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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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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
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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