Payout Slides

Payout Policy in the 21st Century
Alon Brav
Duke University, Durham, NC USA
John R. Graham
Campbell R. Harvey
National Bureau of Economic Research, Cambridge, MA USA
Roni Michaely
Cornell University, Ithaca, NY USA
IDC, Israel
1
Brav/Graham/Harvey/Michaely: Payout Policy
Introduction
In 1956, John Lintner laid the foundation for the modern
understanding of dividend policy
He conducted detailed interviews with 28 companies
His research helped set the agenda for theoretical and empirical
research on dividend policy
Much has changed in the last 50 years.

Possibly different payout policy goals
Repurchases
More insights from theory that may help direct the spotlight in the right
direction
We revisit this path-breaking study at the beginning of the 21st

century
2
Introduction
We survey 384 financial executives with an

instrument that focuses on both dividends and
repurchases
256 public, 128 private
Most presented results are based on the public firms
We conduct one-on-one interviews with 23 CFOs or
Treasurers of prominent corporations
Interviews last between 40 minutes and two hours
3
Methodology
Survey and Interview Design

Draft survey instrument refereed by both finance
researchers and experts in survey design
Interviewed structured to adhere to best scientific
practices of interviews, e.g. Sudman and Bradburn
(1983)
4
Methodology
Survey Delivery
Survey CFOs, Treasurers, Finance VPs
Primarily members of Financial Executives International
Two $500 random winners
Three surveys
FEI CFO Forum (April 23, 2002, Co. Springs CO)
Dave Ikenberry NFCF (May 1, 2002, Houston TX)
Mass emailing to 2200 FEI members
Overall ~16% response rate
5
How are payout decisions made?

Goals of Treasury department:
Fund investment
M&M
Liquidity and possible contingencies
Payout decisions are second-order
Except...
DO NOT CUT DIVIDENDS ranks equal to or
above all of these items
6
Payout vs. Investment Decisions
4e: Fund externally, rather than cut

3e: Fund externally, rather than cut
4a: Investment decision made 1st

3a: Investment decision made 1st
7h: Good alternative investments

6h: Good alternative investments
7j: M&A strategy

6j: M&A strategy
0% 10% 20% 30% 40% 50% 60% 70% 80%
Percent of CFO's who rate choice as +1 or +2 (on scale of -2 to +2)
Repurchases
Dividends
7
Dividends vs. Repurchases (Fig. 2)

Fig. 2A: Of funds that are used to pay dividends, what is their most likely alternative use? (Current dividend
payers only). For each response we report the percentage of respondents who answer 1 or 2 on a scale from -2 to
+2.
Pay down debt

Repurchase shares
Mergers/Acquisitions
Invest more
Retain as cash
Other
0% 10% 20% 30% 40% 50% 60% 70% 80%

Fig. 2B: Of funds that are used to repurchase shares, what is their most likely alternative use? (Current share
repurchasers only). For each response we report the percentage of respondents who answer 1 or 2 on a scale
from -2 to +2.
Pay down debt
Mergers/Acquisitions
Invest more
Retain as cash
Pay more dividends
Other
0% 10% 20% 30% 40% 50% 60% 70% 80% 8

Complements or Substitutes?
Level of dividend fixed

Substitute repurchases for change in dividends
One way substitution
Would use even more repurchases if they were
free of constraint of dividend history
9
Lintner (1956)
Three main points

Target payout ratio (dividend/earnings)
Dividend policy set conservatively
partial adjustment to target payout
smooth through time
sticky (history important)
Level given, focus on changes
tied to long-run sustainable earnings
do not increase now if you might have to cut later
No repurchases
10
Compare to Lintner (1956)
Dividend policy still conservative?

Yes
Perceived big penalty for cut, small reward for
increase
So, smooth, to avoid future cuts
Path dependence of dividend policy
BUT
stealth dividend cut if possible
holding dividend constant OK
11
Payout Decisions Still Made Conservatively? vs. Lintner (1956)
6d: Try to avoid cutting

5d: Try to avoid cutting
4d: Neg. consequence to cutting

3d: Neg. consequence to cutting
7L: Maintain historic policy

6L: Maintain historic policy
5b: change in div what matters

5j: not want to cut in future
5c: smooth from year to year
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Repurchases: No, flexible

Dividends: Yes, still conservative
12
Conservatively increase payout? Similar to Lintner (1956)?
7c: Stability of future earnings

6c: Stability of future earnings
7b: Sustainable change in earnings

6b: Sustainable change in earnings
7d: Excess cash on balance sheet

6d: Excess cash on balance sheet
7a: Temporary increase in earnings

6a: Temporary increase in earnings
0% 10% 20% 30% 40% 50% 60% 70% 80%
Repurchases
Dividends
13
Payout ratio still target? vs. Lintner (1956)
Level of dividends per share
Dividend as a % of earnings
Growth in dividends per share
Dividend yield
Do not target at all
Other
0% 10% 20% 30% 40% 50% 60%
For those that paid dividends within the past 3 years, what do you
target when you make your dividend decisions?
14
A flexible goal
A somewhat strict goal
Not really a goal
A strict goal
0% 10% 20% 30% 40% 50% 60%
For those that paid dividends within the past 3 years, is the target part of
a strict goal or a flexible goal?
15

Extension of Fama-Babiak (1968), Choe (1990)
Di ,t i 1i Di ,t 1 2i E it u .
The SOA= 1 and TP= 2 / 1 .

Both SOA and TP have declined through time using
both matching sample to our survey and broader
Compustat sample
16
Summary vs. Lintner (1956)
Dividend policy still very conservative

Modern cash cows live in (close to) Lintner
world
Repurchase policy is not (i.e., it is more flexible)
Payout ratio no longer target

Targets very flexible
Repurchases now very important

17
Miller and Modigliani (1961)
Payout Policy irrelevant if capital markets perfect
Imperfections that could explain payout policy

Taxes
Managerial agency conflict
Information/signaling
Other factors (EPS, float, credit ratings, etc)
Clienteles could result from imperfections
18
A. Taxes
Theory: At least for individual investors,

dividends are taxed move heavily than capital
gains.
Therefore:
Firms should consider investors taxation when
deciding about payout policy
Relative taxation should affect the amount of
dividends they pay
19
A. Taxes
Interviews: repurchases are efficient way to return capital
taxes (2nd order) important
Surveys: modest support
7g: Investor taxes

6g: Investor taxes
8a: Investor taxes lower vs. dividends

0% 10% 20% 30% 40% 50% 60% 70% 80%
Repurchases
Dividends
20
B. Clienteles
Investors that pay (relatively) more taxes on
dividends should hold stocks that pay out through
repurchases.
Translation: Individual investors should have
an aversion to dividend paying stocks. By
implications, institutions should be more
attracted to such stocks.
Prudent man
Institutions as monitors
21
B. Clienteles
Retail investors
Prefer dividends, in spite of tax disadvantage
Firms like because loyal
Institutions
If anything, prefer repurchases
Some can not invest in zero dividend stocks
42% say pay dividends because of prudent man rules
Tax advantage not an issue to institutions
Firms like because they have the money
22
B. Clienteles
Companies do not think that dividends attract institutions more so than do
repurchases
Companies do not use dividends or repurchases attract institutions to
monitor
Inconsistent with Allen, Bernardo, and Welch (2000) idea that firms use
dividends to attract institutional investors
7o: Attract institutions

6o: Attract institutions
7p: Attract inst. bc they monitor
6p: Attract inst. bc they monitor
7i: Influence of institutions
6i: Influence of institutions
7n: Attract retail investors
6n: Attract retail investors
0% 10% 20% 30% 40% 50% 60% 70% 80% 90%
Repurchases Percent of CFO's who rate choice as +1 or +2 (on scale of -2 to +2)
Dividends 23
C. Agency Stories
Firms pay dividends to impose discipline on

managers
24
C: Free Cash Flow

Interviews: some say: money can burn hole in pocket
But payout not the way to fix the problem
Surveys: (1) no support in general, (2) repurchases work as well as dividends but
(3) Cash cows are much more likely to pay; more reluctant to cut; more likely to
keep dividend growth as earnings growth
7f: Disciplinary role
6f: Disciplinary role
0% 10% 20% 30% 40% 50% 60% 70% 80%

Repurchases Percent of CFO's who rate choice as +1 or +2 (on scale of -2 to +2)
Dividends
25
D. Asymmetric Information
Conveying information
Costly self-imposed actionSignaling
Adverse selection
Do informed investors benefit from repurchase programs,
at expense of uninformed?
Stock undervaluation
26
D: Do payout decisions convey information?

Interviews: Yes, punctuation mark at end of sentence
Need to be consistent with other forms of communication
Repurchases convey as much as dividends
Surveys: Yes, convey info in general
4b: Convey information?

3b: Convey information?
7m: Running low on investments?

6m: Running low on investments?
0% 10% 20% 30% 40% 50% 60% 70% 80% 90%
Repurchases
Dividends
27
Information: Signaling
4h: Look better than competitors?

3h: Look better than competitors?
4i: Show we can bear costs

3i: Show we can bear costs
5i: pass up good investments

5h: investor bear dividend tax
5g: bear external financing cost
0% 10% 20% 30% 40% 50% 60% 70% 80%

Repurchases
Dividends
28
D. Information: Signaling
Surveys
No supporting evidence
Scores are even lower for growth/risky firms
39% (16%) say keep div (repurchase) policy of peers
Interviews
Spent hours on this issue
Generally try to group selves with peers (not separate)
No evidence of
increasing dividend to show market that firm is strong
viewing dividend as self-imposed cost
Avoiding dividend cut
Possibly a signal (costly for bad firms, separate from bad)
Cuts are rare cant explain dividend policy for most firms
Does not explain why firms pay dividends in the first place
29
D. Information: Stock Price

Interviews: Would like to buy when price low, but
often want to maintain liquidity at this time
do not want credit rating downgrade
So, its a conditional objective
Surveys: repurchases, stock good investment
7q: Stock price low
6q: Stock price low
0% 10% 20% 30% 40% 50% 60% 70% 80%

Repurchases
Dividends
30
E. Other factors: EPS

Interviews: managers are concerned about EPS
Some think its automatic that repurchases increase EPS
Other believe that it depends on alternative use of funds
Surveys: EPS important
8b: Increase EPS
8f: Offset stock option dilution
8g: Options not dividend protected
0% 10% 20% 30% 40% 50% 60% 70% 80% 90%
Repurchase questions
31
E. Other factors: Float and credit ratings

Interviews: Float very important
Execs think they need to have a large number of shareholders
Interviews: credit rating important

Hoard cash to improve rating
Especially for financial firms or firms with financial divisions
Repurchases
Dividends
32
Initiate with repurchases or dividends?
share repurchases only
dividends only
some combination of
dividends and
repurchases
0% 10% 20% 30% 40% 50% 60% 70%
Fig. 6D: What would your first payout be if you were

hypothetically deciding to pay out capital for the first time. (For
neither dividend payers nor share repurchasers only.)
33
Why initiate payout?
9i: stock undervalued

10i: stock undervalued
9m: convey info bc undervalued

10L: convey info bc undervalued
9c: Extra cash

10c: Extra cash
9n: Float/liquidity improves

9j: Increase EPS
9L: Offset stock option dilution
0% 10% 20% 30% 40% 50% 60% 70% 80%
Repurchases
Dividends
34
Conclusions
Payout policy is not first-order important*

(M&M)
Repurchases: decided de novo
Dividends: level very important
Managers prefer repurchases over dividends
because they are more flexible.
Not because of taxes.
35
Conclusions
According to managers, payout

convey information
NOT being used as a costly signal
NOT being used to attract institutions
Managers do not use dividends over
repurchases to attract institutions
Institutions do not push for more dividends
36
Conclusions
Managers of cash cows believe more
strongly that
Dividends should be stable
Keeping dividend growth rate with earnings
growth
But all managers reject the notion that they
need dividends so that they will not spend
cash unwisely.
37
Rules of the Game:

How payout policies are determined
Make investment plans first*
Take care of cash/liquidity needs
*BUT, remember, level of dividends fixed
Only reduce dividends in extraordinary
circumstances
Severe penalty for cutting dividend because the market
believes that cuts precede bad news
So, dont ever cut dividends
unless you have an amazing investment opportunity
smaller penalty if competitors cut
Think very carefully before initiating dividends 38
Rules of the Game
Desire to maintain the level of dividend at any

cost consistent with findings in Graham,
Harvey and Rajgopal, 2004, The Economic
Implications of Corporate Financial Reporting
Here managers desire to hit consensus EPS at any cost
55% would knowingly sacrifice value (not pursue a very
positive NPV project) if it would cause the firm to miss
next quarters target!
78% would knowingly sacrifice value to smooth earnings
39

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Payout Policy in the 21st Century

Much has changed in the last 50 years.

We revisit this path-breaking study at the beginning of the 21st

We survey 384 financial executives with an

Survey and Interview Design

How are payout decisions made?

4e: Fund externally, rather than cut

4a: Investment decision made 1st

7h: Good alternative investments

7j: M&A strategy

Dividends vs. Repurchases (Fig. 2)

Pay down debt

0% 10% 20% 30% 40% 50% 60% 70% 80%

Pay down debt

Pay more dividends

0% 10% 20% 30% 40% 50% 60% 70% 80% 8

Level of dividend fixed

Three main points

Compare to Lintner (1956)

Dividend policy still conservative?

6d: Try to avoid cutting

4d: Neg. consequence to cutting

7L: Maintain historic policy

5b: change in div what matters

Repurchases: No, flexible

7c: Stability of future earnings

7b: Sustainable change in earnings

7d: Excess cash on balance sheet

7a: Temporary increase in earnings

Payout ratio still target? vs. Lintner (1956)

Level of dividends per share

Growth in dividends per share

Do not target at all

0% 10% 20% 30% 40% 50% 60%

Payout ratio still target? vs. Lintner (1956)

A somewhat strict goal

Not really a goal

0% 10% 20% 30% 40% 50% 60%

Payout ratio still target? vs. Lintner (1956)

The SOA= 1 and TP= 2 / 1 .

Summary vs. Lintner (1956)

Dividend policy still very conservative

Payout ratio no longer target

Repurchases now very important

Miller and Modigliani (1961)

Payout Policy irrelevant if capital markets perfect

Imperfections that could explain payout policy

Clienteles could result from imperfections

Theory: At least for individual investors,

7g: Investor taxes

8a: Investor taxes lower vs. dividends

Percent of CFO's who rate choice as +1 or +2 (on scale of -2 to +2)

7o: Attract institutions

Firms pay dividends to impose discipline on

C: Free Cash Flow

7f: Disciplinary role

6f: Disciplinary role

0% 10% 20% 30% 40% 50% 60% 70% 80%

Costly self-imposed actionSignaling

D: Do payout decisions convey information?

4b: Convey information?

7m: Running low on investments?

Percent of CFO's who rate choice as +1 or +2 (on scale of -2 to +2)

4h: Look better than competitors?