The authors investigate companies' decision-making processes on dividends and
share repurchases through the use of extensive surveys. Their survey results
show that maintaining dividend levels is as important as making positive net
present value (NPV) investment decisions. In contrast, they find that share
repurchases are often enacted only when excess cash flows exist. Over the past
years, the relationship between earnings and dividends has softened, primarily
because of changes in tax policies and perceived investor preferences.
Changes in the American business environment since Lintner (
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M&M's conclusions are still relevant to today's companies. Miller and Modigliani
(
dividend payout policies, and this paper evaluates these ideas as well. The authors
interview 384 financial executives from 256 public companies and 128 private companies.
Of the public companies, 166 pay dividends, 167 engage in share repurchases, and 77 do
neither.
Regarding dividends, repurchases, and investment decisions, the authors find that
dividend payout levels are decided at the same time as, or immediately prior to,
investment decisions. In contrast, share repurchases are made after payout decisions. In
terms of priorities, survey responses indicate executives would defer positive net
present value (NPV) projects before reducing dividends. Furthermore, 65 percent of
executives at dividend-paying companies would raise new funds for profitable projects in
preference to reducing payouts. Only 16 percent of executives at repurchasing companies,
however, would agree to raise funds for profitable projects in preference to decreasing
share repurchases. Dividends and repurchases are not viewed as interchangeable; more
managers at dividend-paying companies prefer paying down debt to increasing share
repurchases.
Considering how payout policies and payout ratios have been affected by 50 years of
history, the authors find that decisions are still made in the same conservative manner
but that the relative importance of maintaining a target payout ratio has fallen. For
share repurchases, there is no evidence of a repurchase ratio; rather, repurchase levels
change frequently. Historical perspective shows that if a company experiences a decline
in earnings, today's managers are more likely to divest assets and defer positive NPV
projects than to cut the dividend rate. Whereas previously, they would cut the dividend
to reflect the condition of the business. A greater asymmetrical difference exists
between cutting and increasing dividends, with the managers believing little reward to a
dividend increase, compared to huge penalties for cuts.
During the time the surveys were taken, dividend tax rates declined, but only 28 percent
of chief financial officers surveyed said the tax cut would cause their company to raise
dividends. Of those companies that do not currently pay dividends, only 13 percent said
that they would start paying dividends in response to the tax cut. Regarding the
clientele effect, survey results indicate dividends have greater relative importance to
retail, rather than institutional, investors. Executives at dividend-paying companies do
not believe that payout policies are an effective means for the board to impose
discipline on management. Nearly 75 percent of respondents indicate that raising
earnings per share is a consideration for repurchase decisions. Often, repurchase
decisions are enacted to offset earnings declines generated by employee stock option
compensation or stock purchase plans.
For companies currently neither paying dividends nor repurchasing, managers indicated
they would initiate a dividend if institutional investors demanded it or if they had a
rapid rise in profits. Furthermore, they would begin to repurchase shares if they
believed their stock were undervalued or a dearth of investment opportunities persisted.
Their main reason for not initiating a dividend was its inflexibility.