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Dividend Policies in an Unregulated Market: The London Stock Exchange, 1895-1905

Dividend Policies in an Unregulated Market: The London Stock Exchange, 1895-1905. Fabio Braggion (Tilburg University & CentER) Lyndon Moore (Victoria University of Wellington). A Study of Dividend Policies at London Stock Exchange, 1895-1905.

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Dividend Policies in an Unregulated Market: The London Stock Exchange, 1895-1905

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  1. Dividend Policies in an Unregulated Market: The London Stock Exchange, 1895-1905 Fabio Braggion (Tilburg University & CentER) Lyndon Moore (Victoria University of Wellington)

  2. A Study of Dividend Policies at London Stock Exchange, 1895-1905

  3. A Study of Dividend Policies at London Stock Exchange, 1895-1905 • How much did companies pay?

  4. A Study of Dividend Policies at London Stock Exchange, 1895-1905 • How much did companies pay? • Who were the payers?

  5. A Study of Dividend Policies at London Stock Exchange, 1895-1905 • How much did companies pay? • Who were the payers? • Why did they pay?

  6. Motivations: History: very little knowledge of dividend policies at the turn of the Twentieth century • On Britain: Church, Baldwin and Berry (1994) on the Consett Iron Company

  7. Motivations: Finance: London Stock Exchange was an interesting environment • Very Low Taxation on Dividends

  8. Very low taxation on dividends… • Dividends were taxed only once… at a rate of 5% • Capital gains were tax free • Corporate income was treated as individual income… • …Companies just deducted the income tax when paying dividends to shareholders

  9. Very low taxation of dividends… • No different tax rates between retail investors and institutions • Friendly societies were an exception but their activities appear limited • Less likely the existence of dividend clienteles around dividend paying companies • Heavily taxed investors own low dividend shares • Investors with low tax rates own high dividend shares (Michaely and Womack, 1995; Allen, Bernardo and Welch, 2000)

  10. Motivations: Finance: London Stock Exchange was an interesting environment • Also: No “Prudent Man” Regulation

  11. It is not clear whether a stock price reaction to a dividend increase or decrease is a response to • an asymmetric information problem • a reshuffling of clienteles We can focus on the first explanation: • Asymmetric Information (Bhattacharya, 1979; Miller and Rock, 1985; Jensen, 1986)

  12. Our Work: • Collected information on dividend payments, accounting data and asset prices for about 300 public companies between 1895 and 1905 • Identify dividend payers vs. non-payers • First attempt to evaluate different explanations of dividend policies… we will focus on asymmetric information

  13. We find: • More than 100 years ago companies paid out as much as now • Profitable and more mature companies were more likely to pay dividends • Dividends resolved an agency problem: managers wanted to show they “behaved”

  14. The Data • About 300 British Companies quoted at the London Stock Exchange • From Annual Reports Information about: • Earnings • Capital Structure • Dividend Payments • Book Value of the Assets • Dates of the Shareholders Meetings

  15. The Data • From the Times of London: • Weekly Asset Prices • Dividend Announcement dates

  16. Out of this data… …we also construct: • A Weekly Stock Price Index for the London Stock Exchange • Market to Book Ratio (Tobin’s Q)

  17. How Much did they Pay?

  18. How Much did they Pay? • …. Now and Then…. • Allen and Michaely (1990s): • 25 and 85% • Our Results: • 73 and 92%

  19. Characteristics of Dividend Paying Companies (Fama & French, 2001 DeAngelo, DeAngelo and Stultz, 2006) Logit regression Dependent Variable: 1 if the company paid an ordinary dividend in 1901 0 if it did not

  20. We examine… • … 2643 Companies/years… • 573 (22%) Non-Payers • 2070 (78%) Payers

  21. Regressors: • Contemporary and one year lagged profitability • Earnings after interest, depreciation and taxes. Reconstructed from the information provided in the balance sheets • Size: Total Assets

  22. Regressors: Growth Opportunities/ Life Cycles Idea: More mature companies should be more likely to pay dividends • Age of the Company: • Proxied by year of incorporation • Earned Equity to Total Common Equity • Past Growth:

  23. Interpreting the Results: • Contemporaneous Earnings are the most important determinant: • increasing profitability from the first to the third ROA quintile would increase firm’s probability of paying dividends from 60% to 80% • The effect of Age is not very strong • An standard deviation increase of Earned Equity to Common Equity increases the probability of paying dividends of about 27% • Cash to Total Assets has positive sign and it is marginally statistically significant

  24. Why did they pay?Evaluating Explanations We focus on explanations based on Asymmetric Information: • Dividends as a Costly Signal: Dividends are signals for good investment opportunities in the future • Dividends and Agency Theory Dividends are a way to discipline managers, especially in low growth/cash rich companies

  25. Predictions Dividends as a Signal: • A dividend initiation or increase should be followed by a rise of stock returns • A dividend cut or omission should be followed by a decline of stock returns

  26. Predictions Dividends and Agency: • A dividend initiation or increase should be followed by a rise of stock returns for low q companies • A dividend initiation or increase should have no effect (or generate of moderate rise) of stock returns for high q companies • A dividend omission or decrease should be followed by a decline of stock returns for low q companies • A dividend omission or decrease should have no effect (or generate of moderate declie) of stock returns for high q companies

  27. Again Data • Because of asset prices availability we focus on 63 companies • We observe 390 dividend announcements over the period January 1901 through December 1905 • Out of 390 announcements we have: • 44 dividend omissions • 13 dividend commencements (or recommencements) • 115 dividend increases • 133 dividend decreases • 87 dividends left unchanged

  28. Summary of the Results • A dividend decrease or omission leads to a decline of 1.4-2.4% of Stock Returns • This effect is driven by low-Q companies • No effects on High-Q companies • There is support for the Agency Theory of Dividends

  29. Conclusions and Future Directions • Solve the “liquidity problem” • Evaluation of Behavioral Explanations and evidence of “Catering” • Longer run analysis and price drift

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