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Journal ArticleDOI

Why individual investors want dividends

01 Dec 2005-Journal of Corporate Finance (Elsevier)-Vol. 12, Iss: 1, pp 121-158
TL;DR: In this paper, the question of why individual investors want dividends was investigated by submitting a questionnaire to a Dutch investor panel, and the respondents indicated that they want dividends partly because the cost of cashing in dividends is lower than the cost for selling shares.
About: This article is published in Journal of Corporate Finance.The article was published on 2005-12-01 and is currently open access. It has received 81 citations till now. The article focuses on the topics: Dividend policy & Corporate finance.

Summary (3 min read)

1. Introduction

  • The authors test their validity as descriptions of investor behavior with direct survey research conducted on a sample of Dutch household members who constitute a voluntary panel that answers personal survey questionnaires on family financial and consumer matters every week.
  • Section 5 describes survey results and discusses how they relate to their hypotheses.

2. Theories on Why Investors Want Cash Dividends

  • A. The Miller and Modigliani (1961) dividend irrelevance theory Miller and Modigliani (1961) show that in a perfect and complete capital market the dividend policy of a firm does not affect its value.
  • It is interesting to notice that Fuller and Goldstein (2003) conclude that dividend-paying stocks have higher returns than non-dividend paying stocks, and that this effect is especially strong in declining markets.
  • De Jong et al. (2004) provide more discussion of this system and its effects on share value.
  • The authors therefore believe that there is substantial information asymmetry between management and shareholders in the Netherlands.
  • In the old tax system prevailing before January 1, 2001, dividends were treated as ordinary income and were taxed at a progressive rate.

3. Theories on Why Investors Want Stock Dividends

  • An issue that is closely related to that of cash dividends is the question of why some companies “pay” stock dividends.
  • Stock dividends may have an advantage over cash dividends because they may carry lower transaction costs.
  • An investor holding 113 shares might receive one share for 100 stock dividends.
  • Stock dividends are nothing more than a stock split and should not be taxed in the first place.
  • They argue that stock dividends are labeled as dividends.

4.1. Survey Methods and CentER Panel

  • The authors surveyed individual investors to test the theories discussed in the previous two sections.
  • Surveys complement research based on large samples and clinical studies, particularly for a question like dividend policy where the beliefs of investors are the basis for most of the theoretical models.
  • The first is that the respondents may not be representative of the population.
  • If the household does not have a television, CentERdata provides one.
  • Information about the panel can be found at http://www.centerdata.uvt.nl.

4.2. The Questionnaire

  • The authors have made large efforts to avoid the potential problems that are associated with the use of surveys.
  • First, the problem that the respondents may not be representative of the population is avoided by the use of the CentER panel.
  • The confidential nature of the respondent database precludes us interviewing any of them.
  • Therefore the questions have to be couched in plain, unambiguous language that the respondents understand.
  • Questions 1-4 determine whether the respondents own, or have owned within the last three years, shares in companies and/or investment funds.

4.3. Statistical Inference

  • These responses are both presented for the whole sample and for sub-samples according to demographic statistics, i.e., age, income and education.
  • From these interviews, the researcher creates one or more hypotheses about behavior that she can test on larger numbers of subjects or sites.
  • 17 For Questions 5-32, the authors test whether the mean and median responses are significantly different from the neutral response, and whether the responses from demographic groups are significantly different.
  • The authors still use a non-parametric two-sample test for the median responses.
  • For the difference in mean between demographic groups, the authors use a Z-test for the difference in proportions.

5.1. Overview of Survey Respondents

  • For this purpose all panel members of 16 years and older were selected.
  • These results are available on request from the authors.
  • Figure 1 gives the demographic distributions of the survey respondents.
  • It can be concluded from Figure 1 that on average investors are older, have higher income and are better educated than non-investors, which is what the authors would expect.
  • The second additional survey was submitted to the panel in the weekend of March 13, 2004.

5.2. Results for Cash Dividends

  • 19 Table 2 includes the responses to the questions on cash dividends.
  • The results indicate that individual investors do not see dividends as a way to control for possible overinvestment tendencies by management.
  • Both the mean and the median are significantly different from 4. Brav et al. (2004) try to find out from the executives why individual investors want dividends.

5.3. Results on Stock Dividends

  • The first question in Table 5 asks whether respondents consider stock dividends to be more like stock splits (response possibility 7) or like cash dividends (response possibility 1).
  • The median is significantly different from four at the 5% level.
  • The differences in scores between the different education and income groups are also not significant.
  • The second question on stock dividends (Question 29) shows that when only considering transaction costs, on average, investors prefer stock dividends compared to cash dividends.
  • All sub-samples for this question show a score that is significantly higher than 4.

5.4. Robustness Checks

  • Answers by respondents who do not want to receive dividends or who are indifferent may not be valid in testing theories of why dividends are relevant.
  • No a priori theoretical or empirical basis exists for this distinction, but it does seem possible.
  • The authors believe that investors, who prefer not to receive dividends or are indifferent, should still have valid opinions on the theories for and against dividends, since they are equally part of the market for shares.
  • The authors tested to see if this potentially confounding effect exists.
  • The results display a similar pattern to those in Tables 2-5, and so the authors have not reproduced them here.

6. Summary and conclusions

  • Most of the finance theory on dividend policy starts with the behavior of shareholders.
  • The empirical finance literature on this topic either studies share price reactions or surveys corporate executives for their opinions.
  • The authors received 555 responses from consumers that have, or recently had, investments in stocks of individual companies or investment funds.
  • The authors find that investors have a strong preference to receive dividends.
  • The results are inconsistent with the agency theories of Easterbrook (1984) and Jensen (1986).

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Citations
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Journal ArticleDOI
TL;DR: The most important factors influencing dividend policy are the level of current and expected future earnings, the stability of earnings, and the pattern of past dividends, according to survey results as mentioned in this paper.
Abstract: Purpose – The purpose of this research is to analyze survey results on the perception of dividends by managers of dividend‐paying firms listed on the Toronto Stock Exchange (TSX).Design/methodology/approach – Managers from a sample of 291 dividend‐paying TSX‐listed Canadian firms were surveyed about their views on dividends.Findings – The most important factors influencing dividend policy are the level of current and expected future earnings, the stability of earnings, and the pattern of past dividends. Despite dramatic differences in the level of ownership concentration between Canadian and US firms, their corresponding managers' views on the determinants of dividends are similar. Canadian managers believe that dividend policy affects firm value but express little agreement with the theory of a residual dividend policy. They express strong support for the signaling and lifecycle explanations for paying dividends, but not for the bird‐in‐the‐hand, tax‐preference and dividend clientele, agency cost, or cat...

115 citations

Journal ArticleDOI
TL;DR: In this paper, the authors studied dividend payouts of 462 U.S. bank holding companies before and during the 2007-09 financial crisis and found that regulatory pressure was ineffective in limiting dividend payout by under-capitalized banks before the financial crisis.

112 citations

Journal ArticleDOI
TL;DR: In this paper, the authors studied the risk perceptions of individual investors by asking experimental questions to 2,226 members of a consumer panel and analyzed their responses in order to find which risk measures they implicitly use.
Abstract: Risk perceptions of individual investors are studied by asking experimental questions to 2,226 members of a consumer panel. Their responses are analyzed in order to find which risk measures they implicitly use. We find that most investors implicitly use more than one risk measure. For those investors who systematically perceive risk according to the same risk measure, semi-variance of returns is most popular. Semi-variance is similar to variance, but only negative deviations fro the mean or another benchmark are taken into account. Stock investors implicitly choose for semi-variance as a risk measure, while bond investors favor probability of loss. Investors state that they consider the original investment to be the most important benchmark, followed by the risk-free rate of return, and the market return. However, their choices in the experimental questionnaire study reveal that the market return is the most important benchmark.

111 citations

Journal ArticleDOI
TL;DR: In this paper, the authors studied the risk perceptions of individual investors by asking experimental questions to 2226 members of a consumer panel and analyzed their responses in order to find which risk measures they implicitly use.

89 citations

Journal ArticleDOI
TL;DR: In this paper, the authors explore the effect of tax reform on the distribution of corporate dividends in Finland and find that Finnish firms altered their dividend policies based on the changed tax incentives of their largest shareholders.

85 citations

References
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Posted Content
TL;DR: In this paper, the benefits of debt in reducing agency costs of free cash flows, how debt can substitute for dividends, why diversification programs are more likely to generate losses than takeovers or expansion in the same line of business or liquidationmotivated takeovers, and why the factors generating takeover activity in such diverse activities as broadcasting and tobacco are similar to those in oil.
Abstract: The interests and incentives of managers and shareholders conflict over such issues as the optimal size of the firm and the payment of cash to shareholders. These conflicts are especially severe in firms with large free cash flows—more cash than profitable investment opportunities. The theory developed here explains 1) the benefits of debt in reducing agency costs of free cash flows, 2) how debt can substitute for dividends, 3) why “diversification” programs are more likely to generate losses than takeovers or expansion in the same line of business or liquidationmotivated takeovers, 4) why the factors generating takeover activity in such diverse activities as broadcasting and tobacco are similar to those in oil, and 5) why bidders and some targets tend to perform abnormally well prior to takeover.

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TL;DR: In this paper, a firm that must issue common stock to raise cash to undertake a valuable investment opportunity is considered, and an equilibrium model of the issue-invest decision is developed under these assumptions.

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TL;DR: In this paper, the effect of differences in dividend policy on the current price of shares in an ideal economy characterized by perfect capital markets, rational behavior, and perfect certainty is examined.
Abstract: In the hope that it may help to overcome these obstacles to effective empirical testing, this paper will attempt to fill the existing gap in the theoretical literature on valuation. We shall begin, in Section I , by examining the effects the effects of differences in dividend policy on the current price of shares in an ideal economy characterized by perfect capital markets, rational behavior, and perfect certainty. Still within this convenient analytical framework we shall go on in Section II and III to consider certain closely related issues that appear to have been responsible for considerable misunderstanding of the role of dividend policy. In particular, Section II will focus on the longstanding debate about what investors "really" capitalize when they buy shares; and Section III on the much mooted relations between price, the rate of growth of profits, and the rate of dividends per share. Once these fundamentals have been established, we shall proceed in Section IV to drop the assumption of certainty and to see the extent to which the earlier conclusions about dividend policy must be modified. Finally, in Section V , we shall briefly examine the implications for the dividend policy problem of certain kinds of market imperfections.

6,265 citations

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TL;DR: The authors survey 392 CFOs about the cost of capital, capital budgeting, and capital structure and find some support for the pecking-order and trade-off capital structure hypotheses but little evidence that executives are concerned about asset substitution, asymmetric information, transactions costs, free cash flows, or personal taxes.

4,138 citations

Frequently Asked Questions (2)
Q1. What contributions have the authors mentioned in the paper "Why individual investors want dividends" ?

In this paper, the question of why individual investors want to pay dividends was investigated by submitting a questionnaire to a Dutch investor panel, and the results indicated that individual investors do not tend to consume a large part of their dividends. 

The authors do not find much support for the “ irrational ” explanations of the existence of dividends, i. e. the uncertainty resolution theory of Gordon ( 1961, 1962 ) and the behavioral explanation of Shefrin and Statman ( 1984 ).