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1 August 2013 CFA Institute Journal Review

Payout Policy Choices and Shareholder Investment Horizons (Digest Summary)

  1. Tokunboh Ishmael

The number of share repurchase/buyback programs has grown considerably and they are expected to be the payout policy of choice over dividend payments in the long run. The authors find that this phenomenon has been fueled by an increase in institutional ownership, which has grown nearly threefold over the past two decades. Managers seem to make the payout decisions on the basis of the investment horizon of shareholders, and so the authors explore the impact of shareholder investment horizons on corporate payout policy.

What’s Inside?

The authors use a variety of regression analyses to demonstrate that the investment horizon of a company’s shareholders affects that company’s corporate policy, particularly its payout policy. They conduct their analyses for both payout events (i.e., dividends and repurchases) together, repurchasing firms, and dividend-increasing firms. They examine the relationship between shareholder investment horizons and each of the following: (1) the share of repurchases in a payout, (2) the likelihood of a repurchase, (3) market reaction to repurchase announcements, (4) the level of a payout, and (5) the likelihood of a payout among nonpaying firms.

The authors also demonstrate the integrity of their analyses by testing the direction of causality between the payout policy and the shareholders’ investment horizon and testing for sample selection bias.

How Is This Research Useful to Practitioners?

The authors find that the presence of speculators and stronger governance results in a higher proportion of repurchases. Firms favoring repurchases are generally small, have low levels of operating income, and are relatively weak stock performers. In addition, repurchasing firms tend to have volatile stock trading patterns and managerial compensation linked to buyback decisions; firms that have a higher proportion of managerial ownership shun repurchases, and firms that offer options in their compensation structure favor repurchases. Although the market reacts positively to repurchase announcements, it applies a larger discount to announcements from companies with a higher proportion of speculators, who are more likely to drive a firm to start or force repurchases.

The authors believe that their results are significant because increasing the investor portfolio turnover rate by one standard deviation results in a nearly 10% increase in the proportion of repurchases in total payouts. The research highlights how the investment horizon can affect returns. As such, understanding the dynamics of corporate policy decision making—and particularly how exogenous variables affect payout policy—is useful. Furthermore, activists focused on the fundamentals of a company and its growth should be aware of the proportion of speculators buying into a company’s stock.

How Did the Authors Conduct This Research?

The authors construct a data sample from the Compustat database of nonfinancial and unregulated U.S. publicly listed firms that made positive payouts on their common stock securities between 1984 and 2008 (excluding 1987, the year of the stock market crash). In addition, they mine the Thomson Reuters Securities Data Corporation database for corporate announcements regarding open-market repurchase programs and include only those companies that made announcements. Furthermore, the authors use the Thomson Reuters Spectrum 13F database of U.S. SEC filings of the holdings of qualified institutional shareholders to calculate their investment horizons by analyzing the turnover rate of their portfolios. Investors in the top-33rd percentile by turnover rate are classified as short-term investors (speculators), and those in the bottom-33rd percentile are classified as long-term investors (activists). They determine for each company the relative proportions of short-, medium-, and long-term investors in the company’s shareholder structure.

The sample consists of more than 25,000 firms paying out, on average, $95 million irrespective of payout type, with repurchases representing nearly 40% of the payouts. Furthermore, on average, short-term investors typically held 9% of the firm versus 23% held by long-term investors. The authors control for firm size, value, and leverage by using the logarithms of the relevant variables.

Abstractor’s Viewpoint

The authors suggest future research should examine the decisions regarding whether to have a payout or not, as well as how to structure a payout. Although this research may be interesting to practitioners, I believe the question and understanding of how the exogenous variable of a third party’s investment horizon affects a practitioner’s return are more important to the practitioner, especially because this information may typically be unknown.

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