Empirical capital structure: A review, Foundations and Trends in Finance Flashcards
Lifecycle theory
During the rapid growth stage there are many positive NPV projects, investment banks charges for IPOs, so it is more beneficial to sit on cash to finance all those attractive investment projects -> a few dividends pay out (all money reinvested)
During the maturity period there are a few positive NPV projects -> pay out dividends rather than burn cash in NPV < 0 projects. Likely Agency costs -> impose high dividends payouts as a disciplinary measure
De Angelo’s proposition
Payout policy is a trade-off between agency costs and capital raising costs
Reasons to pay high dividends
Clientele effect Low growth companies Agency costs Signaling theory Bird in hand theory
Reasons to pay low dividends
High issue costs Tax effect Clientele effect Costs of financial distress Good growth prospect
Advantages of repurchase
Preserving financial flexibility Correct stock valuation Remove low valuation stockholders Allocation of voting rights Increase reported EPS Transaction costs saving
Why Preserving financial flexibility is a reason of repurchase
- No need for future payments
Why Correct stock valuation is a reason of repurchase
- Buy when undervalued
- Exploit shareholders (arguable)
Why Remove low valuation stockholders is a reason of repurchase
- Increase the value
- Avoid takeovers
Why Allocation of voting rights is a reason of repurchase
- Remove threatening block holders
- Increase management ownership
Why Increase reported EPS is a reason of repurchase
- Simply due to fewer shares
- Productivity growth
Why Transaction costs saving is a reason of repurchase
Less shareholders => less “paper work”
- Small firms
“residual” theory
pays cash when has it left
Factors that influence payout
o Signaling and information distribution o Investor’s mental accounting and behavioural biases o Managerial over-confidence and biases o Taxes o Consumption demand o Clientele
Signaling and information distribution
Challenge to M&M irrelevance theorem (Stock prices react to div. announcements)
Earnings vs payouts (price changes reflect changes in expected level of riskiness of payouts but not always expected earnings)
Hard to choose how to signal
Wrong firms pay dividends (should – young, small, do – old, large)
Mgrs. careful about dividends (reluctant to cut, so often don’t raise) – dividends only a complimentary tool for communication
Stakeholder relations supported (labour unions)
Investor’s mental accounting and behavioural biases
Demand biases (consume only from dividends)
Trends/fashion
Catering theory, but “homemade dividends”
Homemade dividends
Homemade dividends is a concept that in liquid markets an investor can alter a company’s dividend policy to match his own cash flow objectives. … It suggests that investors are indifferent between dividends and capital gains because total return on a stock is made up of both dividends and capital gain.
Managerial over-confidence and biases
Convince investors that no agency costs exist
Overconfident CFOs – lower return projects, pay divs less often, repurchase stock more frequently
Clientele
stockholders differ in their desires in divs vs capital gains
Taxes
Government regulation
Transaction costs
Not realistic – wouldn’t be able to diversify, as pay/don’t pay div. firms similar
What about is article
Authors would like to argue in this paper that adding a friction to the Fisherian Model, particularly asymmetric information, yields an FCF-centric theory that explains the timing and the magnitude of payouts over the lifecycle of a corporation.
3 Reasons why investors are willing to consume from dividends:
(i) they are unwilling to sell too many stocks now,
(ii) they feel that they might regret in case that share price increases,
(iii) marginal utility from one dollar of dividends exceeds the marginal utility of the tenth dollar of capital gains.
Conclusion of the article
Authors conclude that the massive dividends consistently distributed over many decades primarily reflects the corresponding large earnings that dividend payers have generated over the years, and they are not influenced so much by the investor sentiment on firm’s dividend decisions.
