The hierarchy of dividends and investment decisions with discretionary a ccruals
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The Hierarchy of Dividends and Investment Decisions with Discretionary A ccruals. Chuan-San Wang. Research Question. Does payout policy affect investment decision ? Do discretionary accruals differ from other earnings components in cash payout decisions?

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The Hierarchy of Dividends and Investment Decisions with Discretionary A ccruals

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The hierarchy of dividends and investment decisions with discretionary a ccruals

The Hierarchy of Dividends and Investment Decisions with Discretionary Accruals

Chuan-San Wang


Research question

Research Question

  • Does payout policy affect investment decision ?

    • Do discretionary accruals differ from other earnings components in cash payout decisions?

    • Does managers’ accounting discretion mitigate the tension between payouts and investment?


Motivation

Motivation

  • payout policy can be relevant

  • Corporate decisions can reveal earnings quality

  • Accrual accounting can mitigate competition for capital resources


Importance

Importance

  • Dividends can be value-relevant, DeAngelo and DeAngelo (2006)

  • Several crucial studies are based on the irrelevance theorem, e.g., Ohlon’s (1995) valuation model


Contributions

Contributions

  • It shows the causality from dividends to investment

  • It quantifies the competition for capital resources

  • It focuses on the impact of earnings quality on both dividends and investments

  • It provides new evidence based on actual corporate actions


Literature 1

Literature #1

  • Miller and Modigliani (1961) theoretically propose that

    • dividend policy is value-irrelevant because it is made after the investment decision

  • The survey evidence from Brav et al. (2005) indicates the opposite:

    • dividend choices are made simultaneously with (or perhaps a bit sooner than) investment decisions

  • H1: The magnitude of cash dividends is simultaneously determined with that of capital expenditures.


Literature 2

Literature #2

  • Earnings can explain the propensity to pay dividends (Fama and French, 2001)

    • The three earnings components are similar in explaining dummy for dividend increase (Subramanyam, 1996)

    • Accrual accounting provides additional information

  • H2: discretionary accruals increase dividend payouts by mitigating financial constraints.

  • H3: the marginal propensity to pay dividends for discretionary accruals differs from that of other earnings components


  • Research design 1

    Research design #1

    • Cash payout equation

    • 2-stage regressions

      • Simultaneity between Y and X variables

      • diagnostic statistics


    Research design 2

    Research design #2

    • Interaction term for DACC


    The 2 ivs

    The 2 IVs

    • Sargan test for the over-identifying restrictions

      • To show IVs are exogenous to the error term of payout equation

    • One-year lagged depreciation expense, and capital expenditures

    • Jackson et al. (2009)

      • perceived utility, earnings consequences

    • Investment projects need subsequent maintenance and evaluation at multiple stages (Seybert, 2010)


    Discretionary accruals

    Discretionary Accruals

    • cross-sectional version of the Jones model

      • used in Daniel et al. (2008)


    Control variable for dividends

    Control Variable for Dividends

    • life-cycle theory

      • Fama and French (2001), DeAngelo et al. (2006), Chay and Suh (2009)

      • senior firms pay more dividends

        • firm size, MVE

        • firm age, Tage

        • investment opportunities, MtB

        • retained earnings, RE/TE

        • cash flow uncertainty, SRVOL


    More control variables

    More Control Variables

    • dividends persistency and financial slack

      • Lintner (1956), Brav et al. (2005)

        • Past dividends

        • financial leverage


    Other control variable

    Other Control Variable

    • firm performance.

      • Fama and French (2001)

    • value-weighted, market-adjusted buy-and-hold annual stock return, BHARt

    • operating cash flows, OCFt

    • return on assets,ROAt


    Sample

    Sample

    • 2010 version of Compustat

    • CRSP

      • 1989–2008

    • 63,955 firm–years with necessary data available


    Baseline results

    Baseline results

    • IVs for capital expenditures are valid and strong

    • investment magnitude is determined simultaneously with cash dividends

    • investments have a significantly negative effect on dividends

      • but the economic size is rather small


    The hierarchy of dividends and investment decisions with discretionary a ccruals

    (0.4539-0.0624)/(1-0.0624)=0.4176


    Over identifying test

    over-identifying test

    • OLS regression of the second-stage residuals on all exogenous variables (including the two IVs)

    • the R2 is 0.0000

    • The two IVs are exogenous


    Robustness

    Robustness

    • Other measures of discretionary accruals

      • Teoh et al. (1998), Dechow and Dichev (2002), and Ball and Shivakumar (2005)

    • How to measure accruals is independent for

      • the dampening effect of investment on dividends

      • the endogeneity tests


    Conclusions

    Conclusions

    • Dividend policy is at least simultaneously determined with investment decisions (Brav et al 2005)

      • The irrelevance theorem of Miller and Modigliani (1961) may be questionable (DeAngelo and DeAngelo 2006)

    • The competition between dividends and investment

      • is small in size

      • can be mitigated by managers’ use discretionary accruals

    • It is inconclusive for the propensity to pay dividends for discretionary accruals


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