George M. Frankfurter

Dividend Policy of Regulated Industries

This chapter focuses on dividend policy of regulated industries, measuring dividend policy based on dividend payout ratio and yield. Regardless of the rationale for dividend payment, it is generally recognized that fundamental differences exist in the dividend policies of unregulated and regulated firms. A reason for this difference in dividend policy is that historically the investment opportunity set available to regulated firms has been restricted, and these restrictions have limited the capital gains potential from equity investments in regulated firms. Unregulated firms pay out a substantially smaller portion of their earnings than do most regulated industries, especially utilities and Real Estate Investment Trusts (REITs), and the dividend yield of unregulated firms is significantly smaller than the corresponding yield of most regulated firms, with insurance companies being an exception. The tax liability associated with the receipt of dividends as ordinary income, plus the flotation costs associated with new issues, would have to be less than the net transactions cost of receiving the income as capital gains.

The Evolution of the Modern Corporation in The Netherlands and the United Kingdom

This chapter traces the historical evolution of corporate dividend policy from its origins in The Netherlands and the United Kingdom. Precursors of the modern corporation occurred in 14th-century Italy, where merchants formed loose federations for limited purposes. Joint stock companies evolved from these merchant associations as a result of the high capital requirements of foreign trade. Investors provided capital for these corporations, and sailing captains applied their special skills to the profitable use of the assets and paid dividends to the shareholders. The most important joint stock venture in Great Britain was the British East India Company, formed in 1599 as a spin-off of the Levant Company. The British East India Company was granted a charter and monopoly trading rights by an act of Parliament in 1600. The limited number of original shares was sold primarily among acquaintances. Shareholders had unlimited liability and were subject to calls for additional funds if needed. The South Sea Company was granted a charter in 1711 for the purpose of consolidating the national debt of Great Britain and replacing the debt with corporate stock. Secondary issues provided funds for the company to pay exorbitant dividends to original issue shareholders.

Chapter 6 – Preferred Stock and Dividends: A Revealing Divergence

This chapter presents various features of preferred stocks, how they originated, and how their stockholders are treated. The adjective “preferred” in preferred stock implies that the holders of such shares are preferred when it comes to the distribution of income. This would mean that before common stock can receive any cash dividend distribution, the preferred stockholder has to be paid. Most preferred stocks are cumulative—that is dividends were not paid in a quarter, it accumulates for the next quarter, and the quarter after, until all accrued dividends are paid. The official Financial Accounting Standards Board (FASB) treats them as a kind of equity that is preferred over other types of equity, as far as distribution of income is concerned. This perception is rooted in the historical origins of the preferred stock. The idea for preferred stocks can be traced to Europe where shares with dividend priority or preference already existed. The second stage in the development of preferred stock began in the next decade with the sale of shares to private investors. The promise of regular dividends was exchanged for new funds.

Chapter 5 – Dividend Reinvestment Plans: A Puzzle within the Puzzle

This chapter focuses on the features of dividend reinvestment plans (DRIPs), which have their roots in the late 1920s. About more than 1500 firms with DRIPs, representing all walks of life in corporate America, are listed on the internet. In practicality, the DRIP allows small investors to use dollar averaging, bypassing the broker and saving on possibly high brokerage fees. DRIP allows bondholders and preferred stockholders to reinvest coupon payments and preferred dividends in the firms stock and permit customers of the business to contribute through billing systems and savings accounts. DRIP provides safekeeping facilities for stockholders who want to leave their shares with the plan administrator. The most obvious disadvantage of the DRIP from the shareholders point of view is the tax aspect. Taxes must be paid, out of pocket, for the reinvested dividends, and records must be kept concerning the timing and purchase price of the shares.

200 Years of Dividend Practices

This chapter focuses on the emergence of dividend payment patterns and trends throughout the history of the modern corporation. Corporate dividend payments to shareholders began more than 300 years ago and have continued as an acceptable, if not required, activity of corporate managers, despite the apparent contradictory economic nature of these payments. It seems that the corporation progressed from its original liquidating dividend, to distribution of all profits, to a token dividend payment, the size and frequency of which are left to the discretion of management. The lack of financial information available to investors in the late 19th and early 20th centuries magnified the importance of a history of consistent dividend payments. Shareholders and analysts often used this information as their primary input when valuing firms. The major promoters of the notion that dividends are good for the shareholders are financial analysts and other financial mavens. The chapter also focuses on the emergence of dividend reinvestment plans (DRIPs) which is one of the most fascinating developments regarding dividend-paying patterns.

Chapter 11 – The “Balance Sheet” of Academic Research: What It Does/Does Not Prove

This chapter empirically tests in a rigorous statistical framework what the preponderance of models that attempt to explain empirically the dividend puzzle show or do not show. The categorical data analysis method (CDAM) determines whether the method of analysis, observation frequency, and sample period can be used to predict and explain the results of a research. CDAM is a specialized, multivariate analysis technique for the evaluation of response and explanatory variables using weighted least-squares (WLS) procedures. Iterative WLS improves WLS estimates by first estimating the weights, fitting the regression function, and calculating the residuals. Next, the residuals from the first estimation are used to re-estimate the weights and to refit the regression. CDAM and analysis of variance (ANOVA) are similar methods of analysis in one respect—both estimate the interaction between variables. No single economic rationale can explain the dividend phenomenon. The corporate tradition of paying dividends is the sum total of more than 300 years of evolution of the practice of dividend payments. Despite individual differences in policy, consistent identifiable patterns of dividend payment recur through corporations. The chapter concludes that tests of dividend policy theories will remain both inconclusive and inconsistent.

Determinants of Dividend Policies

This chapter empirically examines the determining factors of dividend policies. A time-series cross-sectional model is applied to individual firm data. A Vector Autoregression Model (VAR) model is used to analyze aggregate data. Under the VAR model, a system of dynamic linear equations is constructed such that a vector of dependent variables is related to lagged vectors of all variables in the system. Because the error variance of a variable is identified as the sum of contributions by all variables in the system, this decomposition method is useful for exploring the influence of one variable on another variable. The second test statistic in the VAR technique is the impulse response function (IRF), conceived to trace out the response path of the system variables to an unexpected unit shock in a variable. The chapter examines the contemporary relationship among dividends, earnings, free cash flows, beta, and firm size. The chapter aims to analyze a wide range of dividend determinants—namely, investments, earnings, debt, free cash flows, firm size, beta, and industry classification. The chapter describes that the firms dividend payments are significantly related to earnings, free cash flows, beta, and firm size and dividends are not influenced by investments and debt consistent with the irrelevance proposition of Miller and Modigliani.

Conclusions: Future Research and Thinking

This chapter discusses why there is an urgent need to understand what investors and their professional advisers think about dividends and how they should be educated to overcome mistaken beliefs as part of future research to comprehend the dividend phenomenon and practice. The whole theory of modern finance in general and the notion of market efficiency in particular are based on the axiom of investors risk aversion. In a recession when most stock prices are depressed, the yield can look reassuring one moment and totally lousy the next. Also, there is this little problem of taxes, which may be avoided in a case of a tax-exempt bond, for which both price and yield are more stable, constituting a less risky investment instrument. There are some preconceived notions among financial decision makers, one of which is to maintain dividends and increase dividends only if the firm can continue paying the higher dividend for years to come. It will be prudent to presume that shareholders will reward a prudent response to the ever-changing economic conditions rather than sticking to a strategy that may bring about tragic consequences.

Other Methods of Distribution

This chapter discusses various methods adopted by firms for distributing dividends to shareholders. Both stock dividends and stock splits involve the distribution of additional shares of stock to the existing shareholders in proportion to their ownership. The accounting profession recommends treating stock distributions of greater than 20–25% as stock splits. A more recent mode of investigation of the stock dividend/split phenomenon is the application of some aspects of the blossoming literature of market microstructure and the bid–ask spread. Keeping the stock price within a range management perceives as optimal both for the purpose of liquidity and for making the ownership structure as diffuse as the stewards of the firm think to be optimal is another favorite explanation of the motives for stock dividends/splits. The initial appearance of the responses from firms that did not pay a stock dividend in the period is that perceptions of these executives are similar to those for the primary sample, particularly for the statements receiving the greatest agreement.

What if We Do Not Pay Dividends

This chapter discusses various factors that lead to firms paying dividends to stock holders, and what will happen if they do not pay dividends. Financial officers of firms know well that the market “punishes” firms that either reduce quarterly dividends or skip payment altogether. Some firms pay dividends because they want to be included in “legal listings.” Inclusion in legal listings requires a minimum number of years of consecutive dividend payments. The benefit of being a legally listed firm is, “ceteris paribus,” lower interest rates on these firms publicly issued debt. More firms are paying out more dividends than in the late 1990s, mainly to bolster their stock price and to get rid of excess cash. The first reason is also an important factor in the increase in volume and frequency of share repurchases. Most firms pay dividend for protecting their share price, increasing the share price in order to make management stock options more valuable, and for pacifying shareholders who were educated on the value of dividends since time immemorial. However, firms like Microsoft, Apple Computer, and FedEx have never paid a dividend.