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The Hierarchy of Dividends and Investment Decisions with Discretionary A ccruals

The Hierarchy of Dividends and Investment Decisions with Discretionary A ccruals. Chuan-San Wang. Research Question. Does payout policy affect investment decision ? Do discretionary accruals differ from other earnings components in cash payout decisions?

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The Hierarchy of Dividends and Investment Decisions with Discretionary A ccruals

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  1. The Hierarchy of Dividends and Investment Decisions with Discretionary Accruals Chuan-San Wang

  2. Research Question • Does payout policy affect investment decision ? • Do discretionary accruals differ from other earnings components in cash payout decisions? • Does managers’ accounting discretion mitigate the tension between payouts and investment?

  3. Motivation • payout policy can be relevant • Corporate decisions can reveal earnings quality • Accrual accounting can mitigate competition for capital resources

  4. Importance • Dividends can be value-relevant, DeAngelo and DeAngelo (2006) • Several crucial studies are based on the irrelevance theorem, e.g., Ohlon’s (1995) valuation model

  5. Contributions • It shows the causality from dividends to investment • It quantifies the competition for capital resources • It focuses on the impact of earnings quality on both dividends and investments • It provides new evidence based on actual corporate actions

  6. Literature #1 • Miller and Modigliani (1961) theoretically propose that • dividend policy is value-irrelevant because it is made after the investment decision • The survey evidence from Brav et al. (2005) indicates the opposite: • dividend choices are made simultaneously with (or perhaps a bit sooner than) investment decisions • H1: The magnitude of cash dividends is simultaneously determined with that of capital expenditures.

  7. Literature #2 • Earnings can explain the propensity to pay dividends (Fama and French, 2001) • The three earnings components are similar in explaining dummy for dividend increase (Subramanyam, 1996) • Accrual accounting provides additional information • H2: discretionary accruals increase dividend payouts by mitigating financial constraints. • H3: the marginal propensity to pay dividends for discretionary accruals differs from that of other earnings components

  8. Research design #1 • Cash payout equation • 2-stage regressions • Simultaneity between Y and X variables • diagnostic statistics

  9. Research design #2 • Interaction term for DACC

  10. The 2 IVs • Sargan test for the over-identifying restrictions • To show IVs are exogenous to the error term of payout equation • One-year lagged depreciation expense, and capital expenditures • Jackson et al. (2009) • perceived utility, earnings consequences • Investment projects need subsequent maintenance and evaluation at multiple stages (Seybert, 2010)

  11. Discretionary Accruals • cross-sectional version of the Jones model • used in Daniel et al. (2008)

  12. Control Variable for Dividends • life-cycle theory • Fama and French (2001), DeAngelo et al. (2006), Chay and Suh (2009) • senior firms pay more dividends • firm size, MVE • firm age, Tage • investment opportunities, MtB • retained earnings, RE/TE • cash flow uncertainty, SRVOL

  13. More Control Variables • dividends persistency and financial slack • Lintner (1956), Brav et al. (2005) • Past dividends • financial leverage

  14. Other Control Variable • firm performance. • Fama and French (2001) • value-weighted, market-adjusted buy-and-hold annual stock return, BHARt • operating cash flows, OCFt • return on assets,ROAt

  15. Sample • 2010 version of Compustat • CRSP • 1989–2008 • 63,955 firm–years with necessary data available

  16. Baseline results • IVs for capital expenditures are valid and strong • investment magnitude is determined simultaneously with cash dividends • investments have a significantly negative effect on dividends • but the economic size is rather small

  17. (0.4539-0.0624)/(1-0.0624)=0.4176

  18. over-identifying test • OLS regression of the second-stage residuals on all exogenous variables (including the two IVs) • the R2 is 0.0000 • The two IVs are exogenous

  19. Robustness • Other measures of discretionary accruals • Teoh et al. (1998), Dechow and Dichev (2002), and Ball and Shivakumar (2005) • How to measure accruals is independent for • the dampening effect of investment on dividends • the endogeneity tests

  20. Conclusions • Dividend policy is at least simultaneously determined with investment decisions (Brav et al 2005) • The irrelevance theorem of Miller and Modigliani (1961) may be questionable (DeAngelo and DeAngelo 2006) • The competition between dividends and investment • is small in size • can be mitigated by managers’ use discretionary accruals • It is inconclusive for the propensity to pay dividends for discretionary accruals

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