among firms that paid very small dividends, and • increased real dividends from the top payers swamp the modest dividend reduction from the loss of many small payers. • These trends reflect high and increasing concentration in the supply of dividends which, in turn, reflects high and increasing earnings concentration. • For example, the 25 firms that paid the largest dividends in 2000 account for a majority of the aggregate dividends and earnings of industrial firms.
Concentration of total dollar dividends paid by industrial firms
Concentration of total dollar dividends paid by industrial firms
Dividends and earnings for the 25 industrial firms that paid the largest dividends in 2000
Ikenberry, Lakinoshok and Vermaelen (1995) • We examine long-run firm performance following open market share repurchase announcements, 1980-1990. We find that the average abnormal four-year buy-and-hold return measured after the initial announcement is 12.1%. For ‘value’ stocks, companies more likely to be repurchasing shares because of undervaluation, the average abnormal return is 45.3%. For repurchases announced by ‘glamour’ stocks, where undervaluation is less likely to be an important motive, no positive drift in abnormal returns is observed. Thus, at least with respect to value stocks, the market errs in its initial response and appears to ignore much of the information conveyed through repurchase announcements.
What is share repurchase? • Repurchases are a mechanism for a firm to purchase shares outstanding per se, resulting in equity and cash reduction but leverage increase. • Share repurchase decreases the shares outstanding by purchasing shares in capital market. There are couple of ways repurchasing stocks, including open market share repurchases, tender offering, negotiation, auction, accelerate share repurchase. • Generally, over 90% of repurchases are authorized by this type in U.S. market.
Repurchase motivations • Motivations for why corporations might repurchase their own shares: capital structure adjustment, takeover defense, signaling, excess cash distribution, substitution for cash dividends, and wealth expropriation from bondholders. • While all of these reasons are plausible, signaling has emerged as one of the most prevalent explanations. • When managers are asked why they repurchase shares on the open market, the most commonly cited reason is ‘undervaluation’ and that their shares represent a ‘good investment’, two reasons seemingly consistent with the Traditional Signaling Hypothesis (TSH)
Market reaction to repurchases • Managers typically do not announce that they are canceling a repurchase program. This would suggest that the initial market reaction is too low. • Given that the average market reaction is only on the order of 3%, this would indeed seem to be the case. • Market treats repurchase announcements with skepticism, leading prices to adjust slowly over time. We refer to this as the UnderreactionHypothesis, or UH. • If undervaluation is an important motive overall, it should be particularly important for out-of-favor stocks, which tend to have high book-to-market ratios.
Data • Our sample was formed by identifying all announcements reported in the Wall Street Journal from January 1980 through December 1990 that stated that a firm intended to repurchase its own common stock through open market transactions. • For most of our analysis, we exclude all announcements made in the fourth quarter of 1987. Following the 1987 crash, 777 NYSE, ASE, and NASDAQ firms announced either new or increased share repurchase programs totallingover $45 billion, largely in response to their low post-crash share prices.
Long-run abnormal returns • Repurchase firms generally outperform their benchmark in four years.
Grullon and Michaely (2004) • Contrary to the implications of many payout theories, we find that announcements of open-market share repurchase programs are not followed by an increase in operating performance. • However, we find that repurchasing firms experience a significant reduction in systematic risk and cost of capital relative to non-repurchasing firms. • Further, consistent with the free cash-flow hypothesis, we find that the market reaction to share repurchase announcements is more positive among those firms that are more likely to overinvest. • Finally, we find evidence to indicate that investors underreact to repurchase announcements because they initially underestimate the decline in cost of capital.
Grullon and Michaely (2004) • This paper investigates the abnormal operating performance of open market share repurchases • Two hypotheses are examined: • H1: Repurchase is announced to signal better prospect • H2: Repurchase is to reduce the amount of free cash flow
Empirical results • Announcement of open market share repurchases are not followed by an increase in operating performance • They also find that analysts revise their expectations downward after the repurchase announcement • What can interpret the downward performance is the reduction in R&D expenditure, cash reserves and risk. It means the cost of capital becomes lower post repurchase announcement
Operating performance • Four measures of the operating performance • Return on assets • Return on cash adjusted assets • Return on sales • Cash flow return on assets • All these OP measures are adjusted by industry, M/B and prior performance.
