Why individual investors want dividends
Abstract: The question of why individual investors want dividends is investigated by submitting a questionnaire to a Dutch investor panel. The respondents indicate that they want dividends partly because the cost of cashing in dividends is lower than the cost of selling shares. Their answers provide strong confirmation for the signaling theories of Bhattacharya (1979) [Bhattacharya, S., 1979. Imperfect information, dividend policy and the “bird in the hand” fallacy. Bell Journal of Economics 10, 259–270] and Miller and Rock (1985) [Miller, M., Modigliani, F., 1961. Dividend policy, growth and the valuation of shares. Journal of Business 34, 411–433]. They are inconsistent with the uncertainty resolution theory of Gordon (1961, 1962) [Gordon, M., 1961. The Investment, Financing, and Valuation of the Corporation, Richard D. Irwin, Homewood, IL; Gordon, M., 1962. The savings, investment and valuation of a corporation. Review of Economics and Statistics 44, 37–51.] and the agency theories of Jensen (1986) [Jensen, M.C., 1986. Agency costs of free cash flow, corporate finance and takeovers. American Economic Review 76, 323–329] and Easterbrook (1984) [Easterbrook, F.H., 1984. Two agency-cost explanations of dividends. American Economic Review 74, 650–659]. The behavioral finance theory of Shefrin and Statman (1984) [Shefrin, H.M., Statman, M., 1984. Explaining investor preference for cash dividends. Journal of Financial Economics 13, 253–282] is not confirmed for cash dividends but is confirmed for stock dividends. Finally, our results indicate that individual investors do not tend to consume a large part of their dividends. This raises some doubt as to whether a reduction or elimination of dividend taxes will stimulate the economy.
Summary (3 min read)
- 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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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.
Q2. What have the authors stated for future works in "Why individual investors want 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 ).