The Dividend Substitution Hypothesis: Australian Evidence

In a perfect capital market firms are indifferent to either dividends or repurchases as payout mechanisms, suggesting that the two payout methods should be perfect substitutes. Empirical research at the single country level, as well as cross country studies, provide evidence that dividends and repurchases act as substitutes (the dividend substitution hypothesis), and that the tax treatment of dividends versus capital gains affects this relation. Australia, which operates under a full dividend imputation system, has two types of repurchases: on‐ and off‐market. On‐market repurchases are taxed as capital gains while off‐market repurchases comprise a large dividend component carrying valuable tax credits. Australia thus provides a natural setting to investigate how the tax treatment of proceeds affects the dividend substitution hypothesis. Dividend substitution is found to exist for on‐market repurchases but not for off‐market repurchases, thus providing further support for the idea that the tax treatment of proceeds affects the substitutability of repurchases and dividends.     

Corporate payout policy in Australia and a test of the life‐cycle theory

We provide evidence on the frequency and size of payouts by Australian firms, and test whether the life‐cycle theory explains Australian corporate payout policies. Regular dividends remain the most popular mechanism for distributing cash to shareholders, despite a slight decline in the proportion of dividend payers since the relaxation of buyback regulations in 1998. Off‐market share buybacks return the largest amount of cash to shareholders. Dividend paying firms are larger, more profitable and have less growth options that nondividend paying firms. Consistent with the life‐cycle theory, we observe a highly significant relation between the decision to pay regular dividends and the proportion of shareholders’ equity that is earned rather than contributed.     

Dividend payments as a response to peer influence

I show dividend policies have peer effects. My estimates indicate that firms speed up the time taken to make a dividend change by about 1.5 quarters and increase payments by 16% in response to peer changes. The peer effects matter in increases but not decreases. In contrast to dividends, repurchases show no peer effects. In addition, announcement returns indicate that investors partially anticipate the consequences of peer effects. Overall, peer interdependencies account for 12% of total dividend payments.     

Share pledging,payout policy,and the value of cash holdings

Share pledging for insiders’ personal bank loans is associated with the agency problems of insider risk aversion and stock price crash risk. We examine the relation between insider share pledging and the value of cash holdings using the pledging data of listed firms in Taiwan. We find that the value of cash holdings is lower for pledging firms, especially for those that are relatively more risk averse. Pledging firms that repurchase shares have a higher marginal value of cash than those with other payout methods, likely due to the role of repurchases in reducing the stock price crash risk. Our results show how insiders’ personal financing incentives arising from share pledging would affect the value of cash holdings from the perspective of agency problems and payout policy.     

Short‐selling constraints and corporate payout policy

This study shows that managers adjust corporate payout policies to counteract intensified short‐selling pressures following the removal of a short‐selling constraint. We use a controlled experiment, the Regulation SHO pilot program, to find that changing the short‐selling rule brings small companies to increase cash dividends, but not to repurchase more shares. Because paying dividends is costly, it is acknowledged as a more reliable signal of stock undervaluation than share repurchase. While our evidence suggests that companies select this payout strategy to deter predatory short sellers, it also shows that a short‐selling activity has a causal effect on corporate payout decisions.     

On stock-based loans

We investigate the equilibrium interest rate charges on non-recourse and recourse loans secured by stock. In such loans, the client retains the option to prepay and recover the collateral stock. We adopt a structural model of the firm where debt levels, with endogenous bankruptcy, affect equity dynamics. Complicating matters, the link between total equity and the price of a share of stock that forms the collateral depends on the extent of dilutions and buybacks that occur. For levered firms, due to dilution in bad states of nature, stock prices typically fall faster than equity values; and for firms that engage in buybacks in good states of nature, stock prices will rise faster than equity values. Banks that ignore these features underestimate the equilibrium interest rate charge on stock-based loans. We provide an analysis of individual stock-based loans and their portfolio characteristics, the latter of which can be used by banks to ascertain capital requirements.     

Optimal execution of open-market stock repurchase programs

This paper formalizes the following intuition about open-market share repurchases. Firms do open-market share repurchases to return free cash, which would otherwise be wasted. However, when the firm goes to buy its own shares with this cash, it has inside information and hence the actual execution is characterized by adverse selection. The market knows that the firm has inside information, and consequently the ask price is high to compensate for this adverse selection problem. This implies that, all else equal, the greater the adverse selection problem compared to the cash waste problem, the higher the ask price, and, therefore, the wider the bid–ask spread and the lower the share repurchase completion rate. We test this implication on a sample of U.S. firms and report evidence consistent with the model.     

Growth,governance and corporate payout policy

We show that when growth opportunities decreased following the end of the Cold War, defence firms responded by increasing total payout. This change in policy was largely driven by increased stock buybacks as opposed to changes in cash dividends and primarily by firms that faced stronger external governance. On the other hand, firms with weaker internal governance that were more severely affected by the reduced growth chose to alter the mix of payout at the expense of repurchases. Overall, our findings (i) demonstrate a causal link where exogenous shocks to growth cause payout policy changes, (ii) support the role of internal governance in payout policy design where entrenched managers pre‐commit to higher dividends and (iii) emphasize the monitoring role of external governance in mitigating agency costs of free cash flow.     

The effect of board independence on dividend payouts: A quasi-natural experiment

Motivated by agency theory, we investigate the effect of board independence on dividend policy. We exploit as a quasi-natural experiment the passage of the Sarbanes-Oxley Act and the associated exchange listing requirement, mandating firms to have a majority of independent directors. Our difference-in-difference estimates show that firms forced to raise board independence are significantly more likely to pay dividends than firms not required to change board independence. Our results are consistent with the notion that stronger board independence forces managers to disgorge more cash to shareholders, thereby reducing what is left for possible expropriation by opportunistic managers. Based on an exogenous regulatory shock, our results are more likely to show a casual effect, rather than merely an association.     

Dividends and share repurchases in the European Union

We examine cash dividends and share repurchases from 1989 to 2005 in the 15 nations that were members of the European Union before May 2004. As in the United States, the fraction of European firms paying dividends declines, while total real dividends paid increase and share repurchases surge. We also show that financial reporting frequency is associated with higher payout, and that privatized companies account for almost one-quarter of total cash dividends and share repurchases. Our regression analyses indicate that increasing fractions of retained earnings to equity do not increase the likelihood of cash payouts, whereas company age does.