Dividend payments as a

response to peer influe

nce
Introduction

• Phenomenon:
 Firm’s decisions to change their dividend payments tend to occur at similar times.
• The findings of the author from real-life example:
 General Electric(GE) and Westinghouse(WHS)’ dividends often moved in lockstep
 Firms’ dividend policies are responsive to peer influence
• In this paper, the author examined:
 Why and through what channels, dividend peer effects operate
Introduction
• Partial adjustment model for dividend payment(Lintner, 1956) adopted by the author
 Key inputs: earnings, the target payout ratio, and the adjustment period.
 Hypothesis: dividend peer effects manifest in the choice of a target payout ratio or
adjustment period
• The author separately analyze dividend increases and decreases when testing because
 Lintner’s model does not distinguish between dividend increases or decreases.
 Dividend increases and decreases are not motivated by the same factors (Michaely et
al., 1995) and not symmetric (Leary and Michaely, 2011)
Introduction
When a firm’s idiosyncratic risk decreases, the firm requires
less cash and instead opts to distribute more.

• Challenge to identifying peer effects :

 Reflection problem, a form of endogeneity (Manski, 1993)
 IV strategy where peer influence is instrumented for using the peer firms’ idiosyncratic equity risk,
because there’s relevance between idiosyncratic risk for dividend policy(Hoberg and Prabhala,
2009), and this IV strategy was pioneered by Leary and Roberts(2014)
• Hypothesis of why firms belonging to the same industry tend to behave similarly
 Peer effect, contextual effect, correlated effect
Introduction
• Robustness tests:
 To address if latent common factors attributable to the peer group definition are behind the
finding, a placebo test is conducted that uses randomly assigned peer groups and it reveals
insignificant peer effects for these random peer groups.

• Examine four economic channels for why peer effects exist.

 Learning channel, behavioral channel, industrial organization channel, reputation channel
 The evidence supports a behavioral channel and an industrial organization channel

• Examine whether dividend announcement returns anticipate peer effects.

 Some of the private information is anticipated via peers’ dividend announcements
 Data
2.1. Data sources

• Database:

 Center for Research in Security Prices (CRSP)

 Equity ownership data from ThomsonReuters, merger and acquisition (M&A) data from Securities Data
Company (SDC).

• Time: 1975-2011
 Due to concerns about accounting data and to avoid 1971 dividend freeze(Baker and Wurgler, 2004)
• Financial firms, utilities, and Real Estate Investment Trusts (REITs) are excluded from the sample.
 Because their payout decisions are affected by regulation
 Data
2.2 Peer influence
• Key explanatory variable: dividend peer influence
• Define peer group based on industry by using the 3-digit SIC
• Quantify peer influence by constructing a time series of firm-specific
peer dividend decisions and calculate the fraction of peer firms increasing
dividend payments in the 180 days before an individual firms’ declaration
date
 Data
 
2.3. Risk variables
• Key IV: peer idiosyncratic risk
Construct a quarterly idiosyncratic risk time series and follow the decomposition framework
(Campbell et al. (2001))

(1) where
: daily firm-specific residual return
the excess return on day s in quarter t for stock j that belongs to industry i.
: the value-weighted excess return of industry i on day s in quarter t.

(2) , where
: the idiosyncratic risk of stock j belonging to industry i in quarter t
 Data
 
2.3. Risk variables

(3) , where

: the idiosyncratic risk of industry i in quarter t

: the quarter t weight of stock j that belongs to industry i
 Data
2.4. Other explanatory variables

• Major market frictions that motivates dividend payment:

 Asymmetric information, agency costs and taxes.

• Others:
 Firm size(Brav et al., 2005), the level of institutional holdings(Grinstein and Michaely, 2005)
 Competitiveness (Grullon and Michaely, 2008)
 Changes in the market for corporate control (Billett and Xue, 2007)
 Exposure to fraud (La Porta et al., 2000)
 Data
2.5. Summary statistics
• Table 1: The distribution of firm-specific covariates, which correspond to quarterly
observations, for all firms, dividend-paying firms, and non-dividend-paying firms
 Data
2.5. Summary statistics

• Table 2: Panel A reveals that firms are more likely to increase their dividend payment when
a peer firm increases its dividend payment.
 Data
2.5. Summary statistics

• Table 2, Penal B
 To test the relation between peer influence and dividend changes.
 Result: Higher peer influence is associated with the greater likelihood of regular dividend
payer increasing dividend payments
 Data
2.5. Summary statistics

• Table 3, Panel A
 The relation between peers’ dividend changes and characteristics of an individual firm’s dividend
change
 Result: In each case, peer influence is significantly higher when dividend changes are made.
3. Dividend peer effects
Hypothesis development

• The author’s hypothesis:

 If dividend peer effect exists, a change in dividend payments should be observed when peer firms
change their dividend policy.

• Develop hypothesis from the Lintner(1956) partial adjustment model of dividend payments
 If peer effect exists in dividend, they must manifest in the choice of a target payout ratio or in the
adjustment period.
increase the target payout ratio.
 Peer firms increase dividend, a given firm will Peer effect
shorten the adjustment period.
 The change in earnings does not fully motivate a dividend increase
Hypothesis development

• The author’s hypothesis:

 Peer-induced dividend changes result from either a change in the adjustment period or a change
in the target payout ratio.

• Other literatures
 Dividend cuts are more pronounced than increase (Michaely et al., 1995)
 Dividend increases and decreases are not motivated by the same factor(Brav et al., 2005)
 Financial executives perceive a large asymmetry between dividend increases and decreases (Bra
v et al., 2005)

Therefore, the author separated changes in dividend payments into increases and decreases w
hen testing hypothesis.
Identification strategy(1)

•• Purpose:
  To test whether peer effects exist in dividend decision
• IV specification: To prevent reflection problem identified by Manski(1993)
A known determinant of dividend
policy (Fama and French, 2001;
Hoberg and Prabhala, 2009 )
where : dummy variable indicating a dividend increase or decrease
: peer influence, instrumented for using average peer firms’ idiosyncratic equity risk
: a vector of firm-specific covariates and peer averages of those covariates(i.e., common and
contextual effects)
: firm fixed effect
: time fixed effect
: unobservable error component
Result(1)

Table5 1. Dividend peer effect

exists
2. Peer effects are more
pronounced for
dividend increase
 Consistent with prior
study that increases and
decreases are not
motivated by the same
factor (Brav et al., 2005)
 Result(1)

Unreported coefficient estimates

Firm-specific covariates
for these are insignificant
 Peer influence does
 Contextual effects are not
not displace other
responsible for the propensity
known dividend
of a firm to behave like peer
determinants
firms
Identification strategy(2)

• Purpose: To test whether dividend peer effects manifest in changes in the adjustment period( pro
xied by time between dividend changes), or in the target payout ratio( proxied by observed payou
t ratio).

• IV specification:

 Peer influence is instrumented for using average peer idiosyncratic equity risk

 Include all the same controls(common and contextual effect, firm fixed effect, time fixed effect)

 Dependence variables are either adjustment period change or dividend payout change
Result(2)
a standard deviation increase in peer
influence, expected time to dividend
change is shortened by 1.5 quarters

The average effect is diluted by

including annual changers, but still
remains significant

Dividend peer effects

occur through the
target payout ratio

Overall, these results support the effect

of peer influence on time between
dividend changes and the effect of peer
influence on dividend levels
Robustness checks- The definition of peer group

➢A changes the peer group definition from the

three-digit Standard Industrial Classification

group to a group of randomly selected peer
firms.
Robustness checks- The definition of peer group
Robustness test- the definition of group

➢I find insignificant peer effects for these

random peer groups, which suggests that
peer firms defined by industry are an
appropriate reference group for evaluating
peer effects, and that such a group matters
for dividend policy
Robustness checks- The change in earnings

Motivation: (Benartizi et al.,1997) The test support the hypotheses:

(Nissim and Ziv, 2001) 1. The target payout ratio
Logic: Peer effect → Earnings → Dividend
2. The adjustment period
is the tool to increase dividend
Test the relation

Fail to Reject
2 Ho: There is no peer effect for earnings
1 Whether peer influence coefficient is a great IV.

➢ Peer effect → Earnings → Dividend

Robustness checks- Other factor

Appendix
Other known dividend determinants

Variable Citation Test

Dividend taxes and (Baker and Wurgler, Peer influence

catering 2004)

Product market industrial (Hoberg and Phillips, Peer influence

classification 2016)
Heterogeneity in peer effects
Hypothesis development and empirical

proxies Other known dividend determinants

Means Citation

Bikhchandani et al., 1992;

This set of models generates peer effects
Learning when firms rely on peer-based information Bursztyn et al., 2014;
Foucault and Fresard, 2014

Malmendier and Tate, 2005;

Overconfidence CEOs misread peer’s successes as signals Ben-David, 2011;
that their own successes are coming
Malmendier and Tate, 2015

Industrial organization gener ate peer

Industrial organization with Bolton and Scharfstein, 1990;
effects when weak firms feel compelled to
predatory behavior respond to peers . Fudenberg and Tirole, 1986

Executive reputation-building ac tions can

Reputation-building actions Scharfstein and Stein, 1990
generate peer effects
Heterogeneity in peer effects

Charjit :
Is a dummy variable indicating the firm has the characteristic that
proxies for the economic models and its associated interaction term
 
Char jit x :
The interaction between char and peer idiosyncratic risk.

The reason that added the interaction item :

Because the second instrument satisfies the relevance and exclusion restriction
through the same logic as the first instrument.
Results

There are four types of version of potential

mechanism.

The probability of the firm to

increase dividend payment.
Results

Twice

Despite having cash flow issues rendering the firm vulnerable to

industry competitors, the firm chooses not to retain cash. Rather, it is
twice as likely to payout additional cash when peer influence is high.
Results

Columns 3 and 4 reveal no statistically

significant change in dividend payments
for firms motivated by reputation-building
and learning .

 The empirical result violated the premise that no

single mechanism is more important than another.
5. Repurchase
Hypothesis development

• The author’s hypotheses:

 If dividends are fixed, then something else should be the residual, thus prompting a test for peer effects
on other uses of cash
Any test of dividend policy being a relevant decision indirectly tests for another corporate variable as the

residual shock absorber

• Dividends and repurchases are seen as close but imperfect substitutes (Guay and Harford, 2000; Grullon
and Michaely, 2002)
 Testing for repurchase peer effects helps to determine if dividend peer effects work through dividends
directly or indirectly via a firm’s sources and uses of cash
Identification strategy
 
• To test whether dividend peer effects work through a dividend channel alone or through an alternative
peer effect channel induced by repurchases
• Repurchase replace dividends on both the left-hand and right-hand side of the IV specification

Where dummy variable indicating a repurchase increase or decrease

: share of peer firms within the same industry i that made repurchases before firms
j’s repurchases were made
: a vector of the observable firm-specific covariates and peer averages of those covariates(i.e.,
common and contextual effects)
: firm fixed effect
: time fixed effect
: unobservable error component
Results

• Examine whether a repurchase peer effect is driving

identification of a dividend peer effect
 Estimate is insignificant and close to zero on the
repurchase peer effect in all specifications
6. Announcement effects
Hypothesis development
• Investors react positively to announcements of dividend increases(Michaely et al., 1995)
 The positive reaction is consistent with theoretical models in which investors rationally respond to the
surprise revelation of private information conveyed by the dividend increase
• To evaluate whether investors account for peer influence, I integrate my peer effects model for predicting
a dividend increase with a model of dividend announcement effects.
• Announcement effect models are premised on executives having private information about their firms
that the market does not have, combined with executives’ potential incentive to reveal this information to
the market.
 This revelation of private information by the firm helps explain the market’s positive reaction to
announcements of unexpected dividend increases
Identification strategy
 
• Purpose: determine which dividend announcements are a surprise and thereby reveal private information
to the market, a model of the unexpected component of a dividend announcements necessary
• Good proxy for the unexpected is the error term, , from the peer effects regressions predicting when a
dividend increase will occur[i.e., Eq. (4)]
Large error term is associated with an unexpected increase
Small error term suggests a comparatively greater expected increase

 Calculating simple differences in error terms across regression models isolates how much the unexpected
component of the dividend increase changes with the inclusion of peer-based information
• Two models that investors could use for predicting when a dividend increase will occur are considered
Identification strategy

 With these measures of the unexpected component of dividend increases, the private information
contained in announcement returns can be evaluated
 Two-step approach of (1) calculating the unexpected
(2) using the result to evaluate the announcement returns
which reflects methods developed by other researchers to examine the private information revealed in
corporate announcements(e.g., Eckbo et al.(1990); Nayak and Prabhala (2001); Kai and Prabhala (2007))
Identification strategy
 First step, I estimate the CARs from the announcement of a dividend increase
I use daily data to estimate the parameters of a Carhart four-factor model
(1) the market return, which is the CRSP value-weighted index
(2) SMB, capturing risk related to size
(3) HML, capturing risk associated with B/M characteristics
(4) UMD, addressing risk associated with prior returns
 Event period [-1 , +1], dividend announcement at day 0
  Second step, I use OLS estimates of the CARs along with the error term, , estimated from the models
predicting dividend increases to investigate the degree of investors’ surprise at the dividend announcement

: the error terms from the k = 1, …, 2 regression models that investors could use to predict
dividend increases
: the coefficient of interest, and it represents the investors’ surprise from dividend announcements
Identification strategy

 To understand the incremental change in what is revealed by the announcement of a dividend increase
when investors include peer-based information in their prediction model

∈
  𝑗𝑖𝑡 : error terms from the baseline prediction model

: the difference in error terms, from including peer-based information in the prediction model
: it represents the change in investors’ surprise from dividend announcements when they add peer-
based information to their prediction models for when dividend increase will occur
Identification strategy

• This suggests that the model with peer announcement effects better fits the data and improves
investors’ ability to predict dividend increases
Conclusion

 This study helps to explain the phenomenon of firms deciding to change their dividends at similar times
 Peer firm behavior has a robust and significant impact on dividend increases but not on decreases
 Dividend peer effects working through the adjustment period and target payout ratio in Lintner’s partial
adjustment model of dividend payments instead of through earnings
 Announcement returns indicate that investors anticipate the consequences of peer effects, dividend policy
is a decision firms rarely reverse