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Fox Entmt Group Inc 0.00% 0.00%
Hearst-Argyle Television Inc 0.00% 0.00%
InterActiveCorp 0.00% 0.00%
Liberty Media 'A' 0.00% 0.00%
Lin TV Corp. 0.00% 0.00%
Metro Goldwyn Mayer 0.00% 0.00%
Pixar 0.00% 0.00%
Radio One INC. 0.00% 0.00%
Regal Entertainment Group 2.70% 66.57%
Sinclair Broadcast 0.00% 0.00%
Sirius Satellite 0.00% 0.00%
Time Warner 0.00% 0.00%
Univision Communic. 0.00% 0.00%
Viacom Inc. 'B' 0.56% 19.00%
Westwood One 0.00% 0.00%
XM Satellite `A' 0.00% 0.00%
Average 0.24% 7.20%
Source: Value Line Database
Of the 26 companies in this group, only 5 paid dividends. Relative to the other companies
in this sector, Disney pays high dividends. The interesting question, though, is whether
Disney should be setting dividend policy based upon entertainment firms, most of which


are smaller and much less diversified than Disney, or upon large firms in other businesses
which resemble it in terms of cashflows and risk.
For Deutsche Bank, we used large money-center European banks as comparable
firms. Table 11.13 provides the listing of the firms, as well as their dividend yields and
payout ratios.
Table 11.13: Payout Ratios and Dividend Yields: Home Improvement Products Retailers
Name Dividend Yield Dividend Payout
Banca Intesa Spa 1.57% 167.50%
Banco Bilbao Vizcaya Argenta 0.00% 0.00%
Banco Santander Central Hisp 0.00% 0.00%
Barclays Plc 3.38% 35.61%
Bnp Paribas 0.00% 0.00%
Deutsche Bank Ag -Reg 1.98% 481.48%
Erste Bank Der Oester Spark 0.99% 24.31%
Hbos Plc 2.85% 27.28%
Hsbc Holdings Plc 2.51% 39.94%
Lloyds Tsb Group Plc 7.18% 72.69%
Royal Bank Of Scotland Group 3.74% 38.73%
Sanpaolo Imi Spa 0.00% 0.00%
Societe Generale 0.00% 0.00%
Standard Chartered Plc 3.61% 46.35%
Unicredito Italiano Spa 0.00% 0.00%
Average 1.85% 62.26%
Source: Value Line Database
On both dividend yield and payout ratios, Deutsche Bank pays a much higher dividend
than the typical European bank. It is interesting, though, that the British banks are the
highest dividend payers in the group, with Lloyds maintaining a dividend yield of 7.18%.
For Aracruz, we did look at the average dividend yield and payout ratios of four
sets of comparable firms “ Latin American paper and pulp companies, emerging market
paper and pulp companies, US paper and pulp companies and all paper and pulp
companies listed globally. Table 11.14 summarizes these statistics.
Table 11.14: Dividend Yield and Payout Ratios for Paper and Pulp Companies
Group Dividend Yield Dividend Payout
Latin America 2.86% 41.34%
Emerging Market 2.03% 22.16%
US 1.14% 28.82%
All paper and pulp 1.75% 34.55%


Aracruz 3.00% 37.41%

Aracruz has a dividend yield and payout ratio similar to that of other Latin American
paper and pulp companies, though it is higher than dividends paid out by paper
companies listed elsewhere.
With all three companies, the dangers of basing dividend policy based upon
comparable firms are clear. The “right™ amount to pay in dividends will depend heavily
upon what we define “comparable™ to be. If managers are allowed to pick their peer
group, it is easy to justify even the most irrational dividend policy,

11.7. ˜: Peer Group Analysis
Assume that you are advising a small high-growth bank, which is concerned about the
fact that its dividend payout and yield are much lower than other banks. The CEO of the
bank is concerned that investors will punish the bank for its dividend policy. What do you
a. I think that the bank will be punished for its errant dividend policy
b. I think that investors are sophisticated enough for the bank to be treated fairly
c. I think that the bank will not be punished for its low dividends as long as it tries to
convey information to its investors about the quality of its projects and growth

Using the Market
The alternative to using only comparable firms in the same industry is to study the
entire population of firms and to try to estimate the variables that cause differences in
dividend payout across firms. We outlined some of the determinants of dividend policy in
the last chapter, and we could try to arrive at more specific measures of each of these
determinants. For instance,
Growth Opportunities: Firms with greater growth opportunities should pay out less in

dividends than firms without these opportunities. Consequently, dividend payout
ratios (yields) and expected growth rates in earnings should be negatively correlated
with each other.


Investment Needs: Firms with larger investment needs (capital expenditures and

working capital) should pay out less in dividends than firms without these needs.
Dividend payout ratios and yields should be lower for firms with significant capital
expenditure needs.
Insider Holdings: As noted earlier in the chapter, firms where stockholders have less

power are more likely to hold on to cash and not pay out dividends. Hence, dividend
payout ratios and insider holdings should be negatively correlated with each other
Financial Leverage: Firms with high debt ratios should pay lower dividends, because

they have already pre-committed their cash flows to make debt payments. Therefore,
dividend payout ratios and debt ratios should be negatively correlated with each other
Since there are multiple measures that can be used for each of these variables, we
chose specific proxies “ analyst estimates of growth in earnings for growth opportunities,
capital expenditures as a percent of total assets for investment needs, percent of stock
held by insiders for insider holdings and total debt as a percent of market capitalization as
a measure of financial leverage. Using data from the end of 2003, we regressed dividend
yields and payout ratios against all of these variables and arrived at the following
regression equations (t statistics are in brackets below coefficients):
PYT = 0.3889 - 0.738 CPXFR - 0.214 INS + 0.193 DFR - 0.747 EGR
(20.41) (3.42) (3.41) (4.80) (8.12)
R2 = 18.30%
YLD = 0.0205 - 0.058 CPXFR - 0.012 INS + 0.0200 DFR - 0.047 EGR
(22.78) (5.87) (3.66) (9.45) (11.53)
R2 = 28.5%
PYT = Dividend Payout Ratio = Dividends/Net Income
YLD = Dividend Yield = Dividends/Current Price
CPXFR = Capital Expenditures / Book Value of Total Assets
EGR = Expected growth rate in earnings over next 5 years (analyst estimates)
DFR = Debt / (Debt + Market Value of Equity)
INS = Insider holdings as a percent of outstanding stock
The regressions explain about 20-30% of the differences in dividend yields and payout
across firms in the United States. The two strongest factors seem to be earnings growth


and the debt ratio, with higher growth firms with lower debt ratios paying out less of their
earnings as dividends and having lower dividend yields. While this contradicts our
hypothesis that higher leverage should lead to lower payout, it is not difficult to explain.
It can be attributed to the fact that firms with more stable earnings have higher debt
ratios, and these firms can also afford to pay more dividends. In addition, firms with high
insider holdings tend to pay out less in dividends than do firms with low insider holdings,
and firms with high capital expenditures needs seem to pay less in dividends than firms
without these needs.

divregr.xls: There is a dataset on the web that summarizes the results of
regressing dividend yield and payout ratio against fundamentals for U.S. companies.

Illustration 11.7: Analyzing Dividend Payout Using The Cross Sectional Regrssion
To illustrate the applicability of the market regression in analyzing the dividend
policy of Disney and Aracruz, we estimate the values of the independent variables in the
regressions for the two firms, as shown in Table 11.15.
Table 11.15: Data for Cross-sectional Regressions
Disney Aracruz ADR
Insider Holdings 2.60% 20.00%

Capital Expenditures/Total Assets 2.10% 2%

Debt/ Capital 21.02% 31%
Expected growth in Earnings 8.00% 23%

Substituting into the regression equation for the dividend payout ratio, we predicted the
following payout ratios for the two firms:
For Disney = 0.3889 - 0.738 (0.021)- 0.214 (0.026) + 0.193 (0.2102) - 0.747 (0.08) =
For Aracruz ADR = 0.3889 - 0.738 (0.02)- 0.214 (0.20) + 0.193 (0.31) - 0.747 (0.23) =


Substituting into the regression equation for the dividend yield, we predict the following
dividend yields for the two firms:
For Disney = 0.0205 - 0.058 (0.021)- 0.012 (0.026) + 0.0200 (0.2102)- 0.047 (0.08)=
For Aracruz ADR = 0.0205 - 0.058 (0.02)- 0.012 (0.20)+ 0.0200 (0.31)- 0.047 (0.23) =
Based on this analysis, Disney with its dividend yield of 0.91% and a payout ratio of
32.31% is paying too little in dividends. Aracruz with a payout ratio of 37.41% and a
dividend yield of 3% provides a mixed finding is paying too much in dividends, though
the conclusion has to be tempered by the fact that the company is being compared to
companies in the United States.

Managing Changes in Dividend Policy
In chapter 10, we noted the tendency on the part of investors to buy stocks with
dividend policies that meet their specific needs. Thus, investors who want high current
cash flows and do not care much about the tax consequences migrate to firms that pay
high dividends; those who want price appreciation and are concerned about the tax
differential hold stock in firms that pay low or no dividends. One consequence of this
clientele effect is that changes in dividends, even if entirely justified by the cash flows,
may not be well received by stockholders. In particular, a firm with high dividends that
cuts its dividends drastically may find itself facing unhappy stockholders. At the other
extreme, a firm with a history of not paying dividends that suddenly institutes a large
dividend may also find that its stockholders are not pleased.
Is there a way in which firms can announce changes in dividend policy that
minimizes the negative fall-out that is likely to occur? In this section, we will examine
dividend changes and the market reaction to them and draw broader lessons for all firms
that may plan to make such changes.

Empirical Evidence
Firms may cut dividends for several reasons; some clearly have negative
implications for future cash flows and the current value of the firm, while others have
more positive implications. In particular, the value of firms that cut dividends because of


poor earnings and cash flows should drop, whereas the value of firms that cut dividends
because of a dramatic improvement in project choice should increase. At the same time,
financial markets tend to be skeptical of the latter claims, especially if the firm making
the claims reports lower earnings and has a history of poor project returns. Thus, there is
value to examining the actions at the time of dividend cuts and the announcements made
by firms that cut dividends, to see if the market reaction changes as a consequence.
Woolridge and Ghosh looked at 408 firms that cut dividends, and the actions
taken or information provided by these firms in conjunction with the dividend cuts. In
particular, they examined three groups of companies: the first group announced an
earnings decline or loss with the dividend cut; the second had made a prior announcement
of earnings decline or loss; and the third made a simultaneous announcement of growth
opportunities or higher earnings.10 The results are summarized in Table 11.16.
Table 11.16: Excess Returns Around Dividend Cut Announcements
Periods Around Announcement Date
Category Prior Quarter Announcement Quarter After
Simultaneous -7.23% -8.17% +1.80%
Announcement of
Prior -7.58% -5.52% +1.07%
Announcement of
Earnings Decline or
Loss (N = 208)
Simultaneous -7.69% -5.16% +8.79%
Announcement of
Investment or
We can draw several interesting conclusions from this study. First, the vast
number of firms announcing dividend cuts did so in response to earnings declines (384)
rather than in conjunction with investment or growth opportunities (16). The market

10 Woolridge, J.R. and C. Ghosh, 1986, Dividend Cuts: Do they always signal bad news?, The Revolution
in Corporate Finance, Blackwell.


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