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A Survey of Management Views on Dividend Policy Author(s): H. Kent Baker, Gail E. Farrelly, Richard B.

Edelman Source: Financial Management, Vol. 14, No. 3 (Autumn, 1985), pp. 78-84 Published by: Blackwell Publishing on behalf of the Financial Management Association International Stable URL: . Accessed: 01/07/2011 22:31
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Management Views




H. Kent Baker, Gail E. Farrelly, and Richard B. Edelman

ProfessorsBaker and Edelman are at the Kogod College of Business The American University, Washington,D.C. and Administration, Professor Farrelly is at Rutgers University,Newark, New Jersey.

I. Introduction
The effect of dividend policy on a corporation's marketvalue is a subject of long-standing controversy. Black [2, p. 5] epitomizes the lack of consensus by stating"The harderwe look at the dividend picture, the more it seems like a puzzle, with pieces thatjust don't fit together." Because the academic community has been unable to provide clear guidance about dividend policy, a shift in emphasis is proposed. In the spirit of Lintner's seminal work [II], we asked a sample of corporate financial managers what factors they considered most important in determining their firm's dividend policy. Our objectives were as follows: (i) to compare the determinantsof dividend policy today with Lintner's behavioral model of corporate dividend policy and to assess management's agreement with Lintner's findings; (ii) to examine management's perception of signaling and clientele effects; and
to The authorswish to express theirappreciation RobertA. Taggartand the two anonymousreferees for their helpful suggestions. 78

(iii) to determine whether managers in different industries share similar views about the determinants of dividend policy.' The remainingportion of this paper consists of three sections. Section II sets forth the survey design. Section III presents the research findings and compares them with theory and other empirical evidence. Section IV discusses conclusions and limitations of the study. Because research on dividend policy is already well documented [3], a separate section on the dividend literature is not provided. Instead, relevant aspects of the literatureare incorporatedinto Section III.

II. Survey Design

The firms surveyed were listed on the New York Stock Exchange (NYSE) and classified by four-digit
'Whether industryregulationinfluencesdividendpolicy is a potentially richissue, since it is quiteconceivable thatregulationcreates incentives for managementto adopt a different payout policy than nonregulated firms. Although briefly addressed in this article, this issue has been examinedelsewhere by Edelman, Farrelly, and Baker [61.



Exhibit 1. Major Determinants of Corporate Dividend Policy

Level of Importance Determinant 1 Anticipated level of firm's future earnings None Slight 0 1 3.40% 1.75 1.75 6.12 1.75 2.63 14.29 22.81 Moderate 2 6.80% 14.04 7.89 29.25 29.82 25.44 22.45 21.05 MaxiStandard X2 Great mum DeviProba3 4 Mean Rank ation bility Industry 89.80% 84.21 90.35 64.63 68.42 71.93 63.27 56.14 3.20 3.12 3.21 2.73 2.86 2.94 2.70 2.42 1 1 1 2 2 3 3 4 .74 .71 .66 .89 .74 .78 1.04 1.15 .4572* Mfg W/R Util Mfg W/R Util Mfg W/R

9 Pattern of past dividends


8 Availability of cash


21.24 7 Concernabout maintainingor increasing stock price 13.61 15.79 3.51

34.51 44.22 28.07 22.81

44.25 42.18 56.14 73.68

2.35 2.30 2.47 2.96

4 4 3 2

1.02 .87 .85 .79

Util Mfg W/R Util


*An asteriskindicates inadequatecell size and the chi-square test may not be valid. tUnderlining indicates a significant relationshipat the .05 level of significance. W/R = wholesale/retail;Util = utility. Mfg = manufacturing;

StandardIndustrialClassification (SIC) codes. A total of 562 NYSE firms were selected from three industry groups:utility (150), manufacturing(309), and wholesale/retail (103). A mail questionnairewas used to obtain information about corporate dividend policy. The questionnaire consisted of three parts: (i) 15 closed-end statements about the importance of various factors that each firm used in determining its dividend policy; (ii) 18 closedend statements about theoretical issues involving corporatedividend policy, and (iii) a respondent's profile including such items as the firm's dividends and earnings per share. A pilot test of the preliminary questionnaire was conducted among 20 firms selected from the three industry groups but not included in the final sample of 562 firms. The final survey instrumentwas then sent to the chief financial officers (CFOs) of the 562 firms, followed by a second complete mailing to improve the response rate and reduce potential nonresponse bias. The survey, which was conducted during the period between February and April 1983, did not require firms to identify themselves. The survey yielded 318 usable responses (a 56.6% response rate), which were divided among the three industrygroups as follows: 114 utilities (76.0%), 147 manufacturingfirms (47.6%), and 57 wholesale/retail (55.3%). Based on dividend and earnings per share data provided by the respondents, the 1981 average

dividend payout ratios were computed. The payout ratio of the responding utilities (70.3%) was considerably higher than for manufacturing (36.6%) and wholesale/retail (36.1%).2

III. Results and Discussion A. Determinants of Dividend Policy

Lintner's classic 1956 study [11] found that major changes in earnings "out of line" with existing dividend rates were the most importantdeterminantof the company's dividend decisions. However, because these managers believed that shareholders preferred a steady streamof dividends, firms tended to make periodic partial adjustments toward a target payout ratio ratherthan dramatic changes in payout. Thus, in the
2In the electric utility segment, the dividendpayoutratiocan be distorted by non-cashitems such as allowance for funds used duringconstruction (AFUDC). Moody's Public UtilityManual reportsthat in 1981 (the year surveyed), AFUDC made a substantialcontribution to electric utility net income. In that year, average earnings per share for the industrywas $10.16 from which $7.16 was paid in dividends. This an represents averageutilitypayoutof 70.5% in contrastwith 34%in the othersegments. If AFUDC is excluded from net income, earnings are $4.79 per share. Earningsat this level would representa utility payout ratio of nearly 150%. Firms in the other industrysegments surveyed also have non-cash items charged or added to their income figure. However, Compustat shows no equivalent items in those segments which are consistently usedby all firmsandhave such a profoundeffect on reportedincome. It is ourbelief thatwith or withoutan adjustment the utility payoutratio in for AFUDC, utilities can be viewed as high payout firms relative to and manufacturing wholesale/retailfirms.



short run, dividends were smoothed in an effort to avoid frequent changes. Fama and Babiak's [8] examination of several alternative models for explaining dividend behavior supports Lintner's position that managers increase dividends only after they are reasonably sure that they can permanently maintain them at the new level. To examine how well Lintner's model describes current practice, the respondents were asked to indicate the importance of each of 15 factors in determining their firm's actual dividend policy. A five-point equal interval scale was used for this purpose: 0 = no importance, 1 = slight importance, 2 = moderate importance,3 = great importance, and 4 = maximum importance. It should be noted that the questionnaire does not follow Lintner's model exactly. Exhibit 1 provides summary statistics on the major determinantsof corporate dividend policy as reported by the three industrygroups.3The results show that the same four determinants (identified later by "D") are consideredmost importantby the three industrygroups when ranked by the mean response. The determinant numbersrepresent the order in which each factor was presented in the questionnaire. The most highly ranked determinants are the anticipated level of a firm's future earnings (Dl) and the pattern of past dividends (D9). The high ranking of these two factors is consistent with Lintner's findings. A thirdfactor cited as importantin determining dividend policy is the availability of cash (D8). Although Lintnerdoes not directly address this determinant, Van Hore [19, p. 23] and Weston and Brigham [20, p. 675] note that liquidity is an important managerial consideration. A fourth major determinant is concern about maintaining or increasing stock price (D7). This concern is particularlystrong among utilities who rankedthis factor second in importance. B. Issues Involving Dividend Policy The study's second objective was to investigate CFOs' perceptions of certain specific issues. The respondents were asked to indicate their general opinion about each of 18 closed-end statements based on a seven-point equal interval scale: - 3 = strongly disagree, -2 = moderately disagree, -1 = slightly disagree, 0 = no opinion, + 1 = slightly agree, + 2
of statisticson all 15 determinants corporatedividendpolicy 3Summary are available from the authors.

= moderately agree, and + 3 = strongly agree. Exhibit 2 provides summary statistics on the responses to each of the 18 statements (identified later by "S") for the three industrygroups. The statement numbers refer to the order in which the statements appeared in the questionnaire. Attitudes on Lintner's Findings. One issue was the level of agreement with statements supporting Lintner'sresearch findings, namely, S2, S3, S9, S10, and S 17. The results show that several such statements command the highest level of agreement. For example, two of the highest ranked statements were that a firm should avoid making changes in its dividend rates that might soon have to be reversed (S10) and should strive to maintain an uninterruptedrecord of dividend payments (S17). Respondents also generally agreed that a firm should have a target payout ratio and should periodically adjust the payout toward the target (S3). Lintner's field work also suggests that managers focus on the change in the existing rate of dividend payout, not on the dollar amount of dividends (S9) so that investment requirements generally have little effect on modifying the pattern of dividend behavior (S2). On average, managers expressed no strong opinion on either of these statements. Although management's perceptions could differ significantly from actual decisions, the results in Exhibit 1 do not suggest this. That is, managers' views aboutcontinuity of dividend policy seem to be translated into factors (DI and D9) that are in fact consistent with dividend continuity. Attitudes on Theoretical Issues. A major controversy in the literature involves the relationship between dividends and value. Miller and Modigliani (MM) [15] suggest that dividend policy has no effect on the value of the corporation in a world without taxes, transaction costs, or other market imperfections. However, dividends may be relevant to the extent that market imperfections exist. Some of the explanations for dividend relevance include signaling and clientele effects. Exhibit 2 shows that respondents from all three industry groups agreed relatively strongly that dividend payout affects common stock prices (S1). The utilities showed the highest level of agreement with this statement. These results seem consistent with the finding reportedin Exhibit 1 that concern about maintaining or increasing stock price (D7) is a major determinant of corporate dividend policy, especially for utilities. Management attitudes were also sought on several othertheoretical issues. The first issue involves signal-



Exhibit 2. Issues Involving Corporate Dividend Policy

Statement 10 A firm should avoid making changes in its dividendratesthat might have to be reversedin a year or so. 4 Reasons for dividend policy changes should be adequatelydisclosed to investors. Disagreement -2 -1 0 -3 Agreement +3 +1 +2 86.99% 87.72 91.23 77.40 80.70 70.18 72.79 85.96 93.86 63.01 78.95 64.91 53.74 50.88 74.56 53.47 53.57 62.28 55.10 43.86 50.88 38.62 38.60 51.75 40.41 28.07 21.05 34.93 43.86 54.39 35.66 31.58 38.60 33.56 35.09 52.63 26.03 28.07 40.35 39.73 36.84 51.33 22.76 26.79 43.86 35.62 35.09 10.62 29.25 28.07 33.33 6.16 5.36 5.26

Standard x2 Devi- ProbaMean Rank ation bility Industry

. _

1.37% 7.02 .00 2.05 .00 .88 1.36 17 A firm should strive to maintainan uninterrupted 3.51 recordof dividend payments. .00 7.53 3 A firm should have a target payout ratio and 3.51 periodicallyadjust the payout toward the target. 10.53 6.80 1 Dividendpayoutaffects the price of the common 7.02 stock. 3.51 .69 7 Investorshave differentperceptionsof the relative 3.57 riskiness of dividends and retainedearnings. 1.76 6.80 14 Dividend paymentsprovide a "signaling device" 7.02 of future prospects. 7.02 5.52 5 The marketuses dividend announcementsas 8.77 informationfor assessing security value. 5.26 10.27 9 A change in the existing dividendpayout is more 21.05 than the actual amount of dividends. important 34.21 6.85 16 A stockholderis attractedto firms which have to dividendpolicies appropriate the stockholder's 10.53 6.14 tax particular environment. 6.29 15 Capital gains expected to result from earnings 15.79 retentionare riskier than are dividend 9.65 expectations. 12.33 6 Managementshould be responsive to its 8.77 shareholders'preferencesregardingdividends. 7.02 10.96 12 Investorsin low tax bracketsare attractedto 15.79 high-dividendstocks. 9.65 2 New capital investmentrequirementsof the firm 21.92 31.58 generally have little effect on modifying the 24.78 patternof dividend behavior. 19.31 11 Stockholdersin high tax bracketsare attractedto 17.86 low-dividend stocks. 14.91 28.08 8 Dividend distributionsshould be viewed as a residualafter financingdesired investmentsfrom 38.60 61.95 available earnings. 43.54 13 Financingdecisions should be independentof a 49.12 firm's dividend decisions. 38.60 18 Investorsarebasically indifferentbetween returns 55.48 60.71 from dividends versus those from capital gains. 76.32

11.64% 5.26 8.77 20.55 19.30 28.95 25.85 10.53 6.14 29.45 17.54 24.56 39.46 42.11 21.93 45.83 42.86 35.96 38.10 49.12 42.11 55.86 52.63 42.98 49.32 50.88 44.74 58.22 45.61 39.47 58.04 52.63 51.75 54.11 56.14 40.35 63.01 56.14 50.00 38.36 31.58 23.89 57.93 55.36 41.23 36.30 26.32 27.43 27.21 22.81 28.07 38.36 33.93 18.42

2.47 2.16 2.61 2.09 2.14 2.02 1.97 2.28 2.63 1.47 2.09 1.42 1.41 1.46 1.99 1.38 1.34 1.62 1.37 1.18 1.19 1.02 1.07 1.33 .86 .40 -.21 .80 .88 1.37 .76 .51 .85 .68 .91 1.22 .50 .39 .86 .38 .09 .72 .24 .29 .83 .13 -.07 -1.35 -.36 -.58 -.10 - 1.33 - 1.46 -1.77

1 2 2 2 3 3 3 1 4 4 4 6 5 5 4 6 6 5 7 7 10 8 8 8 9 12 16 10 10 7 11 11 12 12 9 9 13 13 11 14 15 14 15 14 13 16 16 17 17 17 15 18 18 18

.91 1.46 .77 1.28 1.04 1.09 1.05 1.25 .72 1.50 1.20 1.65 1.02 1.23 1.22 1.04 1.28 1.16 1.35 1.26 1.38 1.29 1.47 1.39 1.60 1.67 1.85 1.32 1.48 1.29 1.37 1.47 1.44 1.52 1.52 1.47 1.41 1.57 1.47 1.88 1.97 2.05 1.56 1.59 1.61 1.97 2.12 1.78 2.12 2.04 2.04 1.50 1.54 1.30

.0155*t .3189*

.0001*t .1715 .0059t


.6904 .2040 .000I t .0225t .2816 .0240t .1057 .0786 .0075t

.0001t .7495 .0103t

Mfg W/R Util Mfg W/R Util Mfg W/R Util Mfg W/R Util Mfg W/R Util Mfg W/R Util Mfg W/R Util Mfg W/R Util Mfg W/R Util Mfg W/R Util Mfg W/R Util Mfg W/R Util Mfg W/R Util Mfg W/R Util Mfg W/R Util Mfg W/R Util Mfg W/R Util Mfg W/R Util

test cell indicates *Anasterisk inadequate size andthe chi-square maynot be valid. at a indicates significant relationship the .05 level of significance. tUnderlining Util W/R Mfg = manufacturing; = wholesale/retail; = utility.



ing effects. Managers have access to information about the firm's expected cash flows not possessed by outsiders and thus, changes in dividend payout may provide signals about the firm's future cash flows that cannot be communicated credibly by other means. With some exceptions, empirical studies indicate that dividend changes convey some unanticipatedinformation to the market [1, 5, 9, 10, 16, 21]. Three statements involved signaling effects (S4, S5, and S14). The respondents from all three industry groups agreed, on average, that dividend payments provide a "signaling device" of future company prospects (S14) and that the market uses dividend announcements as informationfor assessing security value (S5). The respondents also demonstrated a high level of agreement that the reasons for dividend policy changes should be adequately disclosed to investors (S4). Another theoretical issue concerns the extent to which investors with different dividend preferences form clienteles. Two possible reasons for the formation of clienteles are different perceptions of the relative riskiness of dividends and retained earnings and different investor tax brackets. Although the research evidence is mixed, it does learn toward the existence of clientele effects [7, 12, 171. Seven statements involved clientele effects (S6, S7, S11, S12, S15, S16, and S18) and these commanded mixed agreement. Respondents from all three industry groups thought that investors have different perceptions of the relative riskiness of dividends and retained earnings (S7) and hence are not indifferent between dividend and capital gain returns(S 18). Yet, there was only slight agreement that a stockholder is attractedto firms with dividend policies appropriateto that stockholder's tax environment (S16) and that management should be responsive to its shareholders' dividend preferences (S6). However, the utilities differed from the other two groups, expressing significantly higher levels of agreement on S16 and S6. C. Industry Influence on Dividend Policy The study's final objective was to investigate differences in managers' attitudes across three broad industry groups. Studies by Dhrymes and Kurz [4], McCabe [13], and Michel [14] have previously detected some effect of industry classification on corporate dividend policy. However, Rozeff [18] concluded that a company's industry does not help to explain its dividend payout ratio. Rozeff's conclusion is not applicable to utilities since he intentionally excluded regulated com-

panies because their policies may be affected by their regulatory status. Chi-square analysis was used to test for differences in the responses among the three industry groups. In order to perform these tests and to avoid inadequate cell sizes, both the five-interval importance scale and the seven-interval disagreement-agreement scale were collapsed into three classes as shown in Exhibits 1 and 2, respectively. Nevertheless, some warnings about low cell counts resulted because of the highly skewed nature of the responses. These tests showed that the responses of the three groups differed significantly at the .05 level among eight of the 15 determinants of dividend policy (partly shown in Exhibit 1) and nine of the 18 issues (Exhibit 2). FurtherChi-square tests were performed using pairwise comparisons between the industry groups on all 15 determinants and 18 issues. The results revealed that the manufacturingand wholesale/retail firms had no significant differences in responses at the .05 level for those questions with adequatecell sizes. Hence, the differences occurred primarily as a result of the utilities' responses relative to either manufacturing or wholesale/retail. The reported differences between the utilities and the other firms may be due to regulation. For example, since regulation gives utilities monopoly power over a product enjoying steady demand, their earnings are comparatively stable. Their risk of having to reduce dividends because of an unexpected decline in earnings is thus less than that for many other companies. It is also plausible that regulation creates incentives for managementto adopt a different payout policy than nonregulatedfirms. This incentive may stem from the fact that funds retained inside the firm are implicitly subject to expropriationby the regulators in future rate cases. Hence, managers of regulated firms may view the world differently than managers operating in a competitive environment. On the other hand, the differences may have nothing to do with regulationper se but with other characteristics. For example, Rozeff [18] notes that the apparently significant industry effect found in past studies results from the fact that other variables are often similar within a given industry. These similarities are the fundamental reason why companies in the same industry have similar dividend payouts. Utilities are high payout firms relative to the two other groups and this characteristic makes them different. To control for dividend payout, the responses by managers in the highest payout quartile for 1981 of



with the firms(51 firms)werecompared nonregulated utilities(114 firms).4 With a few exceptions, the resultswere strikingly similar thosein Exhibit2. Althoughthe meanrankto ings changedlittle, the responsesof the higherpayout firmsmoreclosely resembled utilities the nonregulated on two statements namely,dividendpayoutaffects the priceof the commonstock (Si) and management should be responsive to its shareholders'dividend (S6). preferences Overall, the findings suggest that the attitudesof firm even high-payout are nonregulated managers differentfromthose of utility managers.Hence, regulation may be responsiblefor some of the relationsobserved.

of The industries. resultssuggestthatmanagers regulated firms have a somewhatdifferentview of the in worldthanmanagers operating a competitiveenvito ronment. Thus,it maybe worthwhile segregate regfirmswhen examiningdiviulatedfromnonregulated dendpolicy.

1. P. Asquith and D. Mullins, Jr., "The Impactof Initiating Dividend Paymentson Shareholders'Wealth,"Journal of Business (January1983), pp. 77-96. 2. F. Black, "The Dividend Puzzle," Journal of Portfolio Management(Winter 1976), pp. 5-8. 3. T. E. Copeland and J. F. Weston, Financial Theory and CorporatePolicy, Reading, MA, Addison-Wesley, 1983. 4. P. J. Dhrymes and M. Kurz, "Investment,Dividend, and ExternalFinance Behavior of Firms," in R. Ferber(ed.), Determinantsof Investment Behavior, New York, Columbia University Press, 1967, pp. 427-467. 5. K. M. Eades, "EmpiricalEvidence on Dividends as a Signal of Firm Value,"Journal of Financial and Quantitative Analysis (November 1982), pp. 471-500. 6. R. B. Edelman,G. E. Farrelly, and H. K. Baker, "Public UtilityDividendPolicy: Time for a Change?",Public Utilities Fortnightly(February21, 1985), pp. 26-31. 7. E. J. Elton and M. J. Gruber,"MarginalStockholderTax Rates and the Clientele Effect," Review of Economics and Statistics (February1970), pp. 68-74. 8. E. F. Famaand H. Babiak, "DividendPolicy: An Empirical Analysis," Journal of the AmericanStatistical Association (December 1968), pp. 1132-1161. 9. C. Kwan, "Efficient Market Tests of the Informational Contentof Dividend Announcements:Critiqueand Extension," Journal of Financial and Quantitative Analysis (June 1981), pp. 193-206. 10. P. M. Laub, "Onthe Informational Contentof Dividends," Journal of Business (January1976), pp. 73-80. 11. J. Lintner, "Distribution of Incomes of Corporations Among Dividends, RetainedEarningsand Taxes," American Economic Review (May 1956), pp. 97-113. 12. R. H. Litzenbergerand K. Ramaswamy, "The Effect of Personal Taxes and Dividends on Capital Asset Prices: Theory and Empirical Evidence," Journal of Financial Economics (June 1979), pp. 163-196. 13. G. M. McCabe, "TheEmpiricalRelationshipBetween Investmentand Financing:A New Look," Journal of Financial and Quantitative Analysis (March1979), pp. 119-135. 14. A. Michel, "IndustryInfluence on Dividend Policy," Financial Management(Autumn 1979), pp. 22-26. 15. M. H. Miller and F. Modigliani, "Dividend Policy, Growth,and the Valuationof Shares,"Journal of Business (October 1961), pp. 411-433. 16. S. H. Penman, "The PredictiveContentof EarningsForecasts and Dividends," Journal of Finance (September 1983), pp. 1181-1199.

IV. Conclusions
Before drawingany conclusions, several limiting aspectsof this researchshould be noted. Survey rebias and searchtypicallyinvolves some non-response althoughsteps were taken to ensure a high response rate,this studyis no exception.The problemof nonresponsebias is potentiallygreatestamong manufacturingfirms which had the lowest responserate. Another limiting factor is that views about dividend policy were obtainedonly from chief financialofficers. AlthoughCFOs' views should reflect the attitudesof top management more generally, CFOs are not the only individualsinvolved in dividendpolicy decisions.Finally,coverageis restricted threebroad to New York Stock only industrygroups representing Exchangefirms. With these caveats in mind, several conclusions emergefrom this survey. First, the resultsshow that the majordeterminants dividendpaymentstoday of similarto Lintner's behavioral model appear strikingly the mid-1950's. In particular,redevelopedduring were highly concernedwith dividendconspondents tinuity. seem to believe thatdiviSecond, the respondents dend policy affects sharevalue, as evidencedby the attached dividendpolicy in maintaining to importance orincreasing stockprice.Although surveydoes not the uncoverthe exact reasonsfor theirbelief in dividend relevance,it does provideevidence that the respondents are generallyaware of signaling and clientele effects. Finally, the opinions of the respondentsfrom the utilitiesdiffer markedlyfrom those of the other two
statistics highpayout of and firms 4Summary regulated nonregulated are available fromthe authors.



17. R. R. Pettit, "Taxes, TransactionsCosts and Clientele Effects of Dividends,"Journal of Financial Economics (December 1977), pp. 419-436. 18. M. S. Rozeff, "Growth,Beta and Agency Costs as Determinantsof Dividend PayoutRatios,"Journal of Financial Research (Fall 1982), pp. 249-259. 19. J. C. Van Home, Financial Managementand Policy, 6th

ed., Englewood Cliffs, NJ, Prentice-Hall, 1983. 20. J. F. Weston and E. F. Brigham,ManagerialFinance, 7th ed., Hinsdale, IL, Dryden Press, 1981. 21. J. R. Woolridge, "The InformationContent of Dividend Changes,"Journal of Financial Research (Fall 1982), pp. 237-247.


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