REAL-WORLD FACTORS FAVORING A HIGH-DIVIDEND POLICY

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REAL-WORLD FACTORS FAVORING A HIGH-DIVIDEND POLICY

• THE CLIENTELE EFFECT A RESOLUTION OF REAL-WORLD
  FACTORS?

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REAL-WORLD FACTORS FAVORING A HIGH-DIVIDEND POLICY

• AN INTRODUCTION
• Dividend - Distribution of firms income to
  shareholders.
• Dividend Policy - Determine the value of the
  firms as dividend
• increases or decreases.
• - Trade-off between
  retained earning and distributing
• cash to shareholders.
• Dividend Structure - Communicate to market
  participants
• - Send signals
  about the prospect of the firm

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REAL-WORLD FACTORS FAVORING A HIGH-DIVIDEND POLICY

• Firms pay high-dividend
• even in the presence of personal taxes on these
  dividends
• WHY?
• Consider 4 factors favoring a high-dividend
  policy

4
1st factor

• DESIRE FOR CURRENT INCOME
• Who Retired people and individual living on
  fixed income.
• They would bid up the stock price if dividend
  increase and bid down the stock price should
  dividends decline.
• This argument does not hold in M M theoretical
  model that dividend irrelevancy rest on the
  following assumption.
• No Tax
• No Transaction Cost
• No Issuance Cost
• Existence on Fixed Investment Policy
• Real-world Current income argument is relevant
  and stock sales involve
• Brokerage fees
• Other transaction cost
• Time consuming

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2nd factor

• BEHAVIORAL FINANCE
• Behaviorism in psychology theory human behavior
  is learnt by adapting outside condition
• The self is not something ready-made but
  something in continuous formation through choices
  of action John Dewey.
• Basic idea is Self-Control Investor must deal
  with it and decide on.
• Better return
• Or other investment instruments
• Always set personal rules like, never dipping
  into principle
• Behaviorists do not think that everyone has the
  same concept or idea
• This explain why firm pay dividend even in the
  presence of taxes.

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3rd factor

• AGENCY COST
• Involves 3 parties
• Bondholders
• Stockholders
• Management
• They form mutually beneficial reason and gain at
  the others expense.
• Potential conflict bondholders and stockholders
• Bondholders want higher cash retained so it could
  be available to pay them during financial
  distress
• Make loan agreement to protect themselves on
  dividend payout
• DeAngelo and DeAngelo firms in financial
  distress are reluctant to cut dividends.
• Potential conflict Managers and stockholders
• Managers with selfish goal at the expense of
  stockholders
• Take on projects with negative NPVs or not work
  hard

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3rd factor (continued)

• Several Scholars Dividend to reduce agency cost
• Dividend payout equal to the amount of surplus
  cash flow can reduce management ability to
  squander firms resources
• This factor is not an argument to for dividends
  over repurchases .
• Agency cost imply firms may increase dividend or
  share repurchases over hoarding large sum of
  cash.

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4rd factor

• INFORMATION CONTENT AND DIVIDEND SIGNALING
• Information Content Effects
• Stock price rise when dividend increase
• The rise of stock prices following dividend
  increase is called Information Content Effects
• Stockholders increases their expectation on
  future earning and cash flow
• Genting Malaysia Berhad (GENM) Stock price
  rise 16 after dividend announcement with total
  dividend of 7 as compare to 6.48 in previous
  year. Stock price rises gradually from RM2.50 to
  RM2.90.
• Tradewinds (M) Bhd (TWS) Stock price fall 4.6
  when the total dividend decline from 23 in
  previous year to 20 this year. The stock price
  fall gradually from RM3.02 to RM2.88.

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4rd factor (Continued)

• INFORMATION CONTENT AND DIVIDEND SIGNALING
• Dividend Signaling
• Dividend increases send good news and vice versa
• Signal about the financial state of the firms
• Management could increase dividend to show high
  cash flow even they know that the cash flow
  remain the same.
• This would hurt the stock prices if the market
  participant knew about it.
• Equation Cash Flow Capital Expenditure
  Dividends

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4rd factor (Continued)

• INFORMATION CONTENT AND DIVIDEND SIGNALING
• Suppose firm announces current dividend will be
  30 million and market believes that capital
  expenditures are 70 million, the market would
  then determine cash flow to be 100 million.

Cash Flow Capital Expenditure Dividends
100 70 30
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4rd factor (Continued)

• INFORMATION CONTENT AND DIVIDEND SIGNALING
• Assume the firm makes changes where dividend
  will be 40 million and the cash flow remain the
  same thus implying capital expenditures of 60
  million.

Cash Flow Capital Expenditure Dividends
100 70 30
Cash Flow Capital Expenditure Dividends
100 60 40
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4rd factor (Continued)

• INFORMATION CONTENT AND DIVIDEND SIGNALING
• Assume the firm makes changes where dividend
  will be 40 million and the cash flow remain the
  same thus implying capital expenditures of 60
  million. As a result, the increase of dividend
  would hurt stock price because the increase of
  dividend is obtained by a reduction in capital
  expenditures.

Cash Flow Capital Expenditure Dividends
100 70 30
Cash Flow Capital Expenditure Dividends
100 60 40
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4rd factor (Continued)

• INFORMATION CONTENT AND DIVIDEND SIGNALING
• On the other hand, assume that the capital
  expenditures remain at 70 million as well as
  dividend at 40 million thus implying cash flow to
  be 110 million. As a result, market will learn
  that cash flow has increase and the stock price
  would likely rise. Stock prices usually increase
  with cash flow.

Cash Flow Capital Expenditure Dividends
100 60 40
Cash Flow Capital Expenditure Dividends
110 70 40
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4rd factor (Continued)

• INFORMATION CONTENT AND DIVIDEND SIGNALING
• Most academic model implies that dividend and
  share repurchases are perfect substitutes.
• In these models, managers will consider to reduce
  capital expenditure to increase either dividend
  or share repurchases.
• In conclusion, firms pay higher dividends would
  send good signal about good financial prospect in
  the future and so vice versa.
• This indicates that investors prefer dividends to
  capital gains.

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THE CLIENTELE EFFECTA RESOLUTION OF REAL-WORLD
FACTOR

• Personal taxes favors a low-dividend policy
• whereas other factors favor high-dividend
• HOW?
• Consider group of tax brackets
• favoring low and high-dividend policy

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THE CLIENTELE EFFECTA RESOLUTION OF REAL-WORLD
FACTOR

• Different group of people prefer different
  dividend payout policies
• There are two categories of tax bracket
  individuals apart from tax-free institution and
  corporation
• Low Tax Bracket
• High Tax Bracket
• Retired person, pension funds and university
  lecturers generally prefers cash income much
  better-off if they receive higher payout from
  earning
• Individual who do not need current income or
  individual in high tax bracket may prefer for
  capital gain for tax reason.
• Individual who need current income might sell
  some or all shares to obtain cash and thus
  selling pressure may result drop of stock prices.

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THE CLIENTELE EFFECTA RESOLUTION OF REAL-WORLD
FACTOR (continued)

• A study made by John Graham and Alok Kumar
  disclose that
• Relative to low-income investor, high-income
  investor put a greater percentage of their asset
  into low-dividend securities
• Relative to low-income investor, high-income
  investor put a smaller percentage of their assets
  into high-dividend securities.
• In conclusion
• Clienteles are likely follow from the fact that
  tax bracket vary across investors.
• Suggest that there is also clienteles effect on
  stock prices.
• Further, clienteles effect on desire for current
  income.

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