Global Trends in Payout Policy

Fama and French conducted a study on the disappearing dividends in the United States and established that many industrial companies reduced their dividend payouts from 1978 to 1998. The two researchers argued that the decrease in dividends was related to many relatively unprofitable companies in the stock market. DeAngelo and Skinner extend Fama’s argument by stating that companies in the USA increased their risk-adjusted dividends by 23% from 1978 to 2000. Two tiers of companies emerged, with the first tier comprising 100 most profitable companies with a payout ratio of 42%. The second tier consisted of two types of non-dividend payers—technology companies and financially distressed companies.

Companies adapt their dividend policies over time to the ever-changing preferences of investors. The following broad trends in dividend policy have been observed.

• The fraction of companies paying cash dividends have been in long-term decline in most developed markets.
• Since the early 1980s in the US and early 1990s in the UK and continental Europe, companies engaging in share repurchases have increased.

Ferris, Sen, and Unlu studied the behavior of dividends across 25 countries and concluded that although the number of dividend payers decreased, the amount of dividends and payout has increased. Dividend-paying companies are larger, have few growth opportunities, do not spend much on R&D, and make more profits than non-dividend-paying companies. A negative relationship exists between enhanced corporate governance and dividend increases because governance and transparency improve markets and signaling roles reduce.

Countries that require more detailed corporate disclosures and strong investor protection pay fewer dividends. Reduced agency costs and information asymmetry result from improved corporate governance coupled with share repurchases’ flexibility, explaining the decline in companies that pay dividends.

Question

Which one of the following is a global trend in dividend policy?

1. The distribution of cash dividends has increased more than share repurchases.
2. Taxes on dividends have been reduced to encourage investors.
3. More companies are choosing share repurchases over cash dividends.

Solution

The correct answer is C.

The amount of dividend payout has reduced with companies opting to share repurchases. This is because of good corporate governance practices and transparency.

A is incorrect. The distribution of cash dividends has declined over time while the preference for share repurchases has increased.

B is incorrect. Taxation on dividends varies from one jurisdiction to another. There is no empirical evidence supporting the statement.

Reading 18: Analysis of Dividends and Share Repurchases

LOS 18 (l) Describe broad trends in corporate payout policies.