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An investigation of the dividend decision : with emphasis on the Canadian situation Copeland, Curtis Joseph 1968

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A N I N V E S T I G A T I O N OF T H E D I V I D E N D ' D E C I S I O N , W I T H E M P H A S I S O N T H E C A N A D I A N S I T U A T I O N by 1 C U R T I S J O S E P H C O P E L A N D B . S . F . , U n i v e r s i t y , o f . B r i t i s h C o l u m b i a , 1964 A T H E S I S S U B M I T T E D IN P A R T I A L F U L F I L M E N T OF T H E R E Q U I R E M E N T S F O R T H E D E G R E E O F M A S T E R O F B U S I N E S S A D M I N I S T R A T I O N i n the F a c u l t y , of C o m m e r c e and B u s i n e s s A d m i n i s t r a t i o n We a c c e p t t h i s t h e s i s as c o n f o r m i n g to the r e q u i r e d s t a n d a r d T H E U N I V E R S I T Y O F B R I T I S H C O L U M B I A A p r i l , 1968 In p r e s e n t i n g t h i s t h e s i s i n p a r t i a l f u l f i l m e n t of the r e q u i r e m e n t s f o r an a d v a n c e d d e g r e e at the U n i -v e r s i t y of B r i t i s h C o l u m b i a , I a g r e e that the L i b r a r y s h a l l make i t f r e e l y a v a i l a b l e f o r r e f e r e n c e and s t u d y . I f u r t h e r a g r e e that p e r m i s s i o n f o r e x t e n s i v e c o p y i n g of t h i s t h e s i s f o r s c h o l a r l y p u r p o s e s may be g r a n t e d by the Head of my D e p a r t m e n t o r by h i s r e p r e s e n t a t i v e s . It i s u n d e r s t o o d that c o p y i n g o r p u b l i c a t i o n of t h i s t h e s i s f o r f i n a n c i a l g a i n s h a l l not be a l l o w e d wi thou t my w r i t t e n p e r m i s s i o n . F a c u l t y of C o m m e r c e and B u s i n e s s A d m i n i s t r a t i o n The U n i v e r s i t y of B r i t i s h C o l u m b i a :. V a n c o u v e r 8, C a n a d a . A p r i l , 1 9 6 8 A B S T R A C T The o b j e c t i v e of t h i s t h e s i s i s to i n v e s t i g a t e the n u m e r o u s a s p e c t s of the d i v i d e n d d e c i s i o n w i t h e m p h a s i s on the C a n a d i a n s i t u a t i o n . T h e o r e t i c a l de-v e l o p m e n t s , i n v e s t o r s ' a t t i t u d e s t o w a r d s d i v i d e n d s , and d e c i s i o n c r i t e r i a to e s t a b l i s h the a m o u n t a r e t h r e e a r e a s r e q u i r i n g f u r t h e r w o r k . B o t h o l d and new u n i q u e a p p r o a c h e s a r e u t i l i z e d i n t h i s t h e s i s to e l u c i -d ate t h e s e p r o b l e m a r e a s . The i m p o r t a n c e of the d i v i d e n d d e c i s i o n to the s h a r e h o l d e r , the f i r m , and the e c o n o m y i s f i r s t e s t a -b l i s h e d . ' - V a r i a t i o n s i n i n t e r - i n d u s t r y r a t i o s and i n p a y o u t t r e n d s a r e t h e n e x a m i n e d and e x p l a i n e d to p r o -v i d e an e n v i r o n m e n t f o r the s u b s e q u e n t s t u d i e s . T h e o b j e c t i v e s of the c h a p t e r on t h e o r y a r e to sort-,- r e l a t e , and e x t e n d ( a l s o , to e x a m i n e the p r a g -m a t i c i m p l i c a t i o n s of) the a v a i l a b l e and p e r t i n e n t , t h e o r e t i c a l and e m p i r i c a l c o n t r i b u t i o n s . T h e r e l a t i o n -s h i p b e t w e e n d i v i d e n d d e c i s i o n m a k i n g and t r a d i t i o n a l t h e o r y on c a p i t a l - s t r u c t u r e i s f i r s t d e s c r i b e d . E x t e n -s i o n s t h e r e o f and a l t e r n a t i v e p r o p o s a l s f o l l o w . S t r i c t a d h e r e n c e to t h e o r y i s s u g g e s t e d to be i m p r a c t i c a l . T h e M o d i g l i a n i a n d ' M i l l e r a p p r o a c h t h a t d i v i d e n d s h ave no b e a r i n g on c o s t of c a p i t a l o r s h a r e p r i c e and a r e . i i i t h e r e f o r e not i m p o r t a n t i s r e f u t e d by: 1) l o g i c a l l y a r r a n g i n g , and c o n c l u d i n g f r o m , c r i t i c i s m s of t h e i r - c o s t of c a p i t a l a r g u m e n t ; 2) e x a m i n i n g , c o n s o l i d a t i n g , and v a l i d a t i n g the e a r l y t h e o r y t h a t s t o c k v a l u e s ( u n l e v e r e d e q u i t y ) a r e d e t e r m i n e d by c a p i t a l i z i n g a d i v i d e n d s t r e a m ; 3) c i t i n g r e s u l t s of the p u b l i s h e d s t a t i s t i c a l s t u d i e s , none of w h i c h i n d i c a t e t h a t the p u r e e a r n i n g s h y p o t h e s i s i s c o r r e c t ; 4) e x a m i n i n g i n g r e a t e r d e t a i l the l o g i c p r e -s e n t e d by the a u t h o r s . T h e i m p o r t a n c e of (1) i n f o r m a t i o n a l c o n t e n t s as a l i n k b e t w e e n a c h a n g e i n d i v i d e n d s and a c h a n g e i n s h a r e ' p r i c e and (2). the l e n g t h of t i m e f o l l o w i n g d i v i -d e nd c h a n g e s i s s u b s t a n t i a t e d by a n a l y s i s of t h r e e s t u d i e s and o b s e r v a t i o n of c o m p a n i e s i n v o l v e d i n t h o s e s t u d i e s . To d e t e r m i n e C a n a d i a n i n v e s t o r s ' a t t i t u d e s to d i v i d e n d s , f o u r s t u d i e s , e a c h u s i n g p a i r e d d a t a (1961 to 1965) f r o m up to 144 C a n a d i a n c o m p a n i e s , w e r e u n d e r t a k e n . F i r m s w e r e p a i r e d on the b a s i s of f i n a n -c i a l s i m i l a r i t y , e s p e c i a l l y g r o w t h , and p a y o u t d i f f e -r e n c e to s e t a p a r t d i v i d e n d s as a f a c t o r i n f l u e n c i n g the p r i c e - e a r n i n g s r a t i o . T h e s t u d y u s i n g v e r y c l o s e l y p a i r e d s t o c k s wasdeemed m o s t s i g n i f i c a n t b e c a u s e •g-rowth and o t h e r c o m p a r a t i v e m e a s u r e s a r e a l m o s t i v c o m p l e t e l y i s o l a t e d . T h e r e s u l t s i n d i c a t e (1) t h a t i n v e s t o r s a r e r a t i o n a l i n t h e i r a t t i t u d e to d i v i d e n d p o l i c y ( t h a t i s , t h e y d e s i r e s h a r e s of a c o m p a n y t h a t r e t a i n s e a r n i n g s i f the r e t u r n on t h o s e e a r n i n g s i s d e m o n s t r a t e d to be h i g h ) and (2) t h a t c e r t a i n g r o w t h f i r m s m a y i n c r e a s e the m a r k e t p r i c e of t h e i r s t o c k i n the l o n g - r u n by l o w e r i n g t h e i r d i v i d e n d . T h e d i v i d e n d d e c i s i o n i n p r a c t i c e i s t h e n i n -v e s t i g a t e d . L e g a l and d i s c r e t i o n a r y e l e m e n t s a r e p r e -s e n t e d . R e s u l t s of the g u e s t i o n n a i r e , s e n t to f i f t y d i r e c t o r s of C a n a d i a n c o m p a n i e s , show t h a t (1) net p r o f i t , ;(2) p r e s e n t and: a n t i c i p a t e d n e e d f o r c a s h , (3.) p l a n n e d i n v e s t m e n t p r o j e c t s , (4) p a s t d i v i d e n d s , and (5) e x p e c t e d g r o w t h and v a r i a b i l i t y i n e a r n i n g s and s a l e s a r e c o n s i d e r e d , m o s t i m p o r t a n t ; c o m p e t i t o r s ' p a y o u t and e x i s t e n c e of c o n t r o l g r o u p s , l e a s t i m p o r -t a n t . A n s w e r s to q u e s t i o n s on (1) the e x i s t e n c e of a t a r g e t p a y o u t , (2) the p r i m a r y d i v i d e n d d e c i s i o n , and (3) i m p o r t a n t f e a t u r e s of a s o u n d p o l i c y , as w e l l as a d d i t i o n a l c o m m e n t s by r e s p o n d e n t s , p r o v i d e f u r t h e r i n s i g h t i n t o the d e c i s i o n p r o c e d u r e . . L i n t n e r ' s c l a s s i c d i v i d e n d m o d e l i s t h e n e x a -m i n e d and c r i t i c i z e d to e s t a b l i s h , w i t h the a i d of the q u e s t i o n n a i r e r e s u l t s , t h r e e d i v i d e n d m o d e l s w h i c h a r e put i n the f o r m of r e g r e s s i o n e q u a t i o n s and t e s t e d on a p p r o p r i a t e C a n a d i a n d a t a i n o r d e r to e l u c i d a t e the V d e c i s i o n p r o c e s s . S u b s e q u e n t a n a l y s e s i n d i c a t e t h a t p r o f i t s and c o m p a n y s i z e a r e c o n s i s t e n t l y and h i g h l y s i g n i f i c a n t ; l o n g - t e r m d e b t , f u t u r e p r o s p e c t s , and d e p r e c i a t i o n show l e s s c o n s i s t e n t but s i g n i f i c a n t i n -f l u e n c e ; i n v e s t m e n t and c a s h - n e e d v a r i a b l e s a r e l e s s s i g n i f i c a n t ; d e g r e e of l i q u i d i t y and c o n s e r v a t i s m show no r e l a t i o n s h i p . T h e d i v i d e n d d e c i s i o n i s t h e n e x a m i n e d at the l e v e l of a g g r e g a t e e c o n o m i c s t o c o n s i d e r the i m p a c t of a g g r e g a t e v a r i a b l e s , and i n c o n j u n c t i o n w i t h t h e s e , g o v e r n m e n t m a c r o - e c o n o m i c p o l i c y . T h i s i n v e s t i g a -t i o n s u p p o r t s the q u e s t i o n n a i r e c o n c l u s i o n s . T ' A B L E O F C O N T E N T S C H A P T E R P A G E I . . I N T R O D U C T I O N 1 O b j e c t i v e s . . . 1 M e t h o d o l o g y . . -. -5 I I . I M P O R T A N C E O F D I V I D E N D S 8 I I I . D I V I D E N D P A T T E R N S 13 A n a l y s i s of C a n a d i a n T r e n d s . . . . . . . 13 A m e r i c a n T r e n d s 15 I n d u s t r y P a t t e r n s . . . . • 17 I V . T H E O R E T I C A L A N D E M P I R I C A L C O N T R I B U T I O N S 21 D i v i d e n d D e c i s i o n i n P e r s p e c t i v e . . . . 21 F i n a n c i a l r e l a t i o n s h i p i n t h e o r y . . . 21 E x t e n s i o n s of the b a s i c t h e o r y on d i v i d e n d d e c i s i o n s . 26 R e a l w o r l d r e l e v a n c e 26 A d i f f e r e n t a p p r o a c h . .• 28 D i v i d e n d s m a t t e r v i a the op t imum, c a p i t a l s t r u c t u r e t h e o r y , . . . . 30 E a r n i n g s V e r s u s D i v i d e n d s 34 T h e o r y / 34 E m p i r i c a l r e s u l t s . 42 v i i i C H A P T E R P A G E M i l l e r - M o d i g l i a n i H y p o t h e s i s 49 I m p o r t a n c e of I n f o r m a t i o n a l C o n t e n t s . . 55 S o g a n i c h 55 A s h l e y . . . . . . . 56 B a r k e r . . . . . 58 V . T H E C A N A D I A N I N V E S T O R S ' R E A C T I O N TO D I V I D E N D S 60 P u r p o s e . . 60 M e t h o d . . . . • 60 R e s u l t s 65 D i s c u s s i o n ' of R e s u l t s . . . • 71 C r i t i q u e - of M e t h o d . . . 76 V I . . D I V I D E N D D E C I S I O N IN P R A C T I C E . . . . 80 C o n s t r a i n t s . . . . - 80 D i s c r e tio'na ry ^!C ons ide r a t i o n s 8 2 L i n t n e r 8 2 T h o m p s o n and W a l s h • . 8 5 Q u e s t i o n n a i r e to C a n a d i a n c o m p a n i e s 87 The L i n t n e r D i v i d e n d M o d e l 104 . D e v e l o p m e n t and r e s u l t s . 104 C r i t i c i s ms 106 ' D i v i d e n d M o d e l s A p p l i e d to C a n a d i a n D a t a . I l l P u r p o s e . . . I l l i x C H A P T E R P A G E D h r y m e s a n d ' K u r z 112 I n i t i a l m o d e l . 115 I n t e r m e d i a t e m o d e l 123 F i n a l m o d e l 126 C o m m e n t s 130 V I I . A G G R E G A T E E C O N O M I C S A N D ' T H E D I V I D E N D D E C I S I O N . . . . . . . . . . . 131 V I I I . C O N C L U S I O N S . . . . . . . 145 B I B L I O G R A P H Y . . . .' 150 A P P E N D I X A . D i v i d e n d T r e n d s i n C a n a d a and i n the U n i t e d S t a t e s ' 157 A P P E N D I X B . . H i s t o g r a m . . S h o w i n g P a y o u t R a t i o s of 190 C a n a d i a n F i r m s , 1-9 61 to 1965 161 A P P E N D I X C . H i s t o g r a m s S h o w i n g P a y o u t R a t i o s by I n d u s t r y , 1961 to 1965 . . . ' 163 A P P E N D I X D . P a y o u t - R a t i o s fo r . D i f f e r e n t S i z e C a n a d i a n F i r m s , 195 1- 1962 169 A P P E N D I X E . P a i r e d C o m p a n i e s 171 A P P E N D I X F . C o p i e s of the (1) Two L e t t e r s R e q u e s t i n g C o o p e r a t i o n and (2) A c c o m p a n y i n g Q u e s t i o n n a i r e s 17.7 A P P E N D I X G . F i r m s U s e d f o r M o d e l ' T e s t i n g . .' 182. L I S T 'OF T A B L E S T A B L E P A G E I . ' D i v i d e n d s R e c e i v e d by Income C l a s s i n C a n a d a , 1964 9 I I . A v e r a g e P a y o u t to C o m m o n S h a r e h o l d e r s f r o m M a j o r C a n a d i a n I n d u s t r i e s i n the • P e r i o d 1961 to 1965 18 I I I . R e s u l t s of P a i r i n g 144 C o m p a n i e s T a b u l a t e d by I n d u s t r y 67 I V . R e s u l t s of P a i r i n g 56 C o m p a n i e s E x h i b i t i n g E x c e p t i o n a l G r o w t h . . . .' . 68 V . R e s u l t s of V e r y C l o s e l y P a i r i n g 54 C o m p a n i e s 69 V I . R e s u l t s of P a i r i n g 48 C o m p a n i e s , E a c h C o m p a n y w i t h i n a P a i r H a v i n g a P a y o u t D i f f e r e n c e of O v e r 35 P e r cent 70 V I I . How 195 A m e r i c a n C o m p a n i e s R a n k e d the R e l a t i v e - Impor t ance of C o n t i n u i t y , Ra te S t a b i l i t y , and S i z e of D i v i d e n d 85 V I I I . I m p o r t a n c e of F a c t o r s i n the D i v i d e n d D e c i s i o n f o r a . R a n d o m l y S e l e c t e d G r o u p of 20 C a n a d i a n C o m p a n i e s , E a c h w i t h T o t a l A s s e t s O v e r 10 M i l l i o n D o l l a r s 92 x i T A B L E P A G E I X . I m p o r t a n c e of F a c t o r s i n t h e - D i v i d e n d D e c i s i o n f o r 10 C a n a d i a n C o m p a n i e s i n the F o r e s t P r o d u c t s I n d u s t r y . . . . 93 X. I m p o r t a n c e of F a c t o r s i n the D i v i d e n d D e c i s i o n f o r .8 C a n a d i a n C o m p a n i e s i n the F o o d I n d u s t r y . . . 94 X I . N u m b e r of F i r m s .with and w i t h o u t a T a r g e t ' P a y o u t R a t i o 95 X.II. C a n a d i a n D i r e c t o r s ' R a n k i n g of S i z e , C o n t i n u i t y , and S t a b i l i t y . 97 X I I I . D i r e c t o r s ' O p i n i o n on W h e t h e r the N e e d to C h a n g e the D i v i d e n d A m o u n t i s the P r i m a r y D e c i s i o n . . 98 X I V . I n i t i a l M o d e l A p p l i e d to 25 F i r m s i n the F o r e s t I n d u s t r y , 1964 119 X V . I n t e r m e d i a t e M o d e l A p p l i e d to 25 F i r m s i n the F o r e s t I n d u s t r y , 1964 . . 125 X V I . C o r p o r a t i o n S a l e s and P r o f i t s a f t e r T a x e s i n C a n a d a , by I n d u s t r y , F i r s t H a l f 1966 and 1967 137 L I S T O F F I G U R E S F I G U R E . P A G E 1. R e l a t i o n s h i p be tween the D i v i d e n d D e c i s i o n and O t h e r - V a r i a b l e s 3 2 . D i v i d e n d D e c i s i o n i n T h e o r y . . . . . . . 24 3 . P r o f i t s v e r s u s G a s h F l o w s as a D e t e r m i n a n t - of the D i v i d e n d - D e c i s i o n i n the U n i t e d S t a t e s , 1957 to 1966 . . . 110 4. I n i t i a l M o d e l . - 11-5 5. I n t e r m e d i a t e M o d e l 123 6. S t r u c t u r e of the D i v i d e n d D e c i s i o n i n .Canada B a s e d on 33 D i r e c t o r s ' S t a t e d 0 p i n i o n s 127 7 . F i n a l . M o d e l 128 8. G r o s s N a t i o n a l P r o d u c t I n c r e a s e s , 1960 to 1966; G o v e r n m e n t E s t i m a t e d Inc r e a s e , 1 9 6 7 ( w i t h A d j u s t m e n t f o r P r i c e C h a n g e s ) 135 9. I n c r e a s e s i n C o m p a n y P r o f i t s , 1963 to 1966 13 6 10. A n n u a l P e r c e n t a g e C h a n g e s i n the M a n u f a c t u r i n g I n d u s t r y ' s C a p i t a l E x p e n d i t u r e s ( C u r r e n t D o l l a r s ) , 1964 to 1966; G o v e r n m e n t E s t i m a t e d Change , 1 9 6 7 • . . . 138 x i i i F I G U R E P A G E 11 . G o v e r n m e n t . Budget . , 195 6 to 1966; G o v e r n m e n t E s t i m a t e d B u d g e t , 1967 and 1968 142 A C K N O W L E D G E M E N T S T h i s s t u d y was a p p r e c i a b l y i m p r o v e d by t h e ' c r i t i c i s m s and s u g g e s t i o n s of D r . P. A. L u s z t i g , D r . H..L. P u r d y , and'.Mr, W. F. J . Wood. The w r i t e r e x p r e s s e s h i s g r a t i t u d e to t h e s e m e n , to the c o r p o r a t i o n e x e c u t i v e s who t o o k t i m e to g i v e t h e i r o p i n i o n s on the . s u b j e c t u n d e r s t u d y , and to the o t h e r s who h e l p e d i n s u n d r y ways,. C H A P T E R I I N T R O D U C T I O N I. O B J E C T I V E S : T h e m a j o r a r e a s r e l a t e d to' the d i v i d e n d d e c i -s i o n and to be d i s c u s s e d ' i n t h i s t h e s i s a r e d e p i c t e d i n F i g u r e 1. As s h o w n , the c o m p a n y d i r e c t o r s d e c i d e , by c o n s e n s u s ' o r c o m p r o m i s e , ho.w c e r t . a i n ; c o n s t r a i n t s and d i s c r e t i o n a r y e l e m e n t s s h o u l d be c o n s i d e r e d and s y n t h e s i z e d i n l i g h t of the g e n e r a l e c o n o m i c c l i m a t e and the nature- of t h e . f i r m . T h e ' b o a r d of d i r e c t o r s r e p r e s e n t s the c o m p a n y ' s s h a r e h o l d e r s and m a k e s ma-j o r p o l i c y d e c i s i o n s on - t h e i r b e h a l f . -A.s' m - a x i m i z a t i o n of s h a r e p r i c e i s a p r i m a r y o b j e c t i v e of m a n a g e m e n t , -'-This goal although accepted by most is debated.by many. For the arguments of a dissenter see: R. N. Anthony, "The Trouble with Profit Maximization," Harvard Business Review, vol. 38 (November-December 1960), pp. 126-134. For the arguments of-, a' supporter see: N. R. Greene, "How Much Responsibility Does Management Have for • the Price Level of the Company's Stock. " Readings in Financial Analysis and Investment Management, ed. E. M. Lerner, Homewood, Illinois, Richard D. irwin, Inc. ,~T9~63, pp. 212-215. For a perceptive article on the differences between management and shareholders' objectives see: G. Donaldson, "Financial Goals: Management vs. Stockholders," Harvard  Business Review, vol. 41 (May-June 1963), pp. 116-129; also, C..T7 Potter, Finance 'and Business Administration in Canada, Scarborough, - ' Ont. , P r entice-HaTToTTJanada Ltd., 1U66, pp7362-363. The goal of maxi-mization of share price is often more specifically stated as maximization of the present value of the owners' wealth, including both price apprecia-tion and dividends. For example, see: J. T. S. Porterfield, Investment Decisions and Capital Costs, Englewood C l i f f s , N. J. , Prentice-Hail, M c , iy65,~pp. 85-87.~~~~ 2 o w n e r s ' and i n v e s t o r s ' a t t i t u d e s ( w h i c h a f f e c t s h a r e pr i c e . ) a r e i m p o r t a n t to d i v i d e n d p o l i c y . • E c o n o m i c and f i n a n c i a l t h e o r y has yet to e v o l v e to the s t a g e w h e r e a l l the r e l e v a n t v a r i a b l e s c a n be p e r f e c t l y and s y s t e m a t i c a l l y i n c o r p o r a t e d i n t o the d e c i -s i o n p r o c e s s ..to g i v e a p r e c i s e , o p t i m u m d i v i d e n d . N o n e -t h e l e s s , s u c h t h e o r y has p r o v i d e d v a l u a b l e a n d p r a g m a -t i c i n f o r m a t i o n . T h e s e d e v e l o p m e n t s , t h e r e f o r e , s h o u l d be h e e d e d by the d e c i s i o n - m a k e r s i n t h e i r a t t e m p t to o p t i m i z e ' . The" d i v i d e n d d e c i s i o n has c e r t a i n c o n s e q u e n c e s . M i c r o - ef f e c t s a r e r e f l e c t e d i n th'e a t t i t u d e s of s h a r e -h o l d e r s . C o r p o r a t e d i v i d e n d p o l i c y i n the a g g r e g a t e . a f f e c t s n u m e r o u s m a c r o e c o n o m i c ' . v a r i a b l e s and t h u s has an i n f l u e n c e on e c o n o m i c c o n d i t i o n s and on g o v e r n -m ent p o l i c y . C o n v e r s e l y , the g o v e r n m e n t c a n i n f l u e n c e the d e c i s i o n and he nee-.corporate.* s a v i n g s t h r o u g h d e l i -b e r a t e p o l i c y o r l e g i s l a t i v e a c t i o n . A t t i t u d e s of s h a r e h o l d e r s E c o n o m i c a n d f i n a nc i a1 t h e o r y D I V I D E N D D E C I S I O N 7K "7\ C o m p a n y d i r e c t o r s / \ N a t u r e of the-.-. f i r m . . A c t u a l ' : f d i v i d e n d p a i d E f f e c t s • m i c r o m a c r o l e g a l G o v e r n m e n t a c t i o n E c o n o m i c c o n d i t i o n : p o l i c y " F I G U R E 1 • R E L A T I O N S H I P B E T W E E N T H E D I V I D E N D D E C I S I O N A N D O T H E R V A R I A B L E S c 4 The o v e r a l l t h e s i s o b j e c t i v e i s to e x p a n d 'on the c o n t e n t s of F i g u r e 1 by e x a m i n i n g c e r t a i n c f the' a r e a s 2 r e l a t e d , to the d i v i d e n d d e c i s i o n w i t h e m p h a s i s on the r e c e n t C a n a d i a n , s i t u a t i o n . S p e c i f i c t h e s i s o b j e c t i v e s a r e : ' (1) to d e s c r i b e b r i e f l y ( w i t h i n the c o n t e x t of F i g u r e 1) the i m p o r t a n c e of the d i v i d e n d d e c i s i o n ; (2) to a n a l y s e a g g r e g a t e t r e n d s and to d i s p l a y i n d u s t r y p a t t e r n s to p r o v i d e an e n v i r o n m e n t f o r t he' s u b s e q u e n t s t u d i e s ; (3) to r e l a t e the t h e o r e t i c a l and e m p i r i c a l c o n -t r i b u t i o n s a n d t h e i r i m p l i c a t i o n s ; • (4) to d e t e r m i n e C a n a d i a n s h a r e h o l d e r s ' a t t i t u d e s t o w a r d s d i v i d e n d s ; . ; (.5) to i s o l a t e and e x a m i n e the i m p o r t a n t p o l i c y f a c t o r s - c o n s i d e r e d by d i r e c t o r s of C a n a d i a n c o m p a n i e s ; (6) to. i n v e s t i g a t e , the' d i v i d e n d d e c i s i o n w i t h i n the s e t t i n g of a g g r e g a t e e c o n o m i c s . ; ^ T he - d i v i d e n d d e c i s i o n i n t h i s - t h e s i s r e f e r s to the p a y m e n t of c o m m o n d i v i d e n d s a f t e r t a x e s and p r e -f e r r e d d i v i d e n d s . T h e d e c i s i o n i n v o l v i n g the l a t t e r was e x c l u d e d f r o m the s t u d y b e c a u s e of the d i f f e r e n t n a t u r e of the p r e f e r r e d d i v i d e n d d e c i s i o n and b e c a u s e c o m m o n s t o c k f i n a n c i n g i s m o r e p r e v a l e n t . 5 I I . M E T H O D O L O G Y -.The f o l l o w i n g p a r a g r a p h s o u t l i n e , the m e t h o d o -logy u s e d i n C h a p t e r s II to V I I . ^ . . • • The d e s c r i p t i o n of d i v i d e n d i m p o r t a n c e ( C h a p t e r II) i s c l e a r l y b a s e d on and i s an e x t e n s i o n of F i g u r e 1. T he -unde r l y i n g c a u s e s of d i v i d e n d t r e n d s o v e r r e l a t i v e l y r e c e n t y e a r s a r e .discu-ss .ed i n c h r o n o l o g i c a l o r d e r ( C h a p t e r I I I ) ; i n d u s t r y p a t t e r n s a r e i l l u s t r a t e d by g r a p h s , w h i c h a r e p l a c e d i n the. A p p e n d i c e s . The me thod of a p p r o a c h i n the p r e s e n t a t i o n of t h e o r e t i c a l dev .e lopments ( C h a p t e r . I V ) i s the e x a m i n i n g of c e r t a i n c o n t r o v e r s i a l a r e a s by e s t a b l i s h i n g a p o s i -t i o n and then c o u n t e r i n g o r s t r e n g t h e n i n g t h i s p o s i t i o n w i t h v a r i o u s o t h e r hyp,otheses and e m p i r i c a l r e s u l t s . -In t h i s ' w a y , the works of n u m e r o u s a u t h o r s a r e shown to be r e l a t e d . . To d e t e r m i n e C a n a d i a n i n v e s t o r s ' r e a c t i o n s to d i v i d e n d s of c o m p a n i e s i n d i f f e r e n t s t ages of g r o w t h , i n d i f f e r e n t i n d u s t r i e s , , and i n the o v e r a l l m a r k e t ( C h a p t e r V ) , an e m p i r i c a l s t udy i s a p p l i e d to C a n a d i a n • ' ' • ' • ' • 3 d a t a . The study, i s p a t t e r n e d a f t e r one by B u r r e l ' and O. K . B ' u r r e l , ' " R e l a t i v e V a l u e ' of E a r n i n g s : R e t a i n e d and D i s t r i b u t e d , " The C o m m e r c i a l and F i n a n -c i a l C h r o n i c l e , v o l . .1 8 6- ( J u T y ~ l cT7~rwrr7~pp 7~T~, 2 8 - 2 9 6 • • 4 i n c o r p o r a t e s s e v e r a l i d e a s f r o m one by H a r k a v y , yet u t i l i z e s m o r e e l a b o r a t e p a i r i n g t e c h n i q u e s than e i t h e r . 5 . L i n t n e r a n d , m o r e r e c e n t l y , T h o m p s o n and 6 • W a l s h have i n v e s t i g a t e d t h r o u g h p o l l i n g t e c h n i q u e s the i m p o r t a n c e of the m a j o r p o l i c y v a r i a b l e s . T h e i r r e s u l t s a r e s u m m a r i z e d ( C h a p t e r VL) a f t e r ' a n i n t r o -ductof 'y ' Sec t ion ' on l e g i s l a t i v e - a n d c o n t r a c t u a l c o n -s t r a i n t s . The f o r m of the q u e s t i o n n a i r e u sed f o r t h i s t h e s i s and se-n't to f i f t y C a n a d i a n f i r m s was b a s e d on the t e c h n i q u e s , q u e s t i o n s , and c o n c l u s i o n s of these aut.h-.ors . .-In f a c t , one of the., ,ob j e c t i v e s of the q u e s -t i o n n a i r e was to" tes t the r e l e v a n c e o f , t h e i r c o n c l u s i o n s i n the C a n a d i a n s i t u a t i o n . The s i g n i f i c a n c e of some of the m o r e i m p o r t a n t p o l i c y c o n s i d e r a t i o n s s u g g e s t e d by O s c a r H a r k a v y , "T.he R e l a t i o n B e t w e e n R e t a i n e d E a r n i n g s and C o m m o n S t o c k P r i c e s f o r L a r g e L i s t e d C o r p o r a t i o n s , " The J o u r n a l of F i n a n c e , v o l . V I I I (September-.195377"ppT 290-29~5;. ~ . -. . " 5 ' John L i n t n e r , '"The D e t e r m i n a n t s of C o r p o r a t e S a v i n g s ' , " S a v i n g s i n the Mo de r n E c o n o m y , e d . W. W. H e l l e r and o t h e r s , ~~MFnneapo l i s , U n i v e r s i t y of M i n n i s o t a P r e s s , 1 9 5 3 , p p . 248 - 252; J o h n L i n t n e r , " D i s t r i b u t i o n of Income of. C o r p o r a t i o n s A m o n g D i v i d e n d s , R e t a i n e d E a r n i n g s and T a x e s , " A m e r i c a n E c ono m i c R e v i e w , P a -pe r s and P r o c e e d i n g s , v o l . XT7V T UV1 a y 19 5 WT, p p . 9IT- 9 9 . 6 G . C . . T h o m.p son and F . J . W a l s h , J r . , " C o m -p a n i e s S t r e s s ^Div idend" C o n s i s t e n c y , " M a n a g e m e n t R e -c o r d , N a t i o n a l I n d u s t r i a l C o n f e r e n c e Board" , Inc . , v o l . X 1 T ( J a n u a r y ; 1963 ) , pp . 30 - 36 . 7 the d i r e c t o r s was d e t e r m i n e d by t e s t i n g on the c o m -p u t e r s e v e r a l m o d e l s e x t e n d e d f r o m the L i n t n e r s t u d i e s and a d j u s t e d to o v e r c o m e s o m e of the w e a k n e s s e s i n -h e r e n t i n the L i n t n e r m o d e l / B e c a u s e the L i n t n e r - f o r -m u l a t i o n i s the c l a s s i c i n the e n t i r e d i v i d e n d a r e a and b e c a u s e the m e t h o d of a n a l y s i s u s e d i n C h a p t e r V I d i f f e r s s o m e w h a t f r o m L i n t n e r ' s , b o t h h i s m o d e l and s u b s e q u e n t c r i t i c i s m s a r e p r e s e n t e d . : T h e f i n a l i n v e s t i g a t i o n ( C h a p t e r V I I ) , of d i v i -d e n d s i n the a g g r e g a t e , was i n t e n d e d to supplem'-ent, and c o m p l e m e n t q u e s t i o n n a i r e c o n c l u s i o n s . H e n c e , . a g g r e g a t e d a t a f o r e a c h m a j o r p o l i c y v a r i a b l e a r e ' e x a m i n e d - i n r e l a t i o n • t o • the r e c e n t t r e n d s i n p a y o u t . T r e m e n d o u s s c o p e and c o m p l e x i t i e s p r e c l u d e d an e x a -m i n a t i o n of the - i m p a c t t h a t the d i v i d e n d d e c i s i o n has on the e n t i r e , e c o n o m y and on g o v e r n m e n t p,-olicy-, a l -t h o u g h t h i s a r e a i s n e c e s s a r y ' t o the s c h e m a t i c c o n -s i s t e n c y of F i g u r . e 1. J o h n B r i t t a i n ' s C o r p o r a t e D i v i -7 ' ' • ' . dend P o l i c y , ,. h o w e v e r , a n a l y s e s the s u b j e c t o f . d i v i -d e n d s and m a c r o e c o n o m i c s i n the U n i t e d S t a t e s e c o -n o m y . . . . ' J . A . B r i t t a i n , C o r p o r a t e D i v i d e n d P o l i c y , W a s h i n g t o n , D. C. , .The B r o o k i n g s I n s t i t u t i o n , 1~966, p a s s i m . C H A P T E R II I M P O R T A N C E OF D I V I D E N D S In t h i s c h a p t e r the m a t e r i a l p r e s e n t e d i n F i g u r e 1 i s e x t e n d e d to r e l a t e ' the i m p o r t a n c e of the d i v i d e n d d e c i s i o n to the m a j o r f a c t o r s i n v o l v e d , n a m e l y , the s h a r e h o l d e r , , the f i r m , and the e c o n o m y . T a b l e I shows the 1964 d i v i d e n d s r e c e i v e d by C a n a d i a n s and what p r o p o r t i o n t h e y a r e , o f the t o t a l i n c o m e f o r ea:ch i n c o m e c l a s s . D i v i d e n d s a r e r e l a -t i v e l y m o r e i m p o r t a n t ' to- the w e a l t h y f e w . F o r ex-a m p l e , -3. 6 p e r c e n t of the t a x p a y e r s r e c e i v e d 65.3 p e r c e n t o f - t h e d i v i d e n d s w h i c h a c c o u n t e d f o r 7.2 p e r c e n t of t h e i r t o t a l i n c o m e . .' „ • . ... i R e t a i n e d e a r n i n g s h a v e a c c o u n t e d f o r m o r e t h a n 50 p e r c e n t of t o t a l i n v e s ' t m e n t i n r e c e n t y e a r s :' • ' : 1 ( e x c l u s i v e o f - d e p r e c i a t i o n ) a n d ' t h u s a r e one of the m a j o r , s o u r c e s of f i n a n c i n g the g r o w t h of C a n a d i a n f i r m s ; D i v i d e n d s a r e i m p o r t a n t to the f i r m' s f i n a n -c i n g p l a n s i n o t h e r w a y s . C a n a d i a n B r e w e r i e s , f o r e x a m p l e , r a i s e d i t s , a n n u a l d i v i d e n d to $1.60 a s h a r e j u s t b e f o r e a n n o u n c i n g a s t o c k r i g h t i s s u e - 'in 1960. D o m i n i o n B u r e a u of S t a t i s t i c s , N a t i o n a l A c c o u n t s , I n c o m e and E x p e n d i t u r e , O t t a w a , Q^Teen's P T T n T e r T 19"6 2:, p. W T T W 4 , p . b 2 . •. T A B L E I D I V I D E N D S R E C E I V E D BY. I N C O M E C L A S S IN C A N A D A , 1 9 6 4 Income class (thousands of dollars) Percentage of total income-receivers Dividends (millions of dollars) Percentage of total' dividends Dividends as a percentage of total income l e s s than 1 11. 1 • ': 2. 712. .0.6 0 . 8 1 . - 2 . 999 32. .1 . 29 , . 562 6 . 6 0 . 7 3 . - 4.999 - 29 . 9 - 39 .032 8.7- 0. 5 5 . - 9.999 23 . 3 84. . 707 ' ; 18:;8 0 -. 8 10. - 2 4 . 9 9 9 ' 3 . 2 138 . 628 3 0.'. 8 4. 7 25. and m o r e ' 0. 4 .1 5 5" .3 75 ' 3 4 -. 5 . ' . . . i . 13 . 6 a l l c l a s s e s 100. 0 450 .016 100 vo • ' 1 . 7 S o u r c e : D e p a r t m e n t of N a t i o n a l T a x a t i o n D i v i s i o n , T a x a t i o n Stat i s t i c s Queen's P r i n t e r , 1 9 '6 6~, pp . IT^- 23 . Revenue , P a r t i , Ottawa , 10 • T h i s t y p e of s t r a t e g y may i n c r e a s e the m a r k e t r e c e p -t i v i t y to the new i s s u e and may c o n v i n c e ' the p r e v i o u s s h a r e h o l d e r s t h a t t h e y s h o u l d r e t a i n t h e i r s h a r e s d u r i n g the m a r k e t i n g o p e r a t i o n s - . If l o n g - t e r m p r o s p e c t s , a r e f a v o u r a b l e but w o r k i n g c a p i t a l i n the s h o r t - r u n i s l o w , the f i r m may w i s e l y b o r r o w to m a i n t a i n not •only the d i v i d e n d r a t e " but a l s o the g o o d w i l l of the c a -p i t a l m a r k e t . ' If the m a j o r c o r p o r a t i o n o b j e c t i v e i s m a x i m i z a -t i o n of s h a r e h o l d e r s . 1 , w e a l t h , t.lren d i v i d e n d s p l a y a l a r g e r o l e i n ' t h e e x t e n t to w h i c h the g o a l i s m e t , e s -p e c i a l l y i f d i v i d e n d s h ave a l a r g e i m p a c t on the p r i c e of the s t o c k . . •. •• T h e q u e s t i o n o f " d i v i d e n d s af f e c t i n g, s ha r e p r i c e i s r e a l l y -the c r u x ' of any d i s c u s s i o n on d i v i d e n d i n i r ' p o r t a n c e . F o r e x a m p l e , s o m e of the' s t a t e m e n t s a b o v e on s h a r e h o l d e r s a t i s f a c t i o n and f i n a n c i n g ' p l a n s a s s u m e i m p l i c i t l y t hat' d i v i d e n d s a f f e c t p r i c e . .But, the t r u t h and the e x t e n t of t h i s a s s u m p t i o n r e m a i n s one of the b a s i c , u n s e t t l e d p r o b l e m s i n the. d i v i d e n d a r e a . P r i c e r e a c t i o n i s a c o n s e q u e n c e of i n v e s t o r r e a c t i o n s w h i c h a r e e x a m i n e d i n C h a p t e r V. C h a p t e r I V , on t h e o r y , a l s o -deals' w i t h the q u e s t i o n . ' • . ' - E c o n o m i s t s may be i n t e r e s t e d i n the f o r c e s i n -f l u e n c i n g the d i v i d e n d d e c i s i o n f o r s e v e r a l r e a s o n s , , . 1 1 F i r s t , s u c c e s s f u l . f o r e c a s t s of the c o m p o n e n t s of the n a t i o n a l p r o d u c t d e p e n d to s o m e d e g r e e on knowing the 9 d i v i d e n d ' c o n t r i b u t i o n to p e r s o n a l i n c o m e . S e c o n d l y , the s t a b i l i t y of d i v i d e n d s p l a y s a r o l e i n the s t a b i l i t y of the" e c o n o m i c s y s t e m . A n d f i n a l l y , any i n f l u e n c e , t h a t a c h a n g e ' i n c o r p o r a t e , s a v i n g has on g r o w t h i s of d e f i n i t e i n t e r e s t to g o v e r n ment p o l i c y - m a k e r s . . . B r i t t a i n , who w r o t e C o r p o r a t e D i v i d e n d P o l i c y , s u g g e s t e d t h a t f r o m a'.public p o l i c y p o i n t of v i e w two e f f e c t s of an a g g r e g a t e d i v i d e n d c h a n g e a r e of m a j o r . ,:. : 4' "•' s i g n i f i c a n c e : (1) e f f e c t s on c o r p o r a t e s a v i n g w i t h i m p l i c a - . t i o n s . f d r l i q u i d i t y and .'investment; -: (2) e f f e c t s .on changes- i n i n d i v i d u a l i n c o m e d i s t r i b u t i o n ; t h a t i s , i n c r e a s e d r e t e n t i o n r e d u c e s the s h a r e -of-the w e a l t h y i n t o t a l p e r s o n a l i n c o m e . ' 'Do.broyo Is ky has. c l a i m e d that--a g e n e r a l , c h a n g e i n d i v i d e n d p o l i c y w o u l d l i k e l y a f f e c t the n a t i o n a l p r o -d u c t . F o r an e x p l a n a t i o n s e e : S. P. D o b r o v o l s k y / " E c o n o m i c s of C o r p o r a t e I n t e r n a l and E x t e r n a l F i n a n c i n g , " J o u r n a l of F i n a n c e , v o l . X I I ( M a r c h 1 9 5 8 ) , pp. 3 6 - 3 7 . 3 F o r f u r t h e r d e t a i l s s e e : B r i t t a i n , op. c i t . , p. 212. ~ lb i d . , p . 4 . 12 S ine e ; pe r so na 1 i n c o m e does not i n c l u d e c a p i t a l g a i n s , the l a t t e r e f f ec t has l i t t l e m e a n i n g . I n c r e m e n t s to e c o n o m i c p o w e r w o u l d r e m a i n e i t h e r u n a f f e c t e d o r s l i g h t l y a f f e c t e d . B r i t t a i n made a f u r t h e r s u g g e s t i o n ( a l s o ' o f q u e s t i o n a b l e ' m e r i t ) that d i v i d e n d p o l i c y may a f fec t the o u t c o m e of c o l l e c t i v e b a r g a i n i n g i f u n i o n s c o m p a r e t h e i r wage, s h a r e w i t h d i v i d e n d s i n s t e a d of net p r o f i t s . . . . . . . P e t e r s o n g i v e s , , on p . 6 5 , the A m e r i c a n G o v e r n m e n t d e f i n i t i o n o f - p e r s o n a l i n c o m e as. " . . . the c u r r e n t i n c o m e r e c e i v e d by p e r s o n s f r o m a l l s o u r c e s A s he m a d e . c l e a r ' o n pp . 4 2 1 - 4 2 2 , h o w e v e r , ' a l l . s o u r c e s ' does not i n c l u d e c a p i t a l g a i n s . See: W. ,C . P e t e r s o n , Income , E mp l o y m e n t , and E c o -n o m i c G r o w t h , J e w Y o r k , W~7 W. IMorton and .Company I n c . , .1 91TTT. B r i t t a i n , loc . c i t . C H A P T E R I I I D I V I D E N D P A T T E R N S I. A N A L Y S I S OF C A N A D I A N T R E N D S S t a t i s t i c s i n T a b l e A . I ( A p p e n d i x A) show the p a y o u t to C a n a d i a n ' p e r s o n s f r o m 1926 to 1966. T h e f o l l o w i n g t r e n d s a re. - e v i d e n t : 1. P a y o u t r a t i o s b e f o r e the d e p r e s s i o n a r e s i m i l a r to r a t i o s i n the- p o s t w a r ' p e r i o d . 2., R a t i o s 'in. the d e p r e s s i o n y e a r s a r e m u c h h i g h e r t h a n the o v e r a l l a v e r a g e r a t i o . 3. In the p o s t w a r p e r i o d the r a t i o i n c r e a s e d e r r a t i c a l l y f r o m 3 9.0 p e r c e n t i n 19 4.6 to 5.7.6 p e r - . ,1 • ' - ' c e n t i n 1966. 4. D i v i d e n d s c h a n g e d i n the s a m e d i r e c t i o n as p r o f i t s , a l t h o u g h at a s l o w e r r a t e . 5. G e n e r a l l y , and e x c e p t f o r the d e p r e s s i o n , the payo'ut' r a t i o has b e e n r e l a t i v e l y s t a b l e . T h e h i g h , d e p r e s s i o n r a t i o s w e r e a r e s u l t of the d e c r e a s e d p r o f i t b a s e , the t e n d e n c y f o r f i r m s to pay a s t a b l e a m o u n t ( t h e l a g m e n t i o n e d i n 4 a b o v e ) , and the l a c k of. i n v e s t m e n t o p p o r t u n i t i e s . T h i s s h o r t -age r e s u l t e d ' i n a l o w e r c o r p o r a t e d e m a n d f o r f u n d s and t h u s e a r n i n g s r e t e n t i o n . ; 14 Th e s l i g h t l y l o w e r , e a r l y p o s t w a r ' r a t i o s (1946 to 1950) w e r e a t t r i b u t e d to the p r e v a i l i n g , p e s s i m i s t i c a t t i t u d e t o w a r d s f u t u r e e c o n o m i c p r o s p e r i t y . B e c a u s e of t h i s f e e l i n g o r b e c a u s e of the o v e r w h e l m i n g d e s i r e f o r c o n s u m e r g o o d s , the p u b l i c had l i t t l e d e s i r e to i n v e s t . T h e c o n s e q u e n t d i f f i c u l t y i n o b t a i n i n g f u n d s c o u p l e d w i t h the g r e a t e r i n v e s t m e n t o p p o r t u n i t y and the g r e a t e r n e e d f o r w o r k i n g c a p i t a l p a r t i a l l y e x p l a i n s the h i g h i n t e r n a l f i n a n c i n g . It i s f u r t h e r e x p l a i n e d by m a n a g e m e n t s ' i n h e r e n t t e n d e n c y to c o n s e r v e m o n i e s v i s - a - v i s a r a p i d g r o w t h i n e a r n i n g s . T h i s d e s i r e was a m p l i f i e d by the a n t i c i p a t i o n of a d e p r e s s i o n . R e l a -t i v e l y low c a p i t a l c o s t a l l o w a n c e s a l s o s t i m u l a t e d a h i g h d e m a n d f o r f u n d s . T h e p e r i o d f r o m 1950 to 1952 was c h a r a c t e r i z e d by c o n s i d e r a b l y g r e a t e r p a y o u t and h i g h e r r a t i o s t h a n i n a d j a c e n t p e r i o d s , a l t h o u g h the e a r l y f i f t i e s w e r e a l s o n o t e d f o r r i s i n g i n v e s t m e n t and s u p p o s e d l y a s t r o n g d e m a n d f o r f u n d s . T h i s i n c o n s i s t e n c y i s ex-p l a i n e d by the 1949 c h a n g e i n the m e t h o d s of c a l c u -l a t i n g c a p i t a l c o s t a l l o w a n c e s f o r t a x p u r p o s e s . T h e s u b s t i t u t i o n o f the d i m i n i s h i n g b a l a n c e f o r the s t r a i g h t l i n e m e t h o d r e s u l t e d i n d e p r e s s e d a f t e r - t a x r e p o r t e d p r o f i t s but i n c r e a s e d c a s h f l o w s . , 1 5 D i v i d e n d s t a b i l i t y c o m b i n e d w i t h h i g h e a r n i n g s e x p l a i n s the low p a y o u t s i n 1955 and 1956. T h e h i g h p a y o u t s i n r e c e n t y e a r s w e r e the c o n -s e quence, of not o n l y i n c r e a s e d m a n a g e m e n t c o n f i d e n c e a b o u t f u t u r e p r o f i t a b i l i t y a n d , t h e r e f o r e , the a b i l i t y to pay d i v i d e n d s ( s e e C h a p t e r V I I ) , . but a l s o g r e a t e r c r e d i t e a s e e s p e c i a l l y in. 1.960 and 1961. In o n l y f o u r of the f o r t y y e a r s s i n c e . 1926 h a v e d i v i d e n d s p a i d to C a n a d i a n p e r s o n s b e e n g r e a t e r t h a n d i v i d e n d s p a i d to n o n - r e s i d e n t s . T h i s ' f a c t p o i n t s to the d e p e n d e n c e , of the C a n a d i a n e c o n o m y on f o r e i g n . o w n e r s h i p . M o r e o v e r , t h i s s t a t i s t i c i n d i c a t e s the c o n t r o l tha.t" f o r e i g n i n v e s t o r s h ave o v e r the d i v i d e n d d e c i s i o n in-"Canada. T h i s c o n t r o l c a n be d i m i n i s h e d to s o m e d e g r e e by the g o v e r n m e n t i f d i v i d e n d p o l i c y c o u l d be' r e.gu l a te d by p u b l i c p o l i c y ( s e e C h a p t e r V I I ) . ' I I . A M E R I C A N T R E N D S S t a t i s t i c s i n T a b l e A. II ( A p p e n d i x A) show a g g r e g a t e d i v i d e n d d a t a f o r the A m e r i c a n e c o n o m y . T a b l e s A . I and A. I I a r e not d i r e c t l y c o m p a r a b l e , but g e n e r a l l y the A m e r i c a n p a y o u t r a t i o has i n c r e a s e d m o r e t h a n the C a n a d i a n r a t i o i n r e c e n t y e a r s . Two r e a s o n s f o r t h i s h i g h e r g a i n a r e (1) a g r e a t e r p r o -p o r t i o n ' o f l a r g e and e s t a b l i s h e d f i r m s i n the U n i t e d 17 S t a t e s ; a n d ( 2 ) t h e l a c k of a c a p i t a l ' g a i n s t a x i n C a -n a d a ; c o n s e q u e n t l y , C a n a d i a n s s h o u l d h ave a g r e a t e r d e s i r e t h a n A m e r i c a n s f o r c a p i t a l g a i n s r a t h e r t h a n •, d i v i d e n d s . T h e c u r r e n t A m e r i c a n o u t l o o k i s f o r d e c r e a s i n g p a y o u t s and r a t i o s b e c a u s e of e x p e c t e d d e c l i n e s i n net e a r n i n g s , the T r e a s u r y ' s a c c e l e r a t e d t a x p a y m e n t p r o -g r a m , the l a r g e a m o u n t s - o f c a s h t i e d up i n the a c c u -m u l a t i n g i n v e n t o r y , and' the c o n t i n u i n g h i g h l e v e l of a c c o u n t s r e c e i v a b l e . " D i v i d e n d s a r e u n d e r p r e s s u r e f o r the f i r s t , t i m e s i n c e '19 5 8 . " ^  I I I . I N D U S T R Y P A T T E R N S T a b l e I I s h o w s the a v e r a g e 1.961 to 1965 r a t i o s of d i v i d e n d s on c o m m o n s h a r e s to e a r n i n g s a v a i l a b l e f o r s u c h d i v i d e n d s f o r n e a r - n c r m a l and a b o v e - n o r m a l . " •• 2 g r o w t h f i r m s i n c e r t a i n ' I n d u s t r y g r o u p i n g s . T h e t e x -t i l e , m e r c h a n d i s i n g , n o n - f e r r o u s m e t a l , and c h e m i c a l i " D i v i d e n d s F e e l the P r e s s u r e , " B u s i n e s s Week, M a r c h 18, 1967, p, 59. _ 2 A n e a r - n o r m a l g r o w t h f i r m has a r e c o r d o f a net p r o f i t i n at l e a s t f o u r of the f i v e y e a r s and a p o s i -t i v e t r e n d i n e a r n i n g s and s a l e s o v e r the f i v e y e a r p e r i o d . T h e i n c l u s i o n of d e c l i n i n g f i r m s i n the s a m p l e s w o u l d h a v e r a i s e d the r a t i o s b e c a u s e of d i v i d e n d s t a - ' b i l i t y and f a l l i n g p r o f i t s . 18 i n d u s t r i e s had the l o w e s t -payout; t r u s t c o m p a n i e s and gas and o i l p i p e l i n e f i r m s had the h i g h e s t . The f a c t o r s c a u s i n g i n t e r - i n d u s t r y d i f f e r e n c e s a r e d i s c u s s e d i n C h a p t e r s V and V I . • T A B L E II ' A V E R A G E P A Y O U T T O C O M M O N S H A R E H O L D E R S F R O M M A J O R C A N A D I A N - I N D U S T R I E S I N T H E P E R I O D 1961 TO 1965 I n d u s t r y S a m p l e s i z e A v e r a g e p e r c e n t a g e payout B e v e r a g e - 11 47 C h e m i c a l 12 38 F o o d s t u f f 28 < 46 F o r e s t p r o d u c t ' ..• 17- ; .' 49 Gas and o i l p i p e l i n e 10 55 M e r c h a n d i s i n g .17 36 N o n - f e r r o u s m e t a l ' 12 '- '•' 3 7 P u b l i c u t i l i t y 26 5 0 T e x t i l e . .• 16 . 3 0-T r u s t c o m p a n y 16 59 A l l i n d u s t r i e s 165 45 S o u r c e : The F i n a n c i a l P o s t C o r p o r a t i o n ' S e r v i c e , F i n a n c i a l S u m m a r y C a r d s , T o r o n t o , M a c L e a n - H u n t e r P u b l i s h i n g C o m p a n y , 19 6 6. • 9 T h e - f o l l o w i n g F i g u r e s and T a b l e s , w h i c h a r e i n A p p e n d i c e s B , C, and D , f u r t h e r d e s c r i b e , C a n a d i a n , i n d u s t r y pattern's'. 1. F i g u r e B . l i n A p p e n d i x , B s h o w s the d i s t r i -b u t i o n s of .1961 and 1965 p a y o u t r a t i o s f o r a . g r o w t h w e i g h t e d s a m p l e of 190 C a n a d i a n f i r m s as w e l l as d i s t r i b u t i o n s of w e i g h t e d a v e r a g e r a t i o s ( c r u d e a p p r o -x i m a t i o n s of the- t a r g e t p a y o u t r a t i o s ) f r o m the s a m e s a m p l e but f o r the' e n t i r e p e r i o d 1961 to 1965. T h e m e a n i s l o w e r t h a n the m o d a l c l a s s f o r a l l t h r e e s e t s of d a t a b e c a u s e of the l a r g e p r o p o r t i o n of C a n a d i a n f i r m s and i n d u s t r i e s . s t i l l i n the r e l a t i v e l y e a r l y s t a g e s of t h e i r : c y c l e s . T h o s e f i r m s t h a t w e r e f o r m e r l y i n a low r a t i o c a t e g o r y . and ' t h a t d i s p l a y ' e d ' h i g h e r p a y o u t s i n the l a t e r y e a r s d i d so b e c a u s e of a d e v e l o p i n g ma-t u r i t y . - a n d b e c a u s e 1961 to 19 65. was a p r o s p e r o u s p e r i o d . . - ; • ' •. . • . . .; , • 2. H i s t o g r a m s i n A p p e n d i x C show the d i s p e r -s i o n of the c o m p a n y t a r g e t ' p a y o u t r a t i o s w i t h i n c e r -t a i n m a j o r i n d u s t r i e s and a l s o the i n d u s t r y t r e n d s f r o m 1961 to 1965. T h e l e a s t n o r m a l d i s t r i b u t i o n s o c c u r r e d i n the c h e m i c a l , gas and o i l p i p e l i n e , and t e x t i l e i n d u s t r i e s . T h e f i v e - y e a r c h a n g e i n p a y o u t s was m o s t s i g n i f i c a n t i n the c h e m i c a l , f o o d , n o n -20 f e r r o u s m e t a l , p u b l i c u t i l i t y , and d u s t r i e s . ' 3 . T a b l e D . I i n A p p e n d i x D v i d e n d payou t r a t i o s f r o m 1951 to d i a n p u b l i c f i r m s w i t h i n d i f f e r e n t G e n e r a l l y , l a r g e r c o m p a n i e s p a i d t i v e to p r o f i t s . " t r u s t c o m p a n y i n -shows a v e r a g e d i -1962 f o r a l l C a n a -s i z e c a t e g o r i e s . m o r e d i v i d e n d s re l a C H A P T E R IV T H E O R E T I C A L A N D E M P I R I C A L C O N T R I B U T I O N S •I.-, D I V I D E N D D E C I S I O N I N P E R S P E C T I V E The p u r p o s e of t h i s s e c t i o n i s (1) to r e l a t e on a t h e o r e t i c a l b a s i s the d i v i d e n d d e c i s i o n to t h e . i n -v e s t m e n t a n d ' o t h e r f i n a n c i n g d e c i s i o n s and to the c o s t of c a p i t a l ; (2) to s t a t e e x t e n s i o n s of and oppo -s i t i o n to the t r a d i t i o n a l t h e o r y ; (3) to q u e s t i o n i t s r e l e v a n c e i n the r e a l w o r l d ; and (4) to s h o w . w h y . d i -v i d e n d s , m a t t e r by' the e x a m i n a t i o n of the p r o b l e m w i t h i n the c o n t e x t of t r a d i t i o n a l t h e o r y . F i n a n c i a l R e l a t i o n s h i p s i n T h e o r y A c c o r d i n g to t r a d i t i o n a l t h e o r y , f i r m s have an o p t i m u m c a p i t a l s t r u c t u r e - ( that i s , a 1 - m i n i m u m a v e r -age c o s t of c a p i t a l ) f r o m w h i c h an o p t i m u m d i v i d e n d p o l i c y can be d e r i v e d . 1 A d v o c a t e s o i the t h e o r y c l a i m that a c e r t a i n amount of debt does mot a f f ec t the m a r -ket c a p i t a l i z a t i o n r a t e a p p l i e d to the e q u i t y s h a r e of e a r n i n g s , so t h a t . o v e r a l l c o s t s a r e r e d u c e d by the 1 J". F . W e s t o n and E . F . B r i g h a m , M a n a g e r i a l F i n a n c e , New Y o r k , H o l t , R i n e h a r t and W i n s t o n , l n c . , i yb \6 , p~p. 4 7 4 - 4 7 6 . 22 i n c r e a s i n g of the p r o p o r t i o n of d e b t . B e y o n d a c e r -t a i n o p t i m u m debt e q u i t y r a t i o the a d d e d r i s k of b o t h , debt and e q u i t y r a i s e s the a v e r a g e c o s t . F i g u r e 2-A s h o w s the o p t i m u m c a p i t a l s t r u c t u r e (O) and the a v e r a g e c o s t of c a p i t a l ( A C C ^) f o r f i r m s a c q u i r i n g a f a i r l y l o w . l e v e l o f ' c a p i t a l ( t h a t i s , r e l i -a n c e on- r e t a i n e d e a r n i n g s , d e p r e c i a t i o n , and the a p p r o p r i a t e amount, of d e b t ) . A s the f i r m r e q u i r e s m o r e c a p i t a l and t h e r e f o r e m u s t r e l y to a g r e a t e r e x t e n t on t h e ' m o r e - e x p e n s i v e , o u t s i d e e q u i t y , the a v e r a g e cos.t of c a p i t a l w i l l r i s e . . S i n c e the m a r g i n a l c o s t of. c a p i t a l i n t e r s e c t s the ACC. c u r v e s at t h e - o p -t i m u m s t r u c t u r e , &• m a r g i n a l c o s t c u r v e ( M C C ) r e -p r e s e n t i n g ' the' m i n i m um p o i n t s on'-the A C C c u r v e s c a n be t r a c e d out ( a s i n F i g u r e 2-B) f o r d i f f e r e n t l e v e l s of c a p i t a l a c q u i s i t i o n . If the d e c l i n i n g m a r g i n a l e f - . f i c i e n e y o f ' c a p i t a l c u r v e s ( M E C ) r e p r e s e n t i n g v a r i o u s l e v e l s of i n v e s t m e n t o p p o r t u n i t y a r e s u p e r i m p o s e d on to F i g u r e 2-B, the i n t e r s e c t i o n of the m a r g i n a l r e t u r n and c o s t c u r v e s i n d i c a t e s the i n v e s t m e n t t h a t s h o u l d ; be u n d e r t a k e n ( T I o r T 2 o r T3) f o r the t o t a l a m o u n t of ' i n v e s t m e n t o p p o r t u n i t y a v a i l a b l e to the f i r m at a p a r t i -c u l a r t i m e . P a r t of t h i s a m o u n t r e p r e s e n t i n g i n v e s t -ment t h a t s h o u l d be u n d e r t a k e n g o e s to r e p l a c e w o r n out e q u i p m e n t and f a c i l i t i e s ( a p p r o x i m a t e d by d e p r e -c i a t i o n ) ; the r e s t s h o u l d go to new c a p i t a l i n v e s t m e n t ; 2 3 t h e ; p r o p o r t i o n of t h i s r e m a i n d e r t h a t i s f i n a n c e d by debt o r e q u i t y d e p e n d s on the o p t i m u m c a p i t a l s t r u c -t u r e t h a t i s to be m a i n t a i n e d ( F i g u r e 2-A). If the e q u i t y t h a t s h o u l d be i n v e s t e d i s g r e a t e r t h a n the y e a r ' s e a r n i n g s , t h e n the c o m p a n y s h o u l d not pay d i v i d e n d s b e c a u s e r e t a i n e d e a r n i n g s a r e the c h e a p e s t f o r m of e q u i t y . I f the e q u i t y t h a t s h o u l d be i n v e s t e d i s . l e s s t h a n the e a r n i n g s ,' the e x c e s s s h o u l d be p a i d as d i v i d e n d s . M C G A B L e g e n d k e = cost of equity capital k^ = cost of debt capital T - gross investment AGC = average cost of capital ' MCC = marginal cost of capital MEC = marginal efficiency of capital F I G U R E 2 D I V I D E N D D E C I S I O N I N T H E O R Y T h e f o l l o w i n g e x p l a n a t i o n . . A p p r o p r i a t e g r o s s , i n v e s t m e n t R e p l a c e m e n t c o s t ( a p p r o x i m a t e d . b y . d e p r e c i a t i o n ) -New i n v e s t m e n t O p t i m u m debt r a t i o New i n v e s t m e n t ' f i n a n c e d by debt • New i n v e s t m e n t f i n a n c e d by e q u i t y E a r n i n g s , . E a r n i n g s a v a i l a b l e f o r d i v i d e n d s P e r c e n t a g e p a y o u t e x a m p l e s u m m a r i z e s 1 • T3 = $15 m i l l i o n $15 m i l l i o n .10  $ 5 m i l l i o n . . • ' . 5 .$2.5 2.5 • 6 .' '-3.5 58 the p r e v i o u s T 1 = $25 m i l l i o n $25 m i l l i o n 10  $15 m i l l i o n .5 $7 . 5 7 . 5 6 0 . • 0 T h e a d v i c e . p u t f o r t h by, n u m e r o u s ' a c a d e m i c s on the d i v i d e n d d e c i s i o n i s b a s e d on the a b o v e r e l a t i o n s h i p . As' a p r a c t i c a l m a t t e r , h o w e v e r , we w o u l d s u g -g e s t t h a t f u n d s be r e t a i n e d o n l y i f i n t e r n a l o p p o r -t u n i t i e s o f f e r a c l e a r l y h i g h e r r a t e of r e t u r n , t h a n the m a r k e t c a p i t a l i z a t i o n r a t e f o r the f i r m as a who l e . . . . G.'D. Q u i r i n , T h e C a p i t a 1 E x p e n d i t u r e D e c i -s i o n , H o m e w o o d , I l l i n o i s . , R i c h a r d D. I r w i n , Inc . , I W 7 , p . 110 . 26 E x t e n s i o n s of the B a s i c T h e o r y on D i v i d e n d D e c i s i o n s S m i t h a p p l i e d the s a m e t h e o r e t i c a l r e l a t i o n s h i p as a b o v e to the e n t i r e e c o n o m y and t h u s r e a s o n e d t h a t the i n v e s t m e n t d e c i s i o n i s a p r i m e d e t e r m i n a n t of the d i v i d e n d d e c i s i o n . ^ • S o l o m o n u s e d the t h e o r y to d e r i v e the f o l l o w i n g p r a g m a t i c f o r m u l a t i o n . 4 T h e g r o s s v o l u m e of e x p e n d i -t u r e s (C) i s d e t e r m i n e d f r o m the c a p i t a l b u d g e t ; the r e q u i r e d r e i n v e s t m e n t to m a i n t a i n c a p i t a l a s s e t s i n -t a c t (M) and the n e t f u n d s a v a i l a b l e f o r new i n v e s t -m ent (Q) a r e ' d e r i v e d f r o m the o p e r a t i n g budget.- O p t i -m a l l e v e r a g e (L) i s a l s o n e c e s s a r y . W h e n . ( I - L ) ( C - M ) / (Q) , w h i c h i s the p o r t i o n of new i n v e s t m e n t t h a t s h o u l d be f i n a n c e d by e q u i t y , o v e r the n e t f u n d s a v a i l -a b l e , i s h i g h , a low d i v i d e n d i s i n d i c a t e d , and v i c e v e r s a . W i s e l y / S o l o m o n d i d not p r o c e e d f u r t h e r ; he d i d not c l a i m t h a t a s p e c i f i c pay ou't w o u l d fo l l o w f r o m h i s f o r m u l a t i o n . ^ • ': ' . R e a l W o r l d R e l e v a n c e T h e e n t i r e t h e o r e t i c a l a p p r o a c h d i s c u s s e d so f a r i n t h i s s e c t i o n i m p l i e s t h a t the d i v i d e n d , d e c i s i o n D. C. S m i t h , " C o r p o r a t e S a v i n g B e h a v i o u r , " T h e C a n a d i a n J o u r n a l of E c o n o m i c s and P o l i t i c a l S c T e n c e , v o l . X X I X ( A u g u s t 1 9 6 3 ) , p p ~ 3 0 1 - 3 U 2 . ' 4 E . S o l o m o n , Th e T h e o r y of. F i n a n c i a l M a n a g e - ment , New Y o r k , C o l u m b i a U n i v e r s i t y P r e s s , 1963, pp. 1 4 3 - 1 4 4 . 27 s h o u l d be s u b s e r v i e n t to the i n v e s t m e n t d e c i s i o n and n e g l e c t s b o t h the i m p a c t of the i n f o r m a t i o n a l c o n t e n t s of d i v i d e n d s ('see S e c t i o n I V of t h i s c h a p t e r ) i n the s h o r t - r u n and the c o n s e q u e n t i a l e f f e c t on many c o m m o n s h a r e h o l d e r s . F u r t h e r m o r e , the i m p l i c a t i o n of the s u g -g e s t e d a p p r o a c h i s the s a m e as t h a t of many of the m o d e r n e x p l a n a t o r y , v a l u a t i o n f o r m u l a e ; t h a t i s , the d i v i d e n d p a y o u t i s a f u n c t i o n of the o b j e c t i v e to m i n i -m i z e the f i r m ' s , o v e r a l l c o s t of c a p i t a l , o r c o n v e r s e l y , to m a x i m i z e the v a l u e of the f'ir.m: T h e o u t c o m e i n many c a s e s i s an i n d i c a t e d p a y o u t of. e i t h e r - 0 o r 100 p e r c e n t . O b s e r v a t i o n s h o w s t h a t i n p r a c t i c e t h e s e f i g u r e s are, not r e - ' a i i s t i c because- of-'the f o l l o w i n g r e a s o n s . • ' 1. U n c e r t a i n l y i s a s s o c i a t e d w i t h f u t u r e p r o -f i t a b i l i t y . -2'v T h e o v e r a l l c o n c e p t of the c o s t of c a p i t a l ' o r m a r k . e t c a p i t a l i z a t i o n r a t e i s d i f f i c u l t to i s o l a t e i n the r e a l w o r l d . 3. T h e s o c i a l w e l f a r e a r g u m e n t i s t h a t the m a r k e t s h o u l d d e c i d e on r e i n v e s t m e n t ' o f e a r n i n g s . 4". M a n y i n v e s t o r s p r e f e r d i v i d e n d s r a t h e r t h a n c a p i t a l , g a i n s i n s p i t e of ,a h i g h e r e x p e c t e d r e -t u r n ( a l l o w i n g f o r r i s k), a s s o c ia.t e d w i t h the l a t t e r . Some n e e d the s t e a d y i n c o m e ; t h e y may f i n d i t too' 28 d i f f i c u l t o r too c o s t l y to r e g u l a r l y s e l l i n a f l u c -t u a t i n g m a r k e t a f r a c t i o n of t h e i r h o l d i n g s ; t h e y may be s t u b b o r n , n a i v e , o r l a z y . 5. T h e r e s u l t s of C a n a d i a n and A m e r i c a n s t u d i e s ( s e e t h i s C h a p t e r . a n d C h a p t e r s V.and VI) s u g -g e s t t h a t b o t h the m a r k e t and the. d i r e c t o r s , i n g e n e r a l , p l a c e a g r e a t e r v a l u e on s t a b l e , g e n e r o u s d i v i d e n d s r a t h e r . t h a n on u n s t a b l e , s m a l l e r d i v i d e n d s . . A D i f f e r e n t A p p r o a c h P o r t e r f i e l d , i n 196.5', d e r i v e d an a l t e r n a t i v e t h e o r e t i c a l a p p r o a c h p r i m a r i l y b e c a u s e of the. i m p a c t of d i v i d e n d s ' o n c o m m u n i c a t i o n i n the s h o r t - r u n and b e c a u s e of c o n s e q u e n t c h a n g e s i n the c a p i t a l i z a t i o n r a t e and i n v e s t m e n t p l a n s . . H i s c r i t e r i o n was m a x i -m i z a t i o n of s h a r e h o l d e r s ' w e a l t h , a n d , i n o r d e r t h a t d i v i d e n d s t r a t e g y m i g h t a t t a i n t h i s g o a l , he s u g g e s t e d t h a t a c h a n g e i n d i v i d e n d s be c h o s e n to m a x i m i z e the s u m of the - m a r k e t p r i c e and c u r r e n t d i v i d e n d s . T h u s , h i s d i v i d e n d p o l i c y was s t a t e d as f o l l o w s : ... the f i r m s h o u l d d e c l a r e and pay a d i v i d e n d i f the r e s u l t i n g d e c l i n e i n m a r k e t p r i c e i s l e s s t h a n the a m o u n t of the d i v i d e n d p a i d . D J . T. S .' P o r t e r f i e l d , I n v e s t m e n t  and C a p i t a l C o s t s , E n g l e w o o d C 1 i f f s ', N . H~aTl, inc.. , 19 65 , pp. 85-104._ 6 I b i d . , p. 88, • De c i s i o n s J ~ ~ P T e n t i c e -2 9 ! U n d e r c o n d i t i o n s of c a p i t a l r a t i o n i n g , the p r o -j e c t s a n d the f u n d s o u r c e s w o u l d be r a n k e d by the p r o -j e c t e d c h a n g e s i n m a r k e t p r i c e p e r d o l l a r of f u n d s r e q u i r e d o r s u p p l i e d . T h e s e c h a n g e s w o u l d r e s u l t f r o m c h a n g e s i n the f u t u r e d i v i d e n d s t r e a m and ( o r ) c h a n g e s i n the. m a r k e t c a p i t a l i z a t i o n -rate r e s u l t i n g f r o m p r o -j e c t a c c e p t a n c e o r . f u n d u s e . T h e d e c i s i o n m a k e r w o u l d p r o c e e d - down the, l i s t u n t i l a c c e p t a n c e w o u l d h a v e un-d e s i r a b l e e f f e c t s - o n the. o w n e r s ' w e a l t h . A t e a c h s t e p , h o w e v e r , he w o u l d t e s t .w h e the r s o m e o r a l l of the f u n d s s h o u l d be d i v e r t e d , , to d i v i d e n d p a y m e n t s , s t i l l u s i n g the - c r i t e r i o n , o f e f f e c t on o w n e r s ' w e a l t h . Po.rte r f i e Id s t r e s s e d t h a t the m o r e c o m m o n t h e o -r e t i c a l a p p r o a c h ( s e e S e c t i o n I) i s i n a d e q u a t e b e c a u s e ... i t f a i l s to t a k e a d e q u a t e l y , i n t o a c c o u n t the i m p a c t . o n - t h e owners', w e a l t h of I h e f i r m ' s d e c i s i o n to inves't o r pay d i v i d e n d s . ' He a l s o e x p r e s s e d the o p i n i o n t h a t the i n t e r n a l , r a t e of r e t u r n as. a m e a s u r i n g d e v i c e ha.s.too many l i m i t a -t i o n s . H i s a p p r o a c h , t h e n , c o n s i d e r e d b o t h r i s k - a n d s h a r e h o l d e r s ' a t t i t u d e t o w a r d s r i s k f o r e a c h p r o j e c t and f u n d s o u r c e u n d e r c o n s i d e r a t i o n . I b i d . , p.. 100. 3 0 U n f o r t u n a t e l y , P o r t e r f i e l d d i d not s a y how a c h a n g e i n d i v i d e n d a f f e c t s the c a p i t a l i z a t i o n r a t e o r m a r k e t p r i c e a n d , m o r e s p e c i f i c a l l y , how the e f f e c t i s to be m e a s u r e d . N o r d i d h i s a n a l y s i s c o n s i d e r the r e s u l t i n g p r i c e , v a r i a t i o n s o v e r c h a n g i n g t i m e p e r i o d s . H i s c o n c e p t of d i v i d e n d p o l i c y a l t h o u g h t h e o r e t i c a l l y s o u n d is''too s i m p l e and .too n a i v e i n the r e a l w o r l d . D i v i d e n d s M a t t e r v i a the O p t i m u m . C a p i t a l S t r u c t u r e i T h e o r y If the M o d i g l i a n i and M i l l e r h y p o t h e s i s t h a t the c o s t of c a p i t a l i s i n d e p e n d e n t of l e v e r a g e e m p l o y e d i s a c c e p t e d , the o p t i m u m c a p i t a l s t r u c t u r e d e p i c t e d i n F i g u r e 2- would: riot e x i s t a n d , t a x e s a s i d e , the i n d i c a t e d p r o p o r t i o n s of debt and e q u i t y u s e d to f i n a n c e new i n -v e s t m e n t w o u l d b e m e a n i n g l e s s . C o n s e q u e n t l y , t h e r e c o u l d co n e i t h e r an. o p t i m u m r e s i d u a l a m o u n t of e a r -n i n g s a v a i l a b l e f o r d i v i d e n d s , n o r an o p t i m u m d i v i d e n d p o l i c y . Indeed', M o d i g l i a n i and M i l l e r s t a t e d i n t h e i r a r t i c l e t h a t . . . f o r p r e s e n t p u r p o s e s the d i v i s i o n of the s t r e a m b e t w e e n c a s h d i v i d e n d s and r e t a i n e d e a r -r, :.'nings i s a m e r e d e t a i l . a F . M o d i g l i a n i and M. H. M i l l e r , . "The C o s t of C a p i t . a l , C o r p o r a t i o n ' F i n a n c e and T h e T h e o r y of I n v e s t m e n t , " A m e r i c a n E c o n o m i c R e v i e w , v o l . X L V I I I ( J u n e 1 9 5 8 ) , p. 2ob. . 31 B i c k s l e r , who a r g u e d t h a t d i v i d e n d s . d o m a t t e r ( t h a t i s , t h a t an o p t i m u m d i v i d e n d p o l i c y d oes e x i s t ) , s t a t e d i n r e f e r e n c e to the M o d i g l i a n i and M i l l e r - a r -t i c l e t h a t ... the s t r o n g e s t c a s e f o r the i r r e l e v a n c e of d i v i d e n d ' p o l i c y , was made v i a a c o s t of c a p i t a l • a r g u m e n t ..... . B i c k s l e r t h e n r e s p o n d e d w i t h the f o l l o w i n g - l o g i c . He-p r o v e d t h a t the f u n d a m e n t a l and n e c e s s a r y c o n d i t i o n f o r the i r r e l e v a n c e ' of . d i v i d e n d p o l i c y i s the e x i s t e n c e of p e r f e c t , c a p i t a l m a r k e t s . - E v e n M o d i g l i a n i and M i l -l e r h a v e a d m i t t e d t h a t p e r f e c t c a p i t a l m a r k e t s a r e a n e c e s s a r y c o n d i t i o n f o r . t h e v a l i d i t y of t h e i r .cost of c a p i t a l h y p o t h e s i s . In 1 9 6 6 , t h e y d e c l a r e d : T h i s i n d e p e n d e n c e , of v a l u e a n d f i n a n c i a l ' s t r u c t u r e i s b a s i c a l l y a r e f l e c t i o n of the a s s u m p t i o n of p e r f e c t c a p i t a l m a r k e t s . ^ T h e r e f o r e , , i f t h e i r t h e o r e m i s not v a l i d a n d p e r f e c t c a p i t a l m a r k e t s do not e x i s t , ' d i v i d e n d p o l i c y m a t t e r s . Bic.ks le r.-.t-hen 1 pr'oc e e d e d t'o e x a m i n e the M o d i -g l i a n i M i l l e r h y p o t h e s i s i n the c o n t e x t of d e t e r m i n i n g 9 J . E. B i c k s l e r , E m p i r i c a l . T e_s ts- of C o mpa t i -b i l i t y of Se l e c t e d E q u i t y S h a r e P r i c e " E g u a t i o n s w i t h a Deis c r.i"ptive D i v i d e n d M o d e l , M e n 1 o P a r k , C a l i f o r n i a S t a n f o r d R e s e a r c h I n s t i t u t e , u n p u b l i s h e d , 1966, p. 2. 1 0 M . H. M i l l e r and F. M o d i g l i a n i , "Some E s t i -m a t e s of the C o s t 'of C a p i t a l to the E l e c t r i c U t i l i t y I n d u s t r y , 1-9 5 4 - 1 9 5 7 , " A m e r i c a n E c o n o m i c R e v i e w , v o l . L V I ( J u n e 1966),. p. 338 . ' " 32 the p r e s e n c e of p e r f e c t c a p i t a l m a r k e t s i n the r e a l w o r l d . He c i t e d the f o l l o w i n g f o r s u p p o r t : ^ . ( 1 ) - w r i t i n g s by'Du r a n d , B o d e n h o r n , and B a r g e s w h i c h c l a i m e d t h a t p e r s o n a l l e v e r a g e c o u l d not be s u b s t i t u t e d f o r c o r p o r a t e l e v e r a g e i n the a r b i t r a g e ' 12 p r o c e s s ; (2) h i s own c o m m e n t on the i l l o g i c a l b a s i s of • 1 3 the e q u i v a l e n t r e t u r n c l a s s ; (3) the s t a t e m e n t by S o l o m o n ' t h a t a h i g h l y l e v e r e d c o m p a n y , w i t h a c o n s e q u e n t r i s k y i n c o m e f r o m e q u i t y s h a r e s , has a h i g h e r v a l u a t i o n . p l a c e d on i t s s h a r e s ( T h i s p o i n t i s not c o m p a t i b l e w i t h ' t h e r a -t i o n a l b e h a v i o u r a s s u m p t i o n and t h e r e f o r e i s i l l u s -t r a t i v e 'of how l e v e r a g e c a n c h a n g e the c o s t of 11 B i c k s l e r , op. c i t . , pp. 6-43. A s u b s e q u e n t s t u d y , by W i p p e r n , g i v e s f u r t h e r s u p p o r t to B i c k s l e r ' s c o n t e n t i o n . W i p p e r n u s e d r e g r e s s i o n a n a l y s i s d e s i g n e d to o v e r c o m e p r e v i o u s .measureme.nt p r o b l e m s . See: R. F. W i p p e r n >•" F i n a n c i a l S t r u c t u r e and the V a l u e of the F i r m " J o u r n a l of F i n a n c e , v o l . X X I ( D e c e m b e r 1 9 6 6 ) , pp. 6 1 5 - 6 3 3 . .19 D. Duran.d, "The C o s t of C a p i t a l , . C o r p o r a -t i o n F i n a n c e , and the T h e o r y of I n v e s t m e n t : C o m m e n t , " A m e r i c a n E c o n o m i c Re v i e w , v o l . X L I X . ( S e p t e m b e r 1 9 5 9 ) , ~p~. b\4b; D ;' B o d e n h o r n~, " O n the P r o b l e m of, C a p i t a l B u d -g e t i n g , "• J o u r n a 1 of F i n a n c e , v o l . X I V ( D e c e m b e r ' 1959) , pp. 484- 485; A. B a r g e s , T h e E f f e c t of C a p i t a l S t r u c t u r e on the C o s t of C a p i t a l , E:ri~glewood C lTf f s , JN . T. , P r e n t i c e -H a l T T I i T c T T 1"B63, p.. 83. • B i c k s l e r , o p. c i t . , p. 19. 3 3 . 1 4 -c a p i t a l . ) ; C4) the r e m a r k s by W e s t o n and S o l o m o n on-the l i m i t e d r ange i n the l e v e r a g e r a t i o s , of c o m p a n i e s u sed i n the M o d i g l i a n i and M i l l e r t e s t s ; - ^ (5) the o b s e r v a t i o n b y - W e s t o n that d i f f e r e n t de -f i n i t i o n s of l e v e r a g e were used i n the, t e s t i n g of each p r o p o s i t i o n ; - ^ - ' ' ' (6) the s t a t i s t i c a l r e s u l t s o b t a i n e d by P u r a n d , We s ton ,, Ne i l s on , and • B a r g e s , w h i c h -are c o n t r a r y to the M o d i g l i a n i and M i l l e r t h e o r e m ; ^ (7) the s t a t i s t i c a l b i a s e s no ted by B a r g e s and o t h e r s . ^ 14 E.. S o l o m o n , " L e v e r a g e and the C o s t of C a p i -t a l , " J o u r n a l of F i n a n c e , v o l . X V I I I ( M a y 1963) , pp . 2 7 6-2 7UT ~ ~ - --*-5j. F . W e s t o n , "The M a n a g e m e n t of . C o r p o r a t e C a p i t a l : A R e v i e w A r t i c l e , " The J o u r n a l o f B u s i n e s s , v o l . X X X I V ( A p r i l 1 9 6 1 ) , p . T3~5;. S o l o m o n , T h e o r y of F i n a n c i a l M a n a g e m e n t , p .. 4 0 9 . 1 - • ' ' ' ' • -W e s t o n , "The M a n a g e m e n t of C o r p o r a t e C a -p i t a l : A ' - 'Rev iew A r t i c l e , " p . 136. 1 7 D u r a n d , op,, c i t . , p p . 649- 653; J . F . W e s t o n , " A T e s t of C o s t ' oFT! ap"TTal P r o p o s i t i o n s , " S o u t h e r n  E c o n o m i c J o u r n a 1 , v o l . 13 ( O c t o b e r 1963) ~ pp." 1"0"7 - 110; . S7 IN e i 1 s o n , M a r k" e t V a l u e and F i n a n c i a l S t r u c t u r e i n the  R a i l r o a d IndusTr y , T he T r a v e l le r s i n s u r a n c e C o . , O c c a -s i o n a l P a p e r N o . 4, M a r c h 1 9 6 1 , p p . 1 3 - 1 4 ; B a r g e s , op . c i t. , pp. 4-0-7 6'. ' • 1 8 I b i d . , p . 4 0 . 34 B i c k s l e r c o n c l u d e d t h a t the c h a l l e n g e d t h e o r y i s i n -v a l i d i n the r e a l w o r l d and t h e r e f o r e t h a t d i v i d e n d p o l i c y does m a t t e r . ; I I . E A R N I N G S V E R S U S D I V I D E N D S T h e o r y One of the" old'est d e b a t e s , i n the s e c u r i t y v a -l u a t i o n f i e l d i s , c o n c e r n e d w i t h w h e t h e r i n v e s t o r s c a -p i t a l i z e e a r n i n g s o r d i v i d e n d s . T h e c o n f l i c t c o n s i d e r e d i n t h i s S e c t i o n i s the v a l u a t i o n of u n l e v e r e d e q u i t y ; the c o n f l i c t c o n c e r n i n g l e v e r a g e . w a s e x a m i n e d i n the p r e v i o u s . s e c t i o n . , . ' . • In the h i s t o r y of v a l u a t i o n ,• one g r o u p of a u -t h o r s , the p u r e e a r n i n g s t h e o r i s t s , m a i n t a i n e d t h a t s t o c k v a l u e s w e r e a f u n c t i o n of c o r p o r a t e e a r n i n g s , i n -d e p e n d e n t of d i v i d e n d s . O t h e r s h a v e b a s e d t h e i r a n a -l y s e s of s t o c k p r i c e s and t h u s i n v e s t o r s 1 p r e f e r e n c e s on the a s s u m p t i o n t h a t v a l u a t i o n s e q u a l the p r e s e n t v a l u e s of d i v i d e n d s t r e a m s . I n d e e d , s o m e of the e a r l i e r a u -t h o r s on'the. v a l u a t i o n - o f e q u i t i e s b a s e d t h e i r a n a l y s e s % e n t i r e l y on d i v i d e n d s : U n i t i n g the d i v i d e n d g r o u p . W i l l i a m ' s ,. f o r e x - ' • 1 9 a m p l e , h y p o t h e s i z e d : J.. B . W i l l i a m s , T h e T h e o r y of I n v e s t m e n t V a l u e , C a m b r i d g e , H a r v a rcl U n i v e r s i t y P r e s s , 1 y 3 8 , • pp. 5 5 - 7 0 . 35 ( i ) v -_ V D ( t )  0 > ( T T i F t = I W h e r e : V 0 = p r e s e n t s h a r e p r i c e = d i v i d e n d at end of y e a r i- _ i n t e r e s t r a t e s o u g h t by. i n v e s to r s H i s s i m p l e m o d e l was e x p a n d e d to m a k e a l l o w -a n c e f o r a r e g u l a r growth f a c t o r . (2) v 0 = D o g y l ; + " D 0 . ^ + g ) 2 + - . . Dp a + g ) ^ (1+ D 1 (14- i ) 2 ( 1 + i ) 0 0 .......5 W h e r e : D 0= p r e s e n t d i v i d e n d ' p a y m e n t g = r a t e of g r o w t h i n d i v i d e n d : . ' D (1-f- g)*; = d i v i d e n d p a y m e n t i n y e a r t T h i s s i m p l i f i e d t o : (3) V 0 = £o i - g • ' 2 0 T h i s i s the s a m e as the b a s i c m o d e l u s e d by G o r d o n . . (4) V z (1 - b) v W h e r e : 0 k - -rb 0 r = r e t u r n on i n v e s t m e n t b ' : p r o p o r t i o n of e a r n i n g s r e t a i n e d g = r b i = k Y 0 ' = p r e s e n t e a r n i n g s 2 0 ' ' M. J . G o r d o n , T h e I n v e s tm e n t , F i n a n c i n g and  V a l u a t i o n of the C o r p o r a t i o n ,. Home woo d , I l l i n o i s , R i -c h a r d D. I r w i n , i n c . , 1 y 62, p. 45, m o d e l 4.6. . ' ' ' 3 6 T h i s m o d e l a s s u m e s no d e b t , no o u t s i d e e q u i t y f i -n a n c i n g , k g r e a t e r t h a n r b , r and b c o n s t a n t to i n -f i n i t y , and a q u i c k r a t i o of one. E q u a t i o n (2) was e a s i l y m o d i f i e d to m a k e an a l l o w a n c e f o r d i f f e r e n t g r o w t h r a t e s i n d i f f e r e n t " p e r i o d s . ' . • . _ N • • • D 0 ; ( l + g _ i ) t ^ D N ( l + g - ) 1 ( 5 ) V - \ -* -h > r— Z _ (1 + i ) Z _ _ (1 H - i ) 1 t, = 1 ' t = N - h l ' Whe r e : . -g, z h i g h g r o w t h r a t e ( f o r e x a m p l e , 20 p e r • c e n t f o r N.;years) ".g =; n o r m a l g r o w t h r a t e ( f o r e x a m p l e , 5 p e r n c e n t a f t e r N ' y e a r s ) T h u s , s t o c k p r i c e s a r e : not i n d e p e n d e n t of e a r -n i n g s and c a p i t a l budge ts ,.. s i n c e r e t a i n e d e a r n i n g s and c o m p a n y i n v e s t m e n t s a r e c o n s i d e r e d m a j o r ' f a c -t o r s - i n the p r o s p e c t i v e - g r o w t h of the d i v i d e n d s t r e a m . T h e r e m a i n i n g c o n f l i c t l i e s - b e t w e e n those- who, a d v o -cate' the p u r e e a r n i n g s t h e o r y and t h o s e , the d i v i d e n d t h e o r y . T h e l a t t e r g r o u p s u g g e s t s t h a t -the e a r n i n g s and i n v e s t m e n t s ' h ave an i m p a c t on the s t r e a m of - d i -v i d e n d s . b u t t h a t - d i f f e r e n t d i v i d e n d s and p a y o u t r a t i o s , make a d i f f e r e n c e i n e q u i t y v a l u a t i o n . . D i v i d e n d s r a t h e r t h a n e a r n i n g s . W e s t o n and B r i g h a m a r g u e f o r the d i v i d e n d a d v o c a t e s by r e f e r -r i n g to a f i r m t h a t p a i d no d i v i d e n d s i n the i m m e d i a t e 37' ' p a s t : ". . . by r e t a i n i n g e a r n i n g s it. i s b u i l d i n g up i t s e a r n i n g b a s e and . . . at s o m e p o i n t i n t i m e i n v e s t o r ^ e x p e c t the f i r m to b e g i n to pay d i v i -d e n d s . " ^ 1 A s B o d e n h o r n , and R o b i c h e k and M y e r s h a v e i n d i - ' ' c a t e d , d i s c o u n t i n g tHe s t o c k ' s s h a r e , of f u t u r e e a r n i n g s 2 2 i n v o l v e s d o u b l e c o u n t i n g . A c t u a l in.come i n any f u -t u r e p e r i o d i s l i k e l y to be p a r t of the e a r n i n g s r e i n -v e s t e d i n a.-.-previous, p e r i o d . A d j u s t m e n t of t h i s d o u b l e c o u n t i n g l e a d s b a c k to the d i v i d e n d a p p r o a c h . M o r e r e c e n t a d v o c a t e s ' , of the pure, e a r n i n g s g r o u p haver c l a i m e d t h a t the d i v i d e n d v e r s u s ' e a r n i n g s a r g u m e n t i s e s s e n t i a l l y a s t e r i l e one. T h u s M i l l e r and M o d i g l i a n i showed u n d e r h i g h l y a b s t r a c t e d c o n d i -t i o n s ( p e r f e c t c e r t a i n t y , . p e r f e c t m a r k e t s , and r a -t i o n a l i n v e s t o r s ) - t h a t f o u r m a j o r v a l u a t i o n a p p r o a c h e s , ( e a r n i n g s s t r e a m , d i v i d e n d s s t r e a m , i n v e s t m e n t op-p o r t u n i t i e s , and n e t c a s h f l o w ) r e d u c e to the s a m e f o r m u l a , and hence' the a m o u n t of d i v i d e n d p a y o u t 2 3 m a k e s no d i f f e r e n c e . 21 W e s t o n and B r i g h a m , M a n a g e r i a l F i n a n e e , p. 298. 2 2 - ' • B o d e n h o r n , op. c i t . , p. 473; A. A. R o b i c h e k and S. C. M y e r s , Opt i m a r~"F i nan c i n g D e c i s i o n s , New Y o r k , P r e n t i c e ' - Ha 1-1 , Inc . ., 1 y 6 b , p. b 8 . 2 3 1 • • ' M.H. M i l l e r a n d F . M o d i g l i a n i , " D i v i d e n d P o l i c y , G r o w t h , and the V a l u a t i o n of S h a r e s , " J o u r - n a l of B u s i n e s s , v o l . X X X I V ( O c t o b e r 1961) p. 4 1 7 , m o d e l 9"! " • • . . 3 8 o o (6) V, o x (t) - i (tTj W h e r e : p — c a p i t a l i z a t i o n r a t e ( e x p e c t e d y i e l d , d i v i d e n d s a n d g a i n , on co. mm on '. . . • s t o c k ) • X (t) : i n c o m e , y e a r t I (t) z i n v e s t m e n t , y e a r t S o l o m o n ' a l s o c l a i m e d the i s s u e , i s an e m p t y one. He i l l u s t r a t e d , t h i s by d e r i v i n g two. s i m p l e growth., v a l u a t i o n m o d e l s ( s i m p l e g r o w t h r e f e r s to-the f i r m r e i n v e s t i n g a c o n s t a n t d o l l a r a m o u n t ) , the f i r s t i n t e r m s - of d i v i d e n d s and c a p i t a l g a i n s and the s e c o n d i n t e r m s of e a r n i n g s . H i s a s s u - m p t i o n s we re no debt 'and no o u t s i d e e q u i t y f i n a n c i n g . In t e r m s of d i -v i d e n d s and c a p i t a l g a i n s : ^ (7) V =.J2. _|_ E h m • W h e r e : V - f i r m ' s m a r k e t v a l u e k e k e D - d i v i d e n d i n i n i t i a l p e r i o d . E = net o p e r a t i n g i n c o m e b : p r o p o r t i o n of e a r n i n g s r e t a i n e d . k g = e x p e c t e d y i e l d on c o m m o n - s t o c k r = r e t u r n on I n v e s t m e n t m = r / k , w h e r e r > k 24 •'. S o l o m o n , T h e o r y of F i n a n e i a 1 M a n a g e m e n t , p. 60, m o d e l 5 - 5 . 3 9 In t e r m s of e a r n i n g s : (8) V - _5 , b E ( m - 1 1 k e k e • ' S o l o m o n c o n c l u d e d t h a t b e c a u s e the two m o d e l s c o u l d be made e q u i v a l e n t , v a l u a t i o n c a n be e x p r e s s e d i n t e r m s of d i v i d e n d s o r e a r n i n g s . H o w e v e r , h i s s e c o n d m o d e l c l e a . r l y d o e s not I n v o l v e , a pure..,earnings s t r e a m L i n t n e r c e n t r e d on the p r o b l e m In a t h e o r e t i c a l and p u i s s a n t a r t i c l e : and c o n c l u d e d , a f t e r b e g i n n i n g h i s a n a l y s i s u n d e r ' i d e a l i z e d ' n e o - c l a s s i c a l c o n d i t i o n s and r e l a x i n g a s s u m p t i o n s one by o n e , t h a t : T h e " d i v i d . e n d t h e o r y " ' . . . r e m a i n s v a l i d e v e n , und e r ' f u l l y . gene r a l i z e d c o n d i t i o n s a n d s h o u l d be the b a s i s f o r f u r t h e r t h e o r e t i c a l w o r k . The s o -c a l l e d e a r n i n g s t h e o r y i s v a l i d i f and o n l y i f i t i s s t a t e d i n f o r m s i d e n t i c a l l y r e d u c i b l e to the \ v a l u a t i o n of the c a s h d i v i d e n d f l o w to the i n v e s t o r . . In p a r t i c u l a r , the s i g n i f i c a n c e of the t i m e v e c t o r s of e a r n i n g s (and of c o m p a n y i n v e s t m e n t s ) l i e s i n i t s i m p l i c a t i o n s f o r the p r o s p e c t i v e s t r e a m of d i -v i d e n d s , r a t h e r tha.n v i c e v e r s a . " O t h e r m o d e l s and t h e i r i m p l i c a t i o n s . T h e So-l o m o n s i m p l e g r o w t h mo-de 1 i s • i d e n t i c a l to an e x p l a n a -2 7 t o r y m o d e l p r e p a r e d by W a l t e r v i n 1956. H i s f u n d a -m e n t a l p r e m i s e was t h a t s t o c k p r i c e s r e f l e c t the l b i d . , p. 60, m o d e l 5 - 6. 2 6 J o h n L i n t n e r , " D i v i d e n d s , E a r n i n g s , L e v e r -a g e , S t o c k P r i c e s and the S u p p l y of C a p i t a l to C o r p o r a t i o n s , " . R e v i e w of E c o n o m i c s and S t a t i t i c s , vol.. X'LIV ( A u g u s t i y 62) , p. "ZWtT. ~ ~ : 2 7 J a m e s E. W a l t e r , " D i v i d e n d P o l i c i e s and Com mon S t o c k P r i c e s , " T h e J o u r n a l of F i n a n c e , v o l . X I ( M a r c h 1 9 5 6 ) , p. 283, "mo d e l l , ~ . 40 p r e s e n t v a l u e s of e x p e c t e d d i v i d e n d s and that r e -t a i n e d e a r n i n g s i n f l u e n c e t h i s v a l u e p r i n c i p a l l y t h r o u g h t h e i r e f fec t on the g r o w t h of d i v i d e n d s . R a D + R~7 (E - D) (9) V =  R.„ W h e r e : R a = r a t e of r e t u r n on a d d i t i o n a l i n v e s t m e n t R c = m a r k e t c a p i t a l i z a t i o n a d j u s t e d to 100 pe r cen t payout D = c a s h d i v i d e n d s p e r s h a r e E - e a r n i n g s pe r s h a r e When R a i s g r e a t e r than Rn , m o r e we igh t i s p l a c e d on r e t a i n e d e a r n i n g s i n i t s e f f ec t on v a l u e ; hence a d e c r e a s e i n the d i v i d e n d , g i v e n c o n s t a n t e a r n i n g s , w i l l i n c r e a s e the v a l u e of the s h a r e . T h u s , a c c o r d i n g to these m o d e l s , f i r m s w i t h h i g h p r o f i t -a b i l i t y s h o u l d r e t a i n t h e i r e a r n i n g s , and v i c e v e r s a . When R a e q u a l s Rr, d i v i d e n d p o l i c y has no e f f ec t on s h a r e p r i c e . 41 A n e x a m p l e : D i v i d e n d V a l u a t i o n w h e r e : V a l u a t i o n whe r e : R a = . 12 . R a = .06 R c = • 06 R c = .06 E - $3 E = $ 3 $3 $50.00 $50.00 2 66.66 50.00 1 . 8 3 . 8 3 50.00 0 100.00 50.00 If r e t a i n e d e a r n i n g s and s u b s e q u e n t i n v e s t m e n t s a r e i n c r e a s e d and i n v e s t m e n t o p p o r t u n i t i e s do not c h a n g e , t h e n the r e t u r n on a d d i t i o n a l i n v e s t m e n t , R 9 , w o u l d t e n d to f a l l b e c a u s e of the d e c l i n i n g m a r g i n a l e f f i c i e n c y of c a p i t a l . A n y a n t i c i p a t i o n of s u c h a f a l l w o u l d a f f e c t s t o c k v a l u e s . S i m i l a r l y , as d i v i d e n d s c h a n g e d i n the p r e s e n c e of i r r a t i o n a l i n v e s t o r s , the m a r k e t c a p i t a l i z a t i o n r a t e w o u l d a l s o be e x p e c t e d to c h a n g e ( W a l t e r s had c a r e f u l l y d e f i n e d the m a r k e t c a -p i t a l i z a t i o n r a t e as a d j u s t e d to 100 p e r c e n t p a y o u t ) . T h u s u n d e r r e a l w o r l d c o n d i t i o n s , the i m p l i c a t i o n s of t h e s e m o d e l s a r e not d e f i n i t e a n d c l e a r l y d e p e n d on the r e a c t i o n s and p r e f e r e n c e s of the s h a r e h o l d e r s and the n a t u r e of i n v e s t m e n t o p p o r t u n i t i e s . 42 " S o l o m o n - . f o r m u l a t e d a n o t h e r m o d e l , i n . t e r m s of d y n a m i c g r o w t h , w h e r e a f i r m r e i n v e s t s an i n -c r e a s i n g a m o u n t . ^ C I O ) V = f - - f V b m e T h i s i s . e q u i v a l e n t to the G o r d o n m o d e l . T h e s e dy-n a m i c m o d e l s ' o f v a l u a t i o n i n d i c a t e the s a m e d i v i d e n d p o l i c y as the W a l t e r m o d e l ; t h a t i s , as l o n g as r e -t u r n on i n v e s ' t m e n t i s g r e a t e r t h a n the r e t u r n the s t o c k h o l d e r s e x p e c t , a. lower ' d i v i d e n d - w i l l r e s u l t i n a h i g h e r c o m m o n s t o c k . v a l u e . In- g e n e r a l , the t h e o r e t i c a l e m p h a s i s i n r e c e n t y e a r s has b e e n away f r o m the p u r e e a r n i n g s t h e o r y and towards the d i v i d e n d a p p r o a c h , i n c l u s i v e , of r e -t a i n e d e a r n i n g s as a m a j o r , d e t e r m i n a n t of the p r o s -p e c t i v e - g r o w t h - o f the ' d i v i d e n d s . Tn s p i t e of v a r y i n g c l a i m s a m o n g t h e o r i s t s m o s t of the m o d e l s a r e e q u i -v a l e n t . E m p i r i c a l R e s u l t s G r a h a m et a l . , B u r r e 1 ( 1952) . A s a r e s u l t of e a r l i e r s u g g e s t i o n s , G r a h a m , D o d d , and C o t t l e f o r -m u l a t e d a s i m p l e r u l e of th u m b based'- on o b s e r v a t i o n S o l o m o n , T h e o r y p. 70, m o d e l 5' - 7 . of F i n a n c i a l M a n a g e m e n t , . 4 3 and e x p e r i e n c e t h a t d i v i d e n d s s h o u l d be w o r t h f o u r ' 9 9 t i m e s r e t a i n e d e a r n i n g s i n v a l u a t i o n . In 195 2, B u r r e l l t e s t e d - and u p h e l d t h e i r s u g g e s t i o n w i t h a s t u d y of p a i r e d s t o c k s . ^ 0 L a t e r ( 1 9 6 2 ) , . G r a h a m , D o d d , and C o t t l e r e s t r i c t e d t h e i r f o r m u l a to below-3 1 a v e r a g e and r a i l w a y s t o c k s to h a r m o n i z e w i t h i n -v e s t o r s . ' c h a n g i n g a t t i t u d e s and s u g g e s t e d t h a t i n the c a s e o f . g r o w t h s t o c k s o n l y e a r n i n g s s h o u l d be c o n - ' 3 2 s i d e r e d . . . '29 B. G r a h a m , D. D o dd and S. C o t t l e / - S e c u r i t y A n a l y s i s , New Y o r k , M c G r a w - H i l l B o o k C o m p a n y , 19 5 1, p. 4 5 4•. 3 0 ' O'. K.. B a r r e l , " D i v i d e n d s v e r s u s R e t a i n e d E a r n i n g s as a M a r k e t F o r c e , " T h e C o m m e r c i a l and F i n a n c i a l C h r o n i c l e , v o l . 176 (7Tugust 2 i ,- I 9 b 2 ) , p p ~ T 7 ^ 9 - 3 0 . '— ~ 3 1 G r a h a m , D o d d , and C o t t l e , S e c u r i t y A n a l y s i s , M c G r a w - H i l l B o o k C o m p a n y , 19 62, p~ 5 16, d e f i n e d b e l o w - a v e r a g e s t o c k s as ... t h o s e , s t o c k s w h i c h -have (a) s o l d f o r s o m e r e c e n t p e r i o d of t i m e , s u c h as the a v e r a g e of the l a s t f i v e y e a r s , at l e s s t h a n a p p r o x i m a t e l y \\ t i m e s ' t h e i r b o o k v a l u e and (b) e a r n e d , a r e t u r n on b o o k v a l u e f o r the s a m e p e r i o d b e l o w t h a t f o r , s a y , S t a n d a r d and P o o r ' s 425 i n d u s t r i a l s t o c k s . . 3 2 I b i d . , pp .. 5 17- 5 18 . • 44 H a r k a v y (1953) . H a r k a v y ,• to r e c o n c i l e the p r e -v a i l i n g . ' o p i n i o n a m o n g the f i s c a l t h e o r i s t s w i t h t h a t o f the s e c u r i t y a n a l y s t s , c o n s i d e r e d the i n s t a n t a n e o u s v e r s u s the l o n g - r u n i m p a c t of d i v i d e n d s on s h a r e v a -3 3 l u e . H a r k a v y c o n c l u d e d t h a t at a g i v e n t i m e , p r i c e s v a r i e d d i r e c t l y w i t h d i v i d e n d s but o v e r a p e r i o d of t i m e the. p o s i t i v e r e l a t i o n s h i p e x i s t e d b e t w e e n r e -t a i n e d e a r n i n g s a n d p r i c e . H i s c o n c l u s i o n was p e r -h a p s . o v e r g e n e r a l i z e d on t h e : b a s i s of h i s s t a t i s t i c a l m e t h o d s and r e s u l t s , the s i z e of h i s . s a m p l e , and the i n f l u e n c e of g r o w t h on h i s r e s u l t s . . B u r r e 1 (.1957). A f t e r p a i r i n g e i g h t y s t o c k s f r o m two g r o w t h m u t u a l f u n d s , B u r r e l c o n c l u d e d t h a t d i v i -d e n d s a r e m o s t i m p o r t a n t i i i i n f l u e n c i n g the m a r k e t v a l u e of c o m m o n s h a r e s e v e n i n the c a s e of g r o w t h , and t h a t a p p a r e n t l y " I n v e s t o r s do not rega.rd r e t a i n e d e a r n i n g s as e q u i v a l e n t to m o n e y d e p o s i t e d a t ' a h i g h . e a r -n i n g ' r a t e. "3 4 G o r d o n ( 1962) . G o r d o n , a f t e r e x a m i n i n g the e f f e c t of s e v e n v a r i a b l e s i n c l u d i n g d i v i d e n d s , r i s k 3 3 H a r k a v y , ojo . ci__t. , p a s s i m . 3 4 B u r r e i , " R e l a t i v e V.alue of E a r n i n g s : R e -t a i n e d , and D i s t r i b u t e d , " p p . . 28-2 9. 45 c l a s s , and g r o w t h on the v a l u a t i o n of s h a r e s by r e -g r e s s i o n a n a l y s i s on f o r t y - e i g h t f i r m s i n the f o o d i n d u s t r y ,' c o n c l u d e d t h a t d i v i d e n d s w e r e of s i g n i f i -3 5 c a n t i m p o r t a n c e i n t h e i r e f f e c t on s h a r e e v a l u a t i o n . I n d e e d , the- i n f l u e n c e of d i v i d e n d s was g r e a t e r t h a n a l l o t h e r f a c t o r s c o m b i n e d . A s W e s t o n has p o i n t e d o u t , G o r d o n ' s p r o c e d u r e was i n v a l i d ; B y m e a s u r i n g g r o w t h as e a r n i n g s l e s s d i v i d e n d s o v e r net w o r t h , the i n f l u e n c e of d i v i d e n d s was h i g h l y e x a g g e r a t e d . ^ 6 F i s h e r ( 1 9 6 3 ) . F i s h e r . e x a m i n e d the e f f e c t s of f o u r v a r i a b l e s on s h a r e p r i c e s p r e v a i l i n g Im.t he r i i a r -' 3 7 k e t i n E n g l a n d f o r the y e a r s 1949 to 1957. . T h e s e w e r e : (1) l a s t d e c l a r e d d i v i d e n d . p e r s h a r e ; (2) l a s t d e c l a r e d u n d i s t r i b u t e d p r o f i t s p e r s h a r e ; - . -(3) p a s t a v e r a g e a n n u a l g r o w t h i n d i v i d e n d s p e r s h a r e ; (4) s i z e of c o m p a n y : 3 5 G o r d o n , I n v e s t m e n t , F i n a n c e , and V a l u a t i o n of the C o r p o r a t i o n , ~ p p ~ ! HT2- 145 , 181- 1 ST7 3 6 • J . F . W e s t o n , ' " R e v i e w , " T h e J o u r n a l of  F i n a n c e , v o l . X V I I I ( S e p t e m b e r 19 BUTT p. 580. 3 7 G. R. . F i s h e r , "Some F a c t o r s I n f l u e n c i n g S h a r e P r i c e s , " E c o n o m i c J o u r n a l , v o l . L X X I ( M a r c h 1 9 6 1 ) , pp. 121- ITT. ~ . 4 6 In s p i t e of the f a c t t h a t he d o u b t e d the s t a t i s t i c a l v a l i d i t y of h i s r e g r e s s i o n a n a l y s i s , he c o n c l u d e d t h a t i n a l l c a s e s (1) had by f a r the l a r g e s t i m p a c t , (2) and (4) had s o m e i n f l u e n c e i n t h a t o r d e r of i m -p o r t a n c e , and (3) had no s i g n i f i c a n c e . A s h l e y , B a r k e r , S o g a n i c h . S t u d i e s by A s h l e y , B a r k e r , and' S o g a n i c h * p o i n t to. the i m p o r t a n c e of d i -v i d e n d s , i n the s h o r t - r u n ( s e e S e c t i o n IV r.of t h i s O f f , ' c h a p t e r ) . -t F r i e n d and P u c k e t t ( 1 9 6 4 ) . A r e c e n t and h i g h l y r e f i n e d s t u d y by F r i e n d a.nd P u c k e t t c l a i m e d to. h ave o v e r c o m e .many.: of t h e s t a t i s t i c a l bias.es i n h e r e n t i n p r e v i o u s e f f o r t s to i s o l a t e the e f f e c t of d i v i d e n d s on s h a r e , p r i c e . ' A f t e r r u n n i n g c r o s s - s e c t i o n a l , r e g r e s -s i o n a n a l y s i s f o r f i v e i n d u s t r i e s f o r the y e a r s 1956 , J . W. A s h l e y , " S t o c k . P r i c e s and C h a n g e s i n E a r n i n g s and D i v i d e n d s , - 'Some E m p i r i c a l R e s u l t s , " J o u r n a l of P o l i t i c a l E c o n o m y , v o l . L X X ( F e b r u a r y ' 19 6 2 ) , pp. 8~2-85; TJ. A u s t i n B a r k e r , " E f f e c t i v e S t o c k S p l i t s , " H a r v a r d B u s i n e s s R e v i e w , v o l . 34 ( J a n u a r y - . F e b ' r u a r y 1 9 5 6 ) , pp~i 10 1 - 10~6 ; C . A u s t i n B a r k e r , " E v a l u a t i o n of S t o c k D i v i d e n d s , " H a r v a r d B u s i n e s s R e v i e w , v o l . 36 ( J u l y - A u g u s t 19581, pp. 99-I14;M2. A u s t i n B a r k e r , " S t o c k S p l i t s i n a B u l l M a r k e t , " H a r -v a r d B u s i n e s s Re v i e w , v o l . 3 5 ( M a y - J u n e 19.57), pp. 72-79; J.. Soganich, " P r i c e s and D i v i d e n d s : s o m e a n a m o l i e s s h o w , " T h e F i n a n c i a l P o s t , A p r i l T, 1967, p. 1. 47 and 1958 they, s t a t e d : T h e r e i s some i n d i c a t i o n that i n the non g r o w t h i n d u s t r i e s . . . h i g h e r i n v e s t o r v a l u a t i o n may be p l a c e d on d i v i d e n d s than on r e t a i n e d e a r n i n g s w i t h i n the r ange of payout e x p e r i e n c e d , but that the o p p o -s i t e may be t r u e i n g r o w t h i n d u s t r i e s . To the e x -tent that t h i s c o n c l u s i o n i s v a l i d , i t i s p o s s i b l e that m a n a g e m e n t m i g h t be a b l e , at l e a s t i n some m e a s u r e , to i n c r e a s e s t o c k p r i c e s i n non g r o w t h i n d u s t r i e s by r a i s i n g d i v i d e n d s , and i n g r o w t h i n -d u s t r i e s by g r e a t e r r e t e n t i o n . H o w e v e r , the e v i -dence . . . i s r a t h e r t enuous and t h e r e i s no c o n -v i n c i n g i n d i c a t i o n of w i d e s p r e a d m a n a g e m e n t i r r a -t i o n a l i t y o r i r r e s p o n s i b i l i t y i n payout p o l i c y . ^ F u r t h e r , they a d m i t t e d that t h e i r a n a l y s i s was l i m i t e d i n i n d u s t r y c o v e r a g e , t i m e p e r i o d , and l i n e a r i t y a s -s u m e d . T h e i r r e s u l t s do not r e a l l y a n s w e r one of t h e i r o r i g i n a l o b j e c t i v e s , n a m e l y , to i n d i c a t e the o p t i m a l payout r a t i o r e g a r d e d by i n v e s t o r s u n d e r v a r y i n g c o n -d i t i o n s o r even w h e t h e r t he r e i s an o p t i m a l r a t i o not dependent on p r o f i t p r o s p e c t s . The a u t h o r s c o n c l u d e d : . . . f u r t h e r s tudy of o p t i m a l r a t i o s , w h i l e r e -l a t i v e l y s i m p l e i n t h e o r e t i c a l - t e r m s , i n v o l v e s much m o r e c o m p l i c a t e d a n a l y s i s than has been a t t e m p t e d h e r e . 0 39 I . F r i e n d and M. . P u c k e t t , " D i v i d e n d s and S t o c k P r i c e s , " A m e r i c a n E c o n o m i c R e v i e w , v o l . L I V ( S e p t e m b e r 196 47, p . 68 0. ~ ~ 4 0 I b i d . B i c k s l e r - ( 1 9 6 6 ) . B i c k s l e r ' s c o n c l u s i o n was • c o m p a t i b l e w i t h F r i e n d and P u c k e t t ' s s t a t e m e n t : " .:. t h a t t h e r e i s . l i t t l e b a s i s - f o r the c u s t o -m a r y . v i e w ... a d o l l a r of d i v i d e n d s has the i m -p a c t s e v e r a l t i m e s t h a t of r e t a i n e d e a r n i n g s . " 4 1 T h u s , w h i l e m o s t s t u d i e s p o i n t to d i v i d e n d s as a m a j o r v a r i a b l e a f f e c t i n g s h a r e p r i c e , none i s f r e e f r o m s t a t i s t i c a l e r r o r o r b i a s . B a s i c a l l y , any c a u s e and- e f f e c t r e l a t i o n s h i p b e t w e e n . d i v i d e n d s and p r i c e i s e x t r e m e l y d i f f i c u l t to d e t e r m i n e b e c a u s e of the ' i n f o r m a t i o na 1 r o l e d i v i d e n d s p l a y and b e c a u s e d i v i d e n d s - and e a r n i n g s a r e v e r y h i g h l y ; c o r r e l a t e d . N e v e r t h e l e s s , not one s t a t i s t i c a l s t u d y cite'd.has s u g g e s t e d t h a t d i v i d e n d s h a v e no e f f e c t on s h a r e p r i c e , w h i c h i n d i c a t e s , t h a t d i v i d e n d s do m a t t e r to s o m e d e g r e e and t h a t . i n p r a c t i c e the p u r e e a r n i n g s h y p o t h e s i s i s i n c o r r e c t . ' •' . ' B i c k s l e r , op. c i t . , p . . 10 0 . I I I . • . 49 M I L L E R - M O D I G L I A N I H Y P O T H E S I S The M I l l e r - M o d i g l i a n i t h e o r e m c o n f l i c t s w i t h a l m o s t a l l of the o t h e r t h e o r i e s and e m p i r i c a l r e -s u l t s ( w h i c h h a v e b e e n to a l a r g e e x t e n t r e c o n c i l e d ) , and i s , - t h e r e f o r e , i n v e s t i g a t e d i n c o n s i d e r a b l e d e t a i l i n t h i s tchapte r . M i l l e r and M o d i g l i a n i ' c o n c e n t r a t e d ' i n 1961 on the q u e s t i o n of w h e t h e r d i v i d e n d s m a t t e r and t h r o u g h an e x p l a n a t o r y m o d e l b a s e d on n e o - c l a s s i c a l c o n d i -t i o n s c o n c l u d e d : • -... g i v e n a f i r m ' s i n v e s t m e n t p o l i c y , ' t h e d i ^ vide-nd p a y o u t i t c h o o s e s t o . . f o l l o w w i l l a f f e c t n e i t h e r ' t h e c u r r e n t p r i c e of .its s h a r e s n o r the t o t a l r e t u r n , to i t s s h a r e h o l d e r s . . . \: On the a s s u m p t i o n s of p e r f e c t c a p i t a l m a r k e t s , r a -;t i o n a 1 b e h a v i o u r , and p e r f e c t c e r t a i n t y they,; e s t a -b l i s h e d a m o d e l of s h a r e v a l u a t i o n and r e s t a t e d i t i n t e r m s of v a l u e to the f i r m . ^ 3 . ( i l ) V (t) = 1 (I ' - j-p) 1 W h e r e : D ( f ) 4 - V (t-h 1) - m (t + 1) p ( W V (1) = t o t a l v a l u e of<. the f i r m p (t) z r a t e of r e t u r n , to s h a r e h o l d e r D (t) = t o t a l d i v i d e n d s p a i d i n t t o h o l d e r s , at b e g i n n i n g of t -m ( t - ( - l ) = n u m b e r of new s h a r e s ( i f any) s o l d i i t at e x - d i v i d e n d c l o s i n g p r i c ep( t +- 1) M i l l e r and M o d i g l i a n i , . " D i v i d e n d P o l i c y , G r o w t h , and the V a l u a t i o n ' o f S h a r e s , " p. -414. 4 3 I b i d . , 'p. ,413 ,' m o d e l 3 . " • • • 50 M i l l e r and M o d i g l i a n i f u r t h e r a s s u m e d t h a t the f u t u r e d i v i d e n d p o l i c y i s i n d e p e n d e n t of the d i v i d e n d d e c i s i o n i n t., so t h a t V ( t + 1 ) i s a l s o i n d e p e n d e n t of the c u r r e n t d i v i d e n d d e c i s i o n . T h u s , i n the a b o v e m o d e l , a c h a n g e i n d i v i d e n d has an e f f e c t on f i r m v a -l u e t h r o u g h the two r e m a i n i n g v a r i a b l e s , (1) a c h a n g e i n d i v i d e n d s , p e r . s e , and. (.2). the v a l u e of new s h a r e s s o l d to o u t s i d e r s d u r i n g the pe r i o d., ..In the- a b s t r a c t e d w o r l d s e t up by M i l l e r and M o d i g l i a n i , as d i v i d e n d s r i s e , the f i r m m u s t s e l l m o r e s h a r e s to m a i n t a i n a d e s i r e d l e v e l of i n v e s t m e n t , , w i t h the r e s u l t t h a t the o r i g i n a l o w n e r s -have a. l o w e r s h a r e o f . t h e f i r m ' s v a -l u e . T h e a u t h o r s s h o w e d t h a t e a c h of t h e s e two v a r i -a b l e s have' an e q u a l and 'opposite e f f e c t on f i r m v a l u e . T h a t i s , the i n c r e a s e d c a s h p a y m e n t s to c u r r e n t h o l d e r s e x a c t l y c o m p e n s a t e s thei-r l o w e r s h a r e of the t e r m i n a l v a l u e , w i t h the r e s u l t t h a t the a m o u n t of p a y o u t has no e f f e c t on p r e s e n t f i r m v a l u e . T h e r e f o r e u n d e r t h e s e a s s u m p t i o n s , no d i f f e r e n c e e x i s t s b e t -ween the . t w o f i n a n c i n g s t r a t e g i e s : r e t e n t i o n of- e a r -n i n g s v e r s u s d i v i d e n d i n c r e a s e and the f l o a t i n g of m o r e s h a r e s . T h e a u t h o r s p r o c e e d e d to - r e l a x t h e i r a s s u m p t i o n s to show t h a t the m o d e l was s t i l l r e l e v a n t but i n the r e a l w o r l d the v a l i d i t y of the m o d e l i s not c l e a r , a n d , i n d e e d , t h i s a m b i g u i t y has b e e n ' t h e f o c a l p o i n t of m u c h of the c r i t i c i s m of t h i s p a r t i c u l a r w o r k 51 To i l l u s t r a t e t h e i r c r i t i c i s m of the o t h e r v a l u a -t i o n f o r m u l a e , t h e y d e r i v e d a m o d e l i d e n t i c a l to the G o r d o n m o d e l and s h o w e d t h a t i t i s r e l e v a n t o n l y i n the s p e c i a l c a s e of c o m p l e t e i n t e r n a l f i n a n c i n g . In the c a s e , of s o m e e x t e r n a l f i n a n c i n g , d i v i d e n d s g r o w m o r e s l o w l y t h a n e a r n i n g s . ... t h e . g r o w t h r a t e , o f d i v i d e n d s p e r s h a r e i s n o t . t h e s a m e as the g r o w t h r a t e of the f i r m e x -c e p t i n the s p e c i a l c a s e i n w h i c h a l l f i n a n c i n g i s i n t e r n a l . . T h i s i s m e r e l y , one of a.number of p e c u -l i a r i t i e s of t h i s s p e c i a l c a s e , i n w h i c h , u n f o r t u n -a t e l y , m any'w r i t e r s h a v e b a s e d t h e i r e n t i r e a n a -l y s i s . 4 4 T h e a u t h o r s a l s o , e m p h a t i c a l l y s t a t e d t h a t the f a c t d i v i d e n d s do not m a t t e r i s not r e s t r i c t e d to the' s i t u a t i o n i n . w h i c h the f i r m ' s i n t e r n a l r a t e of r e t u r n i s the s a m e as .the m a r k e t r a t e of r e t u r n ( t h a t i s , w h e r e R a e q u a l s R c i n the W a l t e r m o d e l ) . 4 5 U n d e r , c o n d i t i o n s of p e r f e c t c e r t a i n t y and p e r f e c t c a p i t a l . , m a r k e t s h o w e v e r , the s i t u a t i o n of i n v e s t m e n t o p p o r -t u n i t i e s y i e l d i n g a r e t u r n g r e a t e r t h a n the m a r k e t r a t e of r e t u r n ' i s d i f f i c u l t ' t o v i s u a l i z e . U n d e r c e r -t a i n t y , f o r e s i g h t i s not r e w a r d e d , a c c e p t a n c e of r i s k d o e s not b r i n g a p r e m i u m ( f o r t h e r e i s no r i s k ) , and p r i v i l e g e d o p p o r t u n i t i e s do not e x i s t . If t h i s l o g i c i s v a l i d , t h e n f o r m u l a t i o n s by a l l t h e o r i s t s c o n s i d e r e d I b i d . , p. 4 2 4. I b i d . , p. 414. 5 2 u n d e r c o n d i t i o n s of p e r f e c t c e r t a i n t y w o u l d c o n c u r w i t h the M i l l a r M o d i g l i a n i t h e o r e m . G o r d o n , i n a r e b u t t a l , f o u n d n o t h i n g w r o n g w i t h the p r o o f of the t h e o r e m u n d e r the a s s u m p t i o n 'of f u t u r e c e r t a i n t y . H o w e v e r , u n d e r the a s s u m p t i o n s of r i s k a v e r s i o n and i n c r e a s i n g u n c e r t a i n t y w i t h t i m e , he c o n c l u d e d t h a t - a change 'in d i v i d e n d c h a n g e s s h a r e p r i c e . He r e a s o n e d as f o l l o w s : If the n e a r d i v i d e n d i s reduce.d and t h u s d i s t a n t d i v i d e n d s a r e i n c r e a s e d u n d e r c e r t a i n t y and i f the m a r k e t r a t e e q u a l s the i n -t e r n a l r a t e , p r i c e r e m a i n s c o n s t a n t . . I f , h o w e v e r , the' m a r k e t r a t e , a s s o c i a t e d w i t h f u t u r e , r e c e i p t s r i s e s , w i t h the d i v i d e n d c h a n g e to a d j u s t f o r ' i n v e s t o r i r r a -t i o n a l i t y and the h i g h e r d e g r e e of r i s k , a s s o c i a t e d w i t h f u t u r e r e c e i p t s i' the p r i c e w i l l f a l l . T h e r e f o r e , the q u e s t i o n h i n g e s on w h e t h e r the d i s c o u n t r a t e ... i s a f u n c t i o n of the d i v i d e n d r a t e , G o r d o n has p r e -sented' t h e o r e t i c a l and e m p i r i c a l e v i d e n c e i n s u p p o r t of the a f f i r m a t i v e . 4 ^ The. i n c l u s i o n of i n c r e a s i n g a m o u n t s of r i s k i n f u t u r e d i s c o u n t r a t e s r a i s e s a n o t h e r p'oblem i n the 4 5 G o r d o n , M. J . " O p t i m a l I n v e s t m e n t and F i -n a n c i n g Po l i e y, " J o u r n a l of F i n a n c e , v o l . X V I I I ( M a y 1963 ) , p. 2 6T7" j 4 7 G o r d o n , . I n v e s t m e n t , F i n a n c i n g and V a l u a t i o n of the C o r p o r a t i o n , p a s s i m . 53 d i v i d e n d - v a l u a t i o n area.- R o b i c h e k and M y e r s h a v e p r o v e d t h a t a c o m p o s i t e d i s c o u n t r a t e c a n n o t a d e q u -a t e l y d e f i n e a r i s k l e s s ' r a t e p l u s an a l l o w a n c e f o r r i s and. have- s u g g e s t e d as an a l t e r n a t i v e "the u s e of c e r -t a i n t y e q u i v a l e n t s . 4 ^ W a l t e r , i n a c a s h f l o w a p p r o a c h , c o n c u r s w i t h G o r d o n and a d d s - t h a t g r o w t h i n c a s h f l o w s m u s t be i n d e p e n d e n t .of p a y o u t p o l i c y so t h a t . t h e e f f e c t of a. d i -v i d e n d c h a n g e i s e x a c t l y ' o f f s e t by e x t e r n a l f i n a n c i n g 4 9 f o r the no d i v i d e n d e f f e c t to h o l d . Bo th' L i n t n e r and R o b i c h e k and My e r s 'have r e -a r g u e d the M i 1 l e r - M.o d i gl'ia n i h y p o t h e s i s u n d e r n e o -c l a s s i c a l c o n d i t i o n s but u n e q u i v o c a l l y c o n c l u d e t h a t i t i s u n a c c e p t a b l e u n d e r r e a l w o r l d c o n d i t i o n s . . ^ 4 8 ..... R o b i c h e k and M y e r s , op. c i t . , pp. 6 7-86. 4 9 • • ' J a m e s ' E . W a l t e r , " D i v i d e n d P o l i c y : I t s i n f l u e n c e on the V a l u e 'of the E n t e r p r i s e , " The. J o u r n a l of F i n a n c e , v o l . X.VIII ( M a y 1 9 6 3 ) , pT~2'83 . 5 0 • L i n t n e r , " D i v i d e n d s , E a r n i n g s , L e v e r a g e ' , S t o c k P r i c e s and the S u p p l y o f . ' C a p i t a l .to C o r p o r a -t i o n s , " pp. 247- 250; R o b i c h e k and M y e r s , o p. c i t . , pp. 5 2 - 5 4 . ' " M a r k e t c o m p o n e n t s ar.e n e i t h e r r a t i o n a l n o r c o n s i s -t e n t i n t h e i r e x p e c t a t i o n s and a t t i t u d e s . M a r k e t f l u c t u a t i o n s , .tax c o n s i d e r a t i o n s , a p l a n n e d r a t e of c o n s u m p t i o n e x p e n d i t u r e s , i n e r t i a , , d e s i r e to m a i n -t a i n c o n t r o l , i n a b i l i t y to b o r r o w a g a i n s t f u t u r e d i v i -d e n d s , a r e a l l p o s s i b l e r e a s o n s why i n v e s t o r s may v a l u e c e r t a i n p a t t e r n s of d i v i d e n d s m o r e h i g h l y t h a n oth e r s ' . ; E v e n M i l l e r and M o d i g l i a n i ' s - own i n f o r m a -t i o n a l c o n t e n t s . i n d i c a t e the i m p e r f e c t , f l o w of i n f o r -m a t i o n ' a n d a r e a s o n why t h e i r h y p o t h e s i s d o e s not h o l d . • • . '• • Th e i m p l i c a t i o n ' . . .'. i s th'at> when these' o r s i m i l a r m a r k e t i m p e r f e c t i o n s e x i s t , d i v i d e n d p o l i c y . d o e s not a f f e c t v a l u e and t h a t c e r t a i n p a t t e r n s of d i v i d e n d p a y o u t s a r e w o r t h m o r e to i n v e s t o r s t h a n o t h e r s . ^ 1 51 I b i d . , p. 54. . 5 5 , I V . I M P O R T A N C E . OF I N F O R M A T I O N A L C O N T E N T S One of the many s i g n i f i c ant. c ont r i b u t i o n s p r o -v i d e d by M i l l e r and M o d i g l i a n i was the p a r t i a l r e c o n -c i l i a t i o n of t h e i r t h e o r y w i t h , n u m e r o u s e m p i r i c a l s t u d i e s . They- s u g g e s t e d t h a t a c h a n g e i n s h a r e p r i c e t h a t f o l l o w s a c h a n g e i n d i v i d e n d s m e r e l y r e f l e c t s the i n f o r m a t i o n a l c o n t e n t s of d i v i d e n d s . If a c o m p a n y has a r e c o r d of s t a b l e d i v i d e n d s and t h e n c h a n g e s i t s d i -v i d e n d , i n v e s t o r ' s i n t e r p r e t t h i s c h a n g e as' a c h a n g e i n m a n a g e m e n t ' s v i e w of f u t u r e e a r n i n g s and i n v e s t -m ent p r o s p e c t s . A l s o , d i v i d e n d s may p r o v i d e t a n g i b l e e v i d e n c e t h a t a c o m p a n y i s ab.le to g e n e r a t e c a s h . D i -v i d e n d s may b e a n e x p e n s i v e m e a n s of i n f o r m i n g i n -v e s t o r s b e c a u s e of a l l e g e d d o u b l e t a x a t i o n and the h i g h r e l a t i v e c o s t s of e x t e r n a l f u n d s , but i n an un-c e r t a i n w o r l d w h e r e s p o k e n o r w r i t t e n s t a t e m e n t s a r e o f t e n i n c o n s i s t e n t , o r i g n o r e d , o r m i s i n t e r p r e t e d , d i v i d e n d a c t i o n may be'a m e a n s of m a k i n g a s t a t e m e n t t h a t s p e a k s l o u d e r t h a n a tho.usan'd w o r d s . Th e i m p a c t of d i v i d e n d s ' i n f o r m a t i o n a l c o n -t e n t s i s e s p e c i a l l y e x e m p l i f i e d by t h r e e s t u d i e s . S o g a n i c h ,' S o g a n i c h , the a u t h o r of a 1967 C a n a d i a n s t u d y , o b s e r v e d p r i c e . c h a n g e s v e r y s o o n a f t e r a n n o u n c e d d i v i d e n d c h a n g e s and c o n c l u d e d . t h a t , i n g e n e r a l , p r i c e s had gone up f o r c o m p a n i e s i n c r e a s i n g t h e i r ' 5 6 p a y m e n t s , a n d . v i c e v e r s a . ^ Of the t h i r t y - n i n e c o m -p a n i e s ( s h a r e s a l l f a i r l y a c t i v e l y t r a d e d ) t h a t i n -c r e a s e d o r i n i t i a t e d p a y o u t s , t w e n t y - t w o had a h i g h e r s h a r e p r i c e i n the i m m e d i a t e p e r i o d a f t e r the a n n o u n c e m e n t , w h i l e t h i r t y - t w o had-a h i g h e r p r i c e i n the m o n t h b e f o r e the a n n o u n c e m e n t . T h e e a r l y p r i c e m o v e m e n t p o s s i b l y r e f l e c t e d the m a r k e t ' s a n t i c i p a t i o n of a h i g h e r d i v i d e n d ' r a t e . ' . • C l o s e r a n a l y s i s of the :companie.s i n v o l v e d . , h o w e v e r , r e v e a l e d t h a t t h o s e w i t h a p r i c e r i s e had an I m p r e s s i v e ' growth t r e n d i r i " e a r n i n g s and' s a l e s i n r e -c e n t y e a r s ; .'thus, the d i v i d e n d r e i n f o r c e d i n the i n -v e s t o r s ' m i n d s the i d e a t h a t the d i r e c t o r s w e r e con-, v i n c e d .of a c o n t i n u i n g f a v o u r a b l e o u t l o o k . T h o s e c o m p a n i e s w i t h a f a l l i n g p r i c e ,' i n g e n e r a l , had a l e s s f a v o u r a b l e p a s t g r o w t h t r e n d , and t h e i r move., might, have b e e n s e e n by i n v e s t o r s ' as a f o o l i s h one. S t o c k of s e v e n of the e i g h t c o m p a n i e s r e d u c i n g o r o m i t t i n g d i v i d e n d s e i t h e r d e c l i n e d o r was u n c h a n g e d i n p r i c e , a c l e a r r e f l e c t i o n ..of l o w e r e a r n i n g e x p e c -t a t i o n s . -A s h l e y J o h n A s h l e y (196 2)', u s i n g r e c e n t d a t a f r o m o v e r e i g h t h u n d r e d , c o m p a n i e s on the New Y o r k S t o c k 52 S o g a n i c h , l o c . c i t . 57 E x c h a n g e o r the A m e r i c a n S t o c k E x c h a n g e , c o n c l u d e d t h a t p r i c e s r e s p o n d e d s i g n i f i c a n t l y to c h a n g e s i n d i -v i d e n d s and to a . l e s s e r e x t e n t to c h a n g e s i n e a r n i n g s , a n d ' t h a t the m a x i m u m p e r c e n t a g e c h a n g e i n p r i c e o c c u r r e d a b o u t t h r e e d a y s a f t e r the news of a d i v i -5 3 dend o r e a r n i n g s c h a n g e . A g a i n , d i v i d e n d s i n i -t i a t e d m o r e a c t i o n b e c a u s e to i n v e s t o r s t h e y r e p r e s s s e n t e d m a n a g e m e n t ' s o u t l o o k ' t o w a r d s the .future-, w h e r e a s e a r n i n g s r e p r e s e n t e d a s t a t i c p o s i t i o n , name the d e g r e e of s u c c e s s i n the i m m e d i a t e p a s t . A s h l e y a l s o n o t i c e d t h a t r e s p o n s e s to bad news w e r e f a s t e r t h a n r e s p o n s e s . t o good n e w s . F o r e x a m p l e , i n the s a m p l e of n i n e t y - n i n e c o m p a n i e s t h a t f e l l i n t o the c a t e g o r y of ' ' d i v i d e n d s - i n c r e a s e d - . o r ' r e s u m e d , ' the m e a n p e r c e n t a g e p r i c e i n c r e a s e a f t e r t h r e e d a y s of news date was 1.88, a f t e r , t w o ' w e e k s , 2.3.0, a f t e r one m o n t h , 2.02. Of the f o u r t e e n c o m p a n i e s i n c l u d e d i n the c a t e g o r y . o f ' d i v i d e n d s - d e c r e a s e d o r o m i t t e d , ' c o r r e s p o n d i n g m e a n . p e r c e n t a g e p r i c e i n c r e a s e s w e r e : - 5 . 0 2 , -5. 5.5; -5. 51. A g a i n , a d e c r e a s e ' i n a^  d i v i d e n d was a s u r e s i g n , e s p e c i a l l y i f s u p p o r t e d by d e c l i n i n g e a r n i n g s , o r s a l e s , t h a t the c o m p a n y -was h e a d e d f o r p o o r e r da.ys . A s h l e y : ; op., c i t . , p a s s i m . 58 B a r k e r B a r k e r , , i n a s e r i e s of s t u d i e s ( 1 9 5 6 to' 1 9 5 8 ) , o b s e r v e d t h a t s t o c k d i v i d e n d s and s p l i t s i n c r e a s e d s t o c k p r i c e s s i x m o n t h s a f t e r the e v e n t t o o k p l a c e o n l y i f the d i v i d e n d o r s p l i t . w a s a c c o m p a n i e d byya . 5 4 c a s h d i v i d e n d i n c r e a s e . O t h e r w i s e the m a r k e t p r i c e t e n d e d to f a l l - . 5 0 • • A l h t h r e e s t u d i e s d e a l t , w i t h ' t h e s h o ^ r t - r u n . I n -d e e d , r e s u l t ' s of A s h l e y ' s s t u d y i n d i c a t e d t h a t the p r i c e change r e a c h e s a m a x i m u m i n a b o u t two w e e k s , and a f t e r w a r d s ' r e v e r s e s t o w a r d s the i n i t i a l p r i c e . H a r k a v y had the c o r r e c t a p p r o a c h .when he s e g r e g a t e d d i v i d e n d - caus-ed • p r i c e e f f e c t s i n t o i n s t a n t a n e o u s o r l o n g - t e r m and c o n c l u d e d t h e y w e r e d i f f e r e n t . Q u i r i n , . i n h y p o t h e s i z i n g on the s h a p e of the f i r m 1 s. m a r g i n a l cost'of- c a p i t a l c u r v e , h as s u g g e s t e d t h a t the k e y i s the t i m e p e r i o d ^ i n v o l v e d . He s t a t e d t h a t a d i v i d e n d -c h a n g e p r o v i d e s the o n l y s h o r t - r u n i n f o r m a t i o n - a b o u t t h e . f i r m ' s a c t i v i t i e s and t h e r e f o r e i s i n the s h o r t - r u n 5 4 • '' B a r k e r , _op_. c i t . , • p a s s i m . '5 5 • • The i n f o r m a t i o n a l i m p a c t of e x t r a d i v i d e n d s i s not c l e a r , b u t , p r e s u m a b l y , t h e y a r e c o n s i d e r e d a b o n u s f o r a good y e a r and a r e .not- n e c e s s a r i l y to be e x p e c t e d a g a i n . 5 9 the o n l y f a c t o r c a p a b l e of a f f e c t i n g the c a p i t a -ls fi l i g a t i o n r a t e on the c o m m o n s h a r e s . " In the i n t e r m e d i a t e - r u n , r a t e s a d j u s t to r e f l e c t p r o s p e c t i v e e a r n i n g s f r o m new i n v e s t m e n t s and i n . t h e l o n g - r u n the m a r k e t c o m p l e t e s i t s a d j u s t m e n t to e a r -n i n g s e x p e c t a t i o n s and r i s k ' c h a r a c t e r i s t i c s . The l o -g i c a l c o n c l u s i o n ""is.-that d i v i d e n d s may h a v e a n e g l i -g i b l e e f f e c t on p r i c e i n the l o n g - r u n , w h e r e a s i n the s h o r t - r u n b'ecause -of i n f o r m a t i o n a l c o n t e n t s t h e y h a ve c o n s i d e r a b l e i m p a c t . Q u i r i n , op. c i t . , p.- 131 C H A P T E R V T H E C A N A D I A N - I N V E S T O R S ' R E A C T I O N TO D I V I D E N D S I . P U R P O S E The p u r p o s e of t h i s c h a p t e r i s to d e t e r m i n e the C a n a d i a n i n v e s t o r s ' ' a t t i t u d e s t o w a r d s d i v i d e n d s of c o m p a n i e s ' . a t d i f f e r e n t s t a g e s of' g r o w t h , i n - d i f f e r e n t i n d u s t r i e s , and i n the o v e r a l l m a r k e t . In g e n e r a l t e r m s , the d i v i d e n d t h e o r y s ta tes- that when the r a t e of r e t u r n on new c o r p o r a t e i n v e s t m e n t i s h i g h , the d i v i d e n d r-'a t e . s ho u 1 d be l ow to;- m a x i m i z e ...the w e a l t h of s h a r e h o l d e r s . T h i s s t udy s e e k s to d e t e r m i n e ' n o t . o n l y w h e t h e r i n v e s t o r s a r e r a t i o n a l i n t h i s r e g a r d , but a l s o the e x t e n t , i f a n y , to w h i c h they w o u l d have been b e t t e r off i f they had heede.d the d i v i d e n d t h e o r y i n the f i v e y e a r - p e r i o d , 1 9 6 1 t o 1 & 6.5 .. > I I . M E T H O D 1. A l l the da ta were t a k e n f r o m the' F i n a n c i a l c o m p an y c a r d s f o r the y e a r s 1 9 6 1 , 1962 , 1963 , and 1965.' '" C o m p a n i e s - we re i n i t i a l l y c h o s e n f r o m 1 ' • . ' The F i n a n c i a l P o s t . C o r p o r a t i o n S e r v i c e , F i n a n c i a l S u m m a r y C a r d s , T o r o n t o , M a c L e a n - H u n t e r P u b l i s h i n g Comp any L i m i t e d-, 1 9 6 6 . P o s t 1964 1 61 2 T h e F i n a n c i a l P o s t S u r v e y of I n d u s t r i a l s . R e q u i r e d c h a r a c t e r i s t i c s w e r e t h a t t h e y f i t i n t o one of the C a n a d i a n i n d u s t r i e s s u c h as f o r e s t p r o d u c t s o r b e v e r a g e s , t h a t t h e y be c o m p a n i e s - w i t h n e a r n o r m a l ' o r • 3 a b o v e - n o r m a l g r o w t h p a t t e r n s , and t h a t e a c h c o m -pany be p a i r a b l e . C o m p a n i e s so s e l e c t e d , n u m b e r e d ' 144. Usee- A p p e n d i x E . f o r the; l i s t s of p a i r e d f i r m s . ) 2.. P r i c e - e a r n i n g s and d i v i d e n d p a y o u t r a t i o s w e r e c o m p u t e d - f o r e a c h c o m p a n y ' s s t o c k . S i n c e r e -c e n t e a r n i n g s a r e c o n s i d e r e d m o r e s i g n i f i c a n t to the i n v e s t o r , w e i g h t e d a v e r a g e , p e r s h a r e , e a r n i n g s f i g u r e s w e r e u s e d ( 1963 ( 1),' 1964 ( 2),' 1-965 (3 ) ) . 4 A l l e a r n i n g s and d i v i d e n d s w e r e a d j u s t e d f o r s t o c k s p l i t s and s t o c k d i v i d e n d s , but .company e a r n i n g s w e r e not put on.a n o r m a l i z e d " b a s i s ( s e e S e c t i o n V of t h i s C h a p t e r ) . T h e p r i c e - e a r n i n g s r a t i o was 9 T h e F i n a n c i a l P o s t S u r v e y of I n d u s t r i a l s , A S u r v e y of C a n a d i a n i n d u s t r i a l C o m p a n i e s P r e p a r e d - b y the E d i t o r s of the F i n a n c i a l P o s t , T o r o n t o , M a c L e a n -H u n t e r P u b l i s h i n g C o m p a n y L i m i t e d , 19 66 .' 3 -S u c h f i r m s w e r e r e q u i r e d to h a v e a r e c o r d of a net p r o f i t i n at l e a s t f o u r of.the. f i v e y e a r s and a p o s i t i v e t r e n d - i n - e a r n i n g s and s a l e s o v e r the f i v e y e a r p e r i o d . ' 4 T h e p a r t i c u l a r w e i g h t s w e r e c h o s e n on the b a s i s of the i n v e s t i g a t o r ' s o p i n i o n a r i s i n g f r o m c u r -r e n t i n v e s t m e n t , and f i n a n c i a l l i t e r a t u r e on. the- a t t i -t u d e s of C a n a d i a n - i n v e s t o r s . 6 2 c o m p u t e d by d i v i d i n g the J a n u a r y 13, .1966 ( d a t e a r -b i t r a r i l y c h o s e n ) c l o s i n g p r i c e by the w e i g h t e d a v e r -age e a r n i n g s . T h e d i v i d e n d p a y o u t r a t i o was c o m p u t e d by a v e r a g i n g the r a t i o s f o r 1 9 6 1 , 1 9 6 2 , 1 9 6 3 , 1964, and 1965 w i t h m o r e w e i g h t g i v e n , to r e c e n t r a t i o s . ^ T h i s a v e r a g e was i n t e n d e d to a p p r o x i m a t e the t a r g e t r a t i o a i m e d f o r by the c o m p a n y ( i f i t had one) as w e l l as the r a t i o the i n v e s t o r w o u l d e x p e c t i n an u n c e r t a i n f u t u r e . 3. F i r m s w e r e t h e n p a i r e d on the b a s i s of s i -m i l a r i t y i n a l l r e s p e c t s e x c e p t p a y o u t ' r a t i o and d i s - -s i m i l a r i t y i n p a y o u t r a t i o : P e r f e c t p a i r i n g was i m - '• p o s s i b l e , but' o n l y c o m p a n i e s of the s a m e i n d u s t r y w i t h s i m i l a r - g r o w t h a n d . o t h e r r e c o r d s ' w e r e p a i r e d . A c c o r d i n g to Graham'", D o d d , an d C o t t l e , ' the c h i e f a n a l y t i c a l ; e l e m e n t s t h a t .are r e f l e c t e d i n t h e . f i -n a n c i a l d a t a and t h a t g o v e r n 'the. p r i c e - e a r n i n g s r a t i o 6 ' a r e as f o l l o w s : ' (a) g r o w t h of e a r n i n g s a n d . s a l e s i n the p a s t ; (b) , p r o f i t a b i l i t y ' , r a t e of r e t u r n on i n v e s t e d c a p i t a l ; (c) - s t a b i l i t y of p a s t e a r n i n g s ; T h e m e t h o d of s e l e c t i n g w e i g h t s was i d e n t i c a l to that, u s e d f o r w e i g h t e d e a r n i n g s p e r s h a r e . 6 G r a h a m et a l . , 1962, op. c i t . , p. 230. 63 (d) the d i v i d e n d r a t e and r e c o r d ; (e) f i n a n c i a l s t r e n g t h , o r c r e d i t s t a n d i n g . T h e r e f o r e , a p p r o p r i a t e g r o w t h f i g u r e s o r r a t i o s f o r e a c h of t h e s e e l e m e n t s ( e x c e p t d i v i d e n d s ) w e r e c a l -c u l a t e d f o r . e a c h c o m p a n y and u s e d as the b a s i s f o r p a i r i n g ( w i t h g r o w t h i n e a r n i n g s per share., the m a i n c r i t e r i o n ) . G r o w t h f i g u r e s and r a t i o s u s e d a r e as . f o l l o w s : , (a) a v e r a g e a n n u a l g r o w t h i n e a r n i n g s , p e r s h a r e f o r the f i v e y e a r p e r i o d , 1961 to 19 6.5; (b) a v e r a g e a n n u a l g r o w t h i n s a l e s f o r the s a m e f i v e y e a r p e r i o d , 1961 to 1965; (c) a f t e r t a x p r o f i t - ( 1965-) as a p e r c e n t a g e o'f t o t a l i n v e s t e d c a p i t a l ( b o n d s and s t o c k s ) ; (d.)' s u b j e c t i v e c l a s s i f i c a t i o n : v e r y s t a b l e , s t a b l e , , o r u n s t a b l e t r e n d i n e a r n i n g s p e r s h a r e ; (e) c u r r e n t r a t i o . In the c a s e of e a c h of the f i n a n c i a l c o m p a n i e s , p r o f i t -a b i l i t y - w a s m e a s u r e d by d i v i d i n g the. 1965 a f t e r tax' p r o f i t by- the t o t a l a s s e t s i n the s a m e y e a r . 4. P a i r s of f i r m s w e r e c l a s s i f i e d i n t o one.of two g r o w t h c l a s s e s : (a) a v e r a g e g r o w t h : c o m p a n i e s s h o w i n g a g r o w t h r a t e t h a t was not s i g n i f i c a n t l y d i f f e r e n t f r o m the e c o -nomy a v e r a g e ; 64 (To) s u p e r i o r g r o w t h : c o m p a n i e s s h o w i n g a g r o w t h r a t e t h a t was s i g n i f i c a n t l y h i g h e r t h a n the e c o n o m y a v e r a g e . 5; A v e r a g e p r i c e - e a r n i n g s r a t i o s , p a y o u t r a t i o s , and a p p r o x i m a t e d i v i d e n d y i e l d s w e r e c o m -p u t e d f o r low p a y o u t and h i g h p a y o u t g r o u p s f o r a l l f i r m s , f o r i n d u s t r i e s , and 1 f o r "growth ' c l a s s e s w i t h i n c e r t a i n . i n d u s t r i e s . 61. S i m i l a r l y , average', y.early a p p r e c i a t i o n o v e r the f i v e y e a r p e r i o d ( J a n u a r y 13, 1961 to J a n u a r y 13, 1966) and r e t u r n to s t o c k h o l d e r s , ( i n c l u d i n g d i v i d e n d s and a p p r e c i a t i o n ) as, a p e r c e n t a g e of: the o r i g i n a l i n -v e s t m e n t w e r e c o m p u t e d f o r h i g h and l o w p a y o u t g r o u p s . 7.. T h e e n t i r e p r o c e s s was r e p e a t e d for. f i r m s e x h i b i t i n g g r o w t h f a r a b o v e the e c o n o m y a v e r a g e . ^ .8.' A s a r e s u l t of c r i t i c i s m of the a p p r o a c h ( s e e S e c t i o n V o f t h i s '"chapter), the e n t i r e p r o c e s s was r e -p e a t e d f o r p a i r e d f i r m s w i t h a p a y o u t d i f f e r e n c e g r e a t e r t h a n 35 p e r c e n t . 9. - A l s o as a r e s u l t of a c r i t i c i s m of the ap-p r o a c h , the p r o c e s s was r e p e a t e d f o r c o m p a n i e s t h a t w ere, e x c e e d i n g l y s i m i l a r i n a l l r e s p e c t s e x c e p t p a y o u t r a t i o . ^ • S u c h e x c e p t i o n a l g r o w t h m e a n s at l e a s t an 18. p e r c e n t a v e r a g e y e a r l y g r o w t h r a t e i n e a r n i n g s p e r s h a r e f o r the p e r i o d 1961.to 1965. 8 T a b l e s i n A p p e n d i x E l i s t the p a i r e d f i r m s f o r e a c h of the f o u r s t u d i e s r e f e r r e d to a b o v e . 65 I I I . R E S U L T S R e s u l t s a r e l i s t e d i n T a b l e s I I I , I V , V , and V I . RESULTS OF PAIRING 144 TABLE III COMPANIES TA BULATED BY INDUSTRY Industry and growth category Sample si2e Data for high payout companies Average growth in earnings per share Average weighted payout, 1961-1965 Weighted price-earnings Approx. Average Return yield price aain, 1961-1966, as %age of original price (dividend & aain) as %age of original, investment Data for low payout companies Average growth in earnings per share Average weighted payout, 1961-1965 Weighted price-earnings A pprox. Ave rage yield ' price % gain, 1961-1 Return (dividend & gain) • as %age of as %age original of .investment original price Foodstuff sup. gr. 14 .22 58 13.7 4.2 13 81 .29 31 14.5 2.1 34 183 av. gr. 8 .02 42 11.9 3.5 7 44 '.'03, . 16 . 14.1 1. 1 - 9 59 average' 22 .15 52 13.1 3.9 10 68 .20 26 14.4 1.8 24 • 134 Public utility sup. gr. 12 .19 61 18.3 3.3 12 79 .17 33 19.2 1.7 28 151 'av. gr. 8 , .03 66 20.6 3.2 10 67 .04 • 34 16.6 . 2.0 26 143 average 20 .13 63 19.2 3.3 11 74 .12 34 18.2 1.9 27 148 Forest product sup. gr. 10 . 11 61 13.1 4.7 9 67 . 17 31 9.3 3.3 14 82 av. gr. 6 .03 61 13.4 4.6 T 2 4 '.02 - 43 • 16.4 2.6 14 81 average Non-ferrous* metal 16 8 .08 •  .19 ' 61 49 • 13.2 15.0 4.6 3.3 5 17 43 111 .12 .22 35 18'' 12.0 15.7 .2.9 1/1 14' - 23 82 119 Trust co.* 14 .08 76 23.3 3.3 8 44 . 10 51 17.5 2.9 5 42 Merchand.* 14 . 14 52 19.4 2.7 9 56 .14 27 18.3 1.5 12 . 68 Oil & gas* pipeline 10 .12. 67 20.3 3.3 10 72 . .12 43 18. 1 2.4 10 103 Gas & oil* (integrated)- 4 .05 53 17.3 3.1 0 11 .07 5 18.0 .3 14 71 Textile* 12 .18 43 11.6 3.7 25 158 .41 6 . 8.1 ' .7 52 • 270 Iron & steel* 6 .37 60 • 16.4 3.7 11 70 .22' 45 13.3 3.4 21 118 Chemical* • 6 .15 56 14.5 3.9 6 51 .17 18 17.6 1.0 6 ' 42 Construction* 4 .23 33 11.9 2.7 26 154 .35 11 16.0 .7 44 ' 229 Electrical* 2 .22 33 25.6 1.3 27 134 ' ' .30 16 • 16.3' 1.0 29 148 Beverage* 6 . 14 50 14.4 3.5 20 ' 116 .14 28 15.6 1.8 37 196 All industries sup. gr. 100 .19 56 16.8 3.3 , 88 .24 28 15.6 1.8 24 138 av. gr. 44 .03 58 15.9 3.6 6 48 " .03 30 - 15.0 2.0 13 81 • Overall averages 144 .14 57 16.5' 3.4 11 76 .17 29 15.4 1.9 22 - 125 *These industries did not have large enough samples to warrant a tabular breakdown into growth and average growth categories. R E S U L T S O F P A I R I N G 56 T A B L E IV C O M P A N I E S E X H I B I T I N G E X C E P T I O N A L G R O W T H Sample size Data for high payout companies Data for low payout companies Average price gain; 1981-1966, as %age of original price Keturn (dividend . & gain) as »age of original Investment Average Average weighted Approx. growth weighted price- yield payout, e arnlngs % 1961- • . 1965 In earnings per share Average Keturn price (dividend gain, & gain) 1961- as ttage 1966, of as %age "original of Investment original price 'AVSr'ag'e Average weighted Approx. growth weighted price- yield payout, earnings % 1961-1965 In earnings per share RESULTS OF VERY TABLE V C LOSELY PAIRING 54 COMPANIES Sample size Data for high payout companies Data for low payout companies Average growth in earnings per snare Average weighted payout, 1961-1965 Weighted price-earnings Approx. yield Average price gain, 1961-1966, as %age of original price' Return (dividend Si gain) as *age of original Investment Average growth in earnings per share Average weighted payout, 1961-1965 Weighted price-earnings Approx. yield Average Return price (dividend gain, 1961-.1966, of original price ,& gain) as *age of original investment 40 14 54 .19 .02 53 51 52 17.1 3.1 14.1 3.6 16.2 3.2 12 85 61 78 .19 .02 28 24 27 17.7 12.7 16.2 1.8 1.9 1.7 24 12 20 125 75 107 TABLE VI RESULTS OF PAIRING 48 COMPANIES, EACH COMPANY WITHDtA PAIR HAVING A PAYOUT DIFFERENCE OF OVER 35 PER CENT Industry and growth category Sample size Data for high payout companies Data for low payout companies Average growth in earnings per share Average weighted payout, 1961-1965 Weighted price -earnings Approx. yield Average price gain, 1961-1966, as %age of original price Return (dividend & gain) as 96age of original investment Average growth in earnings per share Average weighted payout, 1961-1965 Weighted p rice-earnings Approx. Average yield price % gain, 1961-of original price Return (dividend & gain) as %age of . original investment All industries sup. gr. av. gr. Overall average 17 7 24 .19 .03 .15 16.9 3.6 15.1 4.4 62 15 5 16.3 3.8 12 42 80 .21 .02 .16 14 23 17 15.1 13.3 14.6 1.0 1.7 1.2 23 18 21 135 103 125 • 7 1 •' I V . D I S C U S S I O N OF R E S U L T S The a t t e m p t to i s o l a t e g r o w t h was not e n t i r e l y s u c c e s s f u l , as e x e m p l i f i e d by the a v e r a g e g r o w t h i n e a r n i n g s pe r s h a r e f o r each of the two payout; g r o u p s . The b a s i c q u e s t i o n that a r o s e was w h e t h e r the h i g h p r i c e - e a r n i n g s r a t i o s c o r r e s p o n d i n g to low payou t g r o u p s -were . - p a r t i a l l y c a u s e d - b y a s m a l l i n c r e m e n t of g r o w t h that c o u l d not be i s o l a t e d . B e c a u s e the , g r o w t h d i s c r e p - e n c y w a s - r e l a t i v e l y s m a l l and, v a r i e d i n c o n s i s t e n t l y , the l o g i c a l c o n c l u s i o n was that the s m a l l amount of n o n - i s o l a t e d g r o w t h had a m i n o r i n -f l u e n c e . The r e m a i n i n g p r o b l e m was w h e t h e r the payout r a t i o was the cause and ..the . p r i c e - e a r n i n g s r a t i o , the e f f e c t . The c o n v e r s e a p p e a r s u n l i k e l y u n l e s s those f i r m s w i t h low p r i c e - e a r n i n g s , r a t i o s were l e s s ab le to f l o a t s t o c k and. c o n s e q u e n t l y w e r e f o r c e d to r e t a i n m o r e f o r e x p a n s i o n . A n - e x a m i n a t i o n of the c o m p a n y h i s t o r i e s , h o w e v e r , showed .no a p p a r e n t d i f f e r e n c e i n the s a l e of c o m m o n s t o c k . F u r t h e r m o r e , 1961 to 1965 9 was a p e r i o d of • h i g h s t o c k p r i c e s . B u r r e l c o n c u r s s t u d y , " R e l a t i v e V a l u e D i s t r i b u t e d , " p . 2 9 .. w i t h t h i s r e a s o n i n g i n h i s of E a r n i n g s : R e t a i n e d and 72 T a b l e I I I shows r e s u l t s f o r the i n d u s t r y g r o u -p i n g s as w e l l as f o r a l l the s u p e r i o r - g r o w t h f i r m s , a l l the a v e r a g e - g r o w t h f i r m s , and a l l f i r m s . In ge -n e r a l , the s tudy i n d i c a t e d that f o r i n d u s t r i e s , s u c h as c h e m i c a l and n o n - f e r r o u s m e t a l , w h i c h (1) have a l o w . p a y o u t r a t i o , (2) a r e at a b e g i n n i n g s tage i n g r o w t h and d e v e l o p m e n t , and (3) need ' funds - fo r c l e a r l y r e c o g n i z e d f u t u r e g r o w t h and e x p a n s i o n , i n v e s t o r s a t t a c h a g r e a t e r s i g n i f i c a n c e ( that i s , h i g h e r p r i c e -e a r n i n g s ) to the l o w e r payou t f i r m s . T h u s , when f u -tu re g r o w t h i s c l e a r l y , p r e d i c t e d , i n v e s t o r s r e a c t s e n s i b l y t"b t h e i r own e x p e c t a t i o n s of g r e a t e r a p p r e -c i a t i o n a c c r u i n g to low payout f i r m s i n s p i t e of h i g h e r d i v i d e n d y i e l d s of the h i g h payou t f i r m s C o n v e r s e l y , whe re the i n d u s t r y i s ' - e s t a b l i s h e d , ' i s c y c l i c i n n a t u r e , has p a i d a r e l a t i v e l y h i g h payout i n the p a s t , and .has • a l e s s c e r t a i n , l e s s d e s i r a b l e fu tu re (as i n the case of the f o r e s t p r o-duc t s . andVt e x t i l e i n d u s t r i e s ) , i n v e s -t o r s d e s i r e a h i g h payout even when the i n d i v i d u a l f i r m has e x h i b i t e d above a v e r a g e g r o w t h c h a r a c t e r i s t i c s . W i t h b a n k s , whe re h i g h payout has been t r a d i t i o n , and to some ex ten t w i t h t r u s t c o m p a n i e s , i n v e s t o r s c l e a r l y d e s i r e f i r m s w i t h a h i g h e r payout r a t i o i n s p i t e of 73 . g r o w t h . ' ' • S u r p r i s i n g l y , i nve s t o r s" a 11 a c h e d g r e a t e r s i g n i -f i c a n c e to low d i v i d e n d s i n the ca se of s u p e r i o r - g r o w t h p u b l i c u t i l i t i e s a n d , s i m i l a r l y , a g r e a t e r s i g n i f i c a n c e to h i g h e r d i v i d e n d s i n the c a s e of a v e r a g e - g r o w t h p u -b l i c u t i l i t i e s , d e m o n s t r a t i n g t h a t , f o r u t i l i t i e s , i n -v e s t o r s a r e r a t i o n a l . I n d u s t r y g e n e r a l i z a t i o n s beyond those d e s i g n a t e d a r e. d i f f i c u l t to m a k e . In f a c t , the s tudy r e s u l t s i l l u s t r a t e d the d i f f i c u l t y i n d r a w i n g c o n -c l u s i o n s about i n v e s t o r s ' a t t i t u d e s t o w a r d s d i v i d e n d s i n d i f f e r en t - i n d u s t r i e s on the ' . bas i s of a s m a l l s a m p l e of c o m p a n i e s . " • The p o s i t i v e and s t a t i s t i c a l l y s i g n i f i c an t r e l a -t i o n s h i p b e t w e e n p r i c e - e a r n i n g s and payout r a t i o s , e x h i b i t e d - when both the d a t a ' o n the f i f t y s u p e r i o r -g r o w t h p a i r s and data on the t w e n t y - t w o a v e r a g e - g r o w t h p a i r s were a v e r a g e d . ( T a b l e I I I on page 6 7 ) , l e d to the same c o n c l u s i o n as that of B a r r e l . I n v e s t o r s want c a s h d i v i d e n d s even when i t can be d e m o n s t r a t e d that the r a t e of r e t u r n on new c o r -p o r a t e i n v e s t m e n t i s h i g h . . T h i s s t a t e m e n t ..in. r e f e r e n c e to banks was made on-the b a s i s of o b s e r v a t i o n and the b a n k s ' a d v a n c e d p o -s i t i o n in ' the d e v e l o p m e n t c y c l e . None of the banks w e r e p a i r e d b e c a u s e of t h e i r s i m i l a r r a t i o s . B u r r e l , " R e l a t i v e • V a l u e of and D i s t r i b u t e d , " p . 29 . E a r n i n g s : R e t a i n e d 74 The r e s u l t s of p a i r i n g f i f t y S s i x . c o m p a n i e s e x h i b i t i n g e x c e p t i o n a l g r o w t h ( T a b l e IV .on. page 68) and the r e - . s u i t s of p a i r i n g f o r t y - e i g h t c o m p a n i e s , e ach w i t h i n a p a i r h a v i n g a payout d i f f e r e n c e , of o v e r 35 pe r ,cent.^ ( T a b l e V on page 69 , ) j a l so s u p p o r t t h i s s ame c o n c l u s i o n . H o w e v e r , to make a g e n e r a l o b s e r v a t i o n out of c o n t e x t -of a p a r t i c u l a r v i n d u s t r y i s -per.n.aps m i s l e a d i n g . The r e s u l t s we.re deemed even l e s s s i g n i f i c a n t by r e s u l t s of the f o l l o w i n g s tudy ' . " - . ' , A f t e r c a r e f u l l y p a i r i n g f i f t y - f o u r c o m p a n i e s ' , e ach of a p a i r h a v i n g - e x t r e m e l y c l o s e c h a r a c t e r i s t i c s . / -( T a b l e V I on page 70), r e s u l t s c o n t r a d i c t o r y to the f o r e -g o i n g w e r e o b t a i n e d . • I n v e s t o r s a t t a c h e d a h i g h e r p r i c e to g r o w t h c o m p a n i e s w i t h "a lo w pay out , and v i c e , v e r s a . F u r t h e r m o r e , a v e r a g e g r o w t h in., e a r n i n g s p e r s h a r e was i d e n t i c a l f o r both payout grb'.ups. T h u s , two v e r y s i g n i f i c a n t o u t c o m e s were that c o m p a n i e s m u s t be v e r y c a r e f u l l y p a i r e d i n s t u d i e s of t h i s . n a t u r e and t ha t , c o n -t r a r y to r e s u l t s of pas t s t u d i e s , i n v e s t o r s a r e r a t i o n a l i n t h e i r a p p r o a c h to'' d i v i d e n d p o l i c y ( that i s , they de -s i r e s h a r e s of a c o m p a n y that r e t a i n s e a r n i n g s i f the r e t u r n on t h o s e e a r n i n g s i s d e m o n s t r a t e d to be h i g h ) . The tax advan tage may be. a c o n t r i b u t i n g r e a s o n . . 7 5 A. c o r o l l a r y i s that c e r t a i n g r o w t h f i r m s may i n ' c r e a s e the m a r k e t p r i c e of t h e i r s t o c k i n the l o n g - r u n by l o w e r i n ' g t h e i r d i v i d e n d . . • T h e ' r e s u l t s -of the. c l o s e l y p a i r e d s a m p l e we re deemed m o r e s i g n i f i c a n t b e c a u s e g r o w t h and o t h e r c o m p a r a t i v e ' m e a s u r e s we re a l m o s t c o m p l e t e l y i s o l a t e d . The c o n t r a d i c t i o n - b e t w e e n the ' r e s u l t s of the two- s a m p l e s p o i n t s to the q u e s t i o n a b i l i t y of B a r r e l ' s , c o n c l u s i o n s and the m e t h o d as he a p p l i e d i t . The e x a c t me thod B a r r e l u s ed to p a i r was not d i s c u s s e d , but the f ac t that he used o n l y a g r o w t h m e a s u r e and the same i n d u s t r y as c r i t e r i a and the f ac t that he s t a r t e d w i t h e i g h t y s t o c k s and was a b l e to p a i r a l l e i g h t y of t hem i n d i c a t e s that h i s p a i r s we re even l e s s c lo s e l y . p a i r e d than those i n the l a r g e s a m p l e of t h i s s t udy whe re o n l y 144 c o m -p a n i e s out of m o r e than 25-0 i n i t i a l l y c h o s e n were p a i r -a b l e . A s a r e s u l t of a p p l y i n g a t e c h n i q u e used by : 13 ' • H a r k a v y , the a v e r a g e yea r ly - p r i c e . a p p r e c i a t i o n as ' • w e l l as the r e t u r n ( d i v i d e n d s p l u s ga in ) on the o r i g i -n a l i n v e s t m e n t fo r the p e r i o d 1961 to 1965 were found to be h i g h e r i n a l l c a s e s f o r low payou t g r o u p s (see T a b l e s I I I , I V , V , and V I , pages 67 to 70) . H a r k a v y , ojp. c i t . , pp . 2 9 0 - 2 9 6 . 7 6 A l t h o u g h H a r k a v y d i d not a t t e m p t to i s o l a t e g r o w t h as a m u t u a l c a u s a l a g e n t , the m e t h o d • i n t h i s s t u d y d i d b u t , a s - m e n t i o n e d on page 71 was not e n t i r e l y s u c c e s s f u l . H e n c e , .only p a r t (but l i k e l y the m a j o r p a r t ) of the s u p e r i o r l o n g - t e r m p r i c e a p p r e c i a t i o n of the low p a y o u t g r o u p c o u l d be a t t r i b u t e d to r e -t a i n e d e a r n i n g s - . N o n e t h e l e s s , l o n g - t e r m g a i n s a r e m o r e apt. to a c c r u e to s h a r e h o l d e r s of l o w p a y o u t c o m p a n i e s t h a t " e x h i b i t a t l e a s t a v e r a g e , g r o w t h . V. C R I T I Q U E OF METHOD ' . B u r r ' e l - s t a t e d : -... the m o s t v a l i d c r i t i c i s m ... i s t h a t i n s o m e c a s e s the p a i r i n g d i d not i n v o l v e a r e a l l y h i g h p a y o u t • a g a i n s t a r e a l l y ^ l o w p a y o u t s t o c k but r a t h e r a ' l o w p a y o u t p a i r e d , w i t h a m u c h lower p a y -out c o m p a n y . ^  • .. S i m i l a r l y , a d i f f e r e n c e i n p.ayouts of 10 to 20 p e r c e n t may not be s i g n i f i c a n t e n o u g h i n the m i n d s of i n v e s t o r s to h a v e any m e a n i n g f u l e f f e c t on the p r i c e -e a r n i n g s r a t i o s . T a b l e V, page '69, i s c o n s t r u c t e d - t o o v e r c o m e t h e s e two c r i t i c i s m s . t a i n e d B a r r e l , " R e l a t i v e V a l u e and D i s t r i b u t e d , •" ..p . ' .2 9 . of E a r n i n g s : Re -- 7 7 C e r t a i n a n a l y t i c a l e l e m e n t s g o v e r n i n g the p r i c e -e a r n i n g s r a t i o a r e d i f f i c u l t to. q u a n t i f y . T h e s e i n c l u d e : (a) q u a l i t y of m a n a g e m e n t ; (b) n a t u r e and p r o s p e c t s of the i n d u s t r y ; (c) c o m p e t i t i v e p o s i t i o n and i n d i v i d u a l p r o s -p e c t s of the i n d u s t r y . A c o m m o n and p a r t i a l l y . . v a l i d c r i t i c i s m was t h a t t h e s e f a c t o r s s h o u l d be c o n s i d e r e d s o m e h o w i n the p a i r i n g of c o m p a n i e s . . G r a h a m , e t • a 1. h ave c o u n t e r e d t h a t t h e s e f a c t o r s a l r e a d y h ave e x e r t e d ' c o n s i d e r a b l e i n f l u e n c e on the f i n a n c i a l d a t a w h i c h show' to a c e r t a i n e x t e n t how good a b u s i n e s s and how- good a m a n a g e m e n t the c o m p a n y h a s . T h e i r a r g u m e n t w o u l d not h o l d , how-e v e r , i f new m a n a g e m e n t had r e p l a c e d the o l d o r i f i n n o v a t i o n i n an i n d u s t r y ( f o r e x a m p l e , the d r u g - I n -dus t r y ) had m a d e . p a s t r e s u l t s i r r e l e v a n t f o r the ' f u t u r e . S i m p l e o b s e r v a t i o n r e v e a l e d , t h a t the'se l a t t e r s i t u a t i o n s , a r e u n u s u a l , i n Canada' whe-re m a n y f i r m s e x i s t w i t h i n p r i m a r y a n d n o t ' . h i g h l y d y n a m i c i n d u s t r i e s . A r e c e n t . a n d r a t h e r s t a r t l i n g A m e r i c a n s t u d y has s h o w n - t h a t v e r y l i t t l e - c o r r e l a t i o n e x i s t e d b e t w e e n e a r n i n g s p e r s h a r e i n one g i v e n p e r i o d and e a r n i n g s G r a h a m et a l . , 1962, o _ p . c i t . , p . 231 78 1 6 p e r s t a r e i n the s u b s e q u e n t p e r i o d . T h e s e , c o n c l u -s i o n s i m p l y t h a t c o m p a n i e s c a n n o t be compare'd on the b a s i s of p a s t g r o w t h i n e a r n i n g s p e r s h a r e and t h a t g r o w t h i n , e a r n i n g s p e r s h a r e d o e s not. i n d i c a t e c a p a c i t y of m a n a g e m e n t o r has l i t t l e r e l a t i o n s h i p to p a y o u t r a t i o , p r o f i t m a r g i n , and o t h e r v a r i a b l e s . Another- r e c- ent 1 A m e r i c a n "study',' on : t h e f a c t o r s i n -f l u e n c i n g the p r i c e - e a r n i n g s r a t i o , c o n c l u d e d t h a t e x p e c t a t i o n of f u t u r e g r o w t h - w a s m o r e s i g n i f i c a n t 17 • • t h a n p a s t r e c o r d s . T h e e x t e n t to w h i c h the r e s u l t s of t h e s e two s t u d i e s a r e v a l i d ^ i n C a n a d a s i g n i f i e s the e x t e n t of the v a l i d i t y of c e r t a i n ' ^ c r i t i c ism's o f - t h e me-t h o d u s e d f o r t h i s s t u d y . A l t h o u g h e a r n i n g s . w e r e not n o r m a l i z e d b e -c a u s e of l a c k of s u i t a b l e i n f o r m a t i o n , the r e l a t i v e l y l a r g e s i z e of the s a m p l e s t o g e t h e r w i t h the 'law of l a r g e n u m b e r s ' w o u l d t e n d to swamp, any e f f e c t c a u s e d by d i f f e r e n t a p p r o a c h e s u's'ed in' c a l c u l a t i n g e a r n i n g s . ' 1-6 J . E. M u r p h y , J r . , " R e l a t i v e G r o w t h of E a r n i n g s p e r S h a r e , " F i n a n c i a l A n a l y s t s J o u r n a l , v o l . 2 2 ( N o v e m b e r - D e c e m b e r F9 6 6 ) , pp. 7.3 -76. • 17 • • J . E . H a m me l a n d D. A. Ho d e s , " F a c t o r s • I n f l u e n c i n g P / E M u l t i p l e s , " F i n a n c i a l A n a l y s t s J o u r n a l , v o l . 2 3 ( J a n u a r y - F e b r u a r y I y b\77 , pp. y (J - 9 2~. 79 S u r v e y s of i n v e s t o r o p i n i o n i n the U n i t e d S t a t e s h a v e i n d i c a t e d t h a t d i v i d e n d s a r e s e l d o m a c o n s i d e r a -1 8 t i o n i n the p u r c h a s e of s t o c k . B u t , t h i s o u t c o m e i s not a d i r e c t c r i t i c i ' s m of the m e t h o d u t i l i z e d i n t h i s s t u d y . I n v e s t o r s ' s t a t e m e n t s and a c t i o n s a r e not n e -c e s s a r i l y the s a m e . F u r t h e r m o r-e , c e r t a i n s a m p l e s may be p e c u l i a r to an a r e a .or to a type' of i n v e s t o r . F i v e y e a r s i s a r e l a t i v e l y s h o r t p e r i o d i n a f i r m ' s h i s t o r y on w h i c h to b a s e a g r o w t h t r e n d ( a l -t h o u g h i n many c a s e s t h i s may be p r e c i s e l y what i n -v e s t o r s d o ) . T h i s c r i t i c i s m was p a r t i a l l y . o vercome b e c a u s e f i v e c r i t e r i a , not j u s t g r o w t h i n e a r n i n g s , w e r e u s e d f o r p a i r i n g and b e c a u s e c o m p a n i e s i n the s a m e i n d u s t r y a r e a f f e c t e d by the s a m e b u s i n e s s c y c l e and t h u s have, r e l a t i v e l y the s a m e l o n g - t e r m g r o w t h . p a t t e r n s . T h e p r i m a r y r e a s o n f o r - s e l e c t i n g a f i v e y e a r p e r i o d i n t h i s s t u d y , h o w e v e r , was the l a c k of the n e c e s s a r y h i s t o r i c a l d a t a f o r m any of the c o m -p a n i e s e x a m i n e d . . F r i e n d and P u c k e t t , . op. c i t . , p. 658. C H A P T E R V I D I V I D E N D . D E C I S I O N I N P R A C T I C E T h e p u r p o s e of t h i s ''chapter i s to i n v e s t i g a t e the d i v i d e n d d e c i s i o n i n p r a c t i c e . F i r s t , the l e g a l e l e m e n t s w h i c h p l a c e c o n s t r a i n t s on the d e c i s i o n and the d i s c r e t i o n a r y - e l e m e n t s w h i c h , a r e ' c o n s i d e r e d s u b -j e c t i v e l y by the d e c i s i o n m a k e r s a r e d i s c u s s e d . Se-c o n d l y , the r e s u l t s of the q u e s t i o n n a i r e , s e n t by the i n v e s t i g a t o r to f i f t y d i r e c t o r s of C a n a d i a n c o m p a n i e s , a r e e x a m i n e d . L i n t n e r ' s d i v i d e n d m o d e l i s t h e n de-v e l o p e d . a n d c r i t i c i z e d to e s t a b l i s h , on. a. l o g i c a l b a s i s , t h r e e d i v i d e n d m o d e l s . A l l m o d e l s a r e put i n the f o r m of r e g r e s s i o n e q u a t i o n s which- a r e t e s t e d on a p p r o -p r i a t e C a n a d i a n d a t a i n o r d e r , to e l u c i d a t e -the t a s k of m a k i n g d i v i d e n d d e c i s i o n s i n C a n a d a . I. C O N S T R A I N T S A f i r m m u s t c o n s i d e r . c e r t a i n l e g i s l a t i v e and c o n t r a c t u a l c o n s t r a i n t s to a r r i v e at the di v i d e n . d de-c i s i o n . S e c t i o n 160 of T he C a n a d a C o r p o r a t i o n s A c t ^ s t a t e s t h a t d i r e c t o r s may m a k e l a w s f o r the d e c l a r a -t i o n and p a y m e n t of d i v i d e n d s . ; h o w e v e r , S e c t i o n The C ana da P r i n t e r ~ 1 9 p T C o r p o r a t i o n s 9~9~; A c t , O t t a w a , Q u e e n ' s 81 83 (2). s t a t e s t h a t no d i v i d e n d s h o u l d be d e c l a r e d u n d e r the f o l l o w i n g c o n d i t i o n s : when the c o m p a n y i s i n s o l v e n t , when i t w o u l d be r e n d e r e d i n s o l v e n t , o r ' ' 3 when i t s c a p i t a l w o u l d be i m p a i r e d . If d i r e c t o r s pay a d i v i d e n d c o n t r a r y to S e c t i o n 83 (2) t h e y a r e j o i n t l y l i a b l e f o r a l l the debt up to the a m o u n t of d i v i d e n d s p l u s i n t e r e s t . A n y d i r e c t o r who o f f i c i a l l y p r o t e s t s the d i v i d e n d p a y m e n t i s e x o n e r a t e d f r o m l i a b i l i t y . T h e s e l e g a l r e s t r i c t i o n s i n j e c t a c o n s e r v a t i v e b i a s i n t o the d i v i d e n d p o l i c y e s p e c i a l l y i n the f o r m a -t i v e y e a r s when the c o m p a n y , i s b u i l d i n g up i t s e q u i t y . B o t h the b a l a n c e s h e e t , I n d i c a t i n g the p r e s e n t s t a t e of s o l v e n c y and the s t a t u r e of the f i r m ' s c a p i t a l , and the p r o j e c t e d c a s h f l o w , i n d i c a t i n g the a n t i c i p a t e d s t a t e of s o l v e n c y at t i m e of d i v i d e n d p a y m e n t , i n c o r -p o r a t e e s t i m a t e s t h a t may be i n a c c u r a t e . O v e r v a l u a -t i o n of a c c o u n t s r e c e i v a b l e ( u n d e r e s t i m a t i o n of b a d d e b t s ) and f i n a l g o o d , I n v e n t o r y v a l u e s w i l l c a u s e o v e r s t a t e m e n t of p r o j e c t e d c a s h r e c e i p t s . S i m i l a r l y , u n d e r e s t i m a t i o n of l i a b i l i t i e s . f o r w a r r a n t i e s and g u a r a n t e e s w i l l c a u s e u n d e r s t a t e m e n t , of p r o j e c t e d c a s h d i s b u r s e m e n t s . T h e r e f o r e , m a n a g e m e n t s h o u l d 2 I b i d . . , pp. 56- 58. 3 • S u b j e c t to (4) w h i c h e x c l u d e s f i n a n c i n g com-' p a n i e s and c o m p a n i e s w i t h 75 p e r c e n t of a s s e t s of a w a s t i n g n a t u r e . 82 a l l o w a m a r g i n .for e r r o r to i n s u r e t h a t the f i r m i s not r e n d e r e d i n s o l v e n t . T h e c r e d i t o r , i n o r d e r to p r e v e n t a r e d u c t i o n i n r e t a i n e d e a r n i n g s a f t e r l e n d i n g on the b a s i s of p r o t e c -t i o n of s u c h e a r n i n g s , may put an a p p r o p r i a t e c l a u s e i n the l o a n t r u s t d e e d . F o r e x a m p l e , A l b e r t a D i s t i l l e r s , L i m i t e d , 6% S i n k i n g - F u n d ^ D e b e n t u r e s , S e r i e s A, Due F e b r u a r y 1, 1979. P a y m e n t of d i v i d e n d s o r oth e r d i s t r i b u t i o n s on • c o m m o n "stock i s l i m i t e d to net p r o f i t s a f t e r J u ne 1 , 1 9 5 8 . 4 " I I . D I S C R E T I O N A R Y C O N S I D E R A T I O N S L i n t n e r A f t e r c o n s i d e r a b l e . r e s e a r c h on the d e t e r m i n a n t s of c o r p o r a t e d i v i d e n d po l i e y ' L i n t n e r s u g g e s t e d t h a t the f o l l o w i n g i n t e r r e l a t e d c h a r a c t e r i s t i c s o r f a c t o r s i n -5 • ' f l u e n c e d d i v i d e n d p o l i c y : (1) t y p e of i n d u s t r y : p : r o d u c e r g o o d s , c o n s u m e r g o o d s , d u r a b l e o r n o n - d u r a b l e go:ods; 4 C .: C . P o t t e r , F i n a n c e and B u s i n e s-s A d m i n i s -t r a t i o n i n C a n a d a , S c a r b o r o u g h " 0 n t . , P~r e n t i c e - l i a l l of C a n a d a Ltd-. , - 1966 , p. 3 1 1 . 5 L i n t n e r , "The D e t e r m i n a n t s of C o r p o r a t e S a v i n g s , " pp. 2 4 8 - 2 5 2 ; L i n t n e r , " D i s t r i b u t i o n of I n - , come of C o r p o r a t i o n s A m o n g D i v i d e n d s , R e t a i n e d • E a r n i n g s and T a x e s , " pp. 9 9 - 1 0 2 ; B i c k s l e r , op. c i t . , p. 45. . . ' — 83 (2) s i z e of c o m p a n y ; (3) g r o w t h i n s a l e s and e a r n i n g s ; (4) s t a b i l i t y o r v a r i a b i l i t y of s a l e s o r e a r n i n g s ; (5) f r e q u e n c y of c h a n g e s i n d i v i d e n d r a t e s ; (.6) a v e r a g e p a y o u t r a t i o ; (7) a v e r a g e p r i c e e a r n i n g s r a t i o ; (8) b a l a n c e s h e e t and "fund f l o w l i q u i d i t y ; (9) c a p i t a l , s t r u c t u r e ; (10) u s e of s t o c k d i v i d e n d s , s p l i t s , and e x t r a s ; (11) r e l a t i v e s i z e of s t o c k o w n e r s h i p by m a n a g e -ment and o t h e r ' c o n t r o l 'groups . ' A f t e r p e r s o n a l i n t e r v i e w s of k e y - c o r p'b r a t e e x e c u t i v e s and f i n a n c i a l a n a l y s i s of a l l ' the p u b l i s h e d d a t a of t w e n t y - e i g h t c o m p a n i e s c h o s e n f r o m a l i s t of s i x ' h und-r e d l a r g e l i s t e d i n d u s t r i a l c o r p o r a t i o n s , L i n t n e r c o n -c l u d e d t h a t the. m a j o r d i v i d e n d d e c i s i o n w a s: Do we n e e d to c h a n g e the a m o u n t of d i v i d e n d we a r e p r e s e n t l y 6 p a y i n g ? M o s t c o r p o r a t i o n e x e c u t i v e s i n t e r v i e w e d f e l t t h a t s e t t i n g the d i v i d e n d a m o u n t at a l e v e l w h i c h w o u l d not h a v e : to be i n c r e a s e d i n the f u t u r e was the f i r s t and f o r e m o s t r u l e of d i v i d e n d p o l i c y . In s p i t e of h i s b i a s e d s a m p l e , L i n t n e r c o n c l u d e d t h a t c u r r e n t net p r o f i t was the m a j o r f a c ' t o r i n d e c i d i n g w h e t h e r o r not to c h a n g e L i n t n e r , D i s t r i b u t i o n of I n c o m e , " p. 99. • 84 the p r e s e n t d i v i d e n d l e v e l . - T h i s a m o u n t of c h a n g e , L i n t n e r s u g g e s t e d , d e p e n d e d on the t a r g e t p a y o u t r a t i o and the s p e e d of a d j u s t m e n t f a c t o r , b o t h of w h i c h , i n t u r n , d e p e n d e d on a n u m b e r of f a c t o r s , 7 n a m e l y : - ' (1) e a r n i n g s and g r o w t h p r o s p e c t s f o r b o t h the f i r m ' and 'the ' i n d u s t r y ; (2) the.-.c-ycle of i n v e s t m e n t o p p o r t u n i t i e s , w o r k i n g c a p i t a l n e e d s , and' h i s t o r i c a l j u d g e m e n t of i n t e r n a l f u n d f l o w s ; (3) m a n a g e m e n t ' s v i e w o f ' s h a r e h o l d e r s ' a t t i -t u d e s on m a r k e t a p p r e c i a t i o n o'r c u r r e n t d i v i d e n d s ; (4) d i v i d e n d p o l i c i e s of c o m p a r a b l e f i r m s ; " (5) f i n a n c i a l p o s i t i o n of 'the c o m p a n y , a c c e s s 8 '• to c a p i t a l m a r k e t s , and p r e f e r e n c e f o r p a r t i c u l a r 9 • t y p e s "of f i n a n c i n g ; ' , ' I b i d . •, p . 104; B i c k s l e r , op', c i t . , p . 48 . 8 I n v e s t o r s may a t t a c h a g r e a t e r d e g r e e of r i s k to a f i r m not y e t p r o v e n by t i m e so t h a t the f i r m may f i n d . g r e a t e r d i f f i c u l t y o r c o s t i n o b t a i n i n g c a p i t a l f r o m i n v e s t o r s r a t h e r t h a n f r o m r e t a i n e d e a r n i n g s . . 9 R e t a i n i n g e a r n i n g s i s s o m e t i m e s p r e f e r r e d , to p a y i n g d i v i d e n d s and- h a y i n g to r e s o r t to s e l l i n g s h a r e s and d i l u t i n g c o n t r o l , or' i n c r e a s i n g l e v e r a g e and t h u s r i s k to the s h a r e h o l d e r s . . I n t e r n a l f i n a n c i n g a v o i d s d i -v e r s i o n of t i m e , e n e r g y , and o u t - o f - p o c k e t e x p e n s e s i n v o l v e d i n f l o a t i n g a new i s s u e . • 85 (6) the c o n f i d e n c e m a n a g e m e n t had i n the f i n a n -c i a l d a t a r e l e a s e d by the a c c o u n t i n g d e p a r t m e n t . L i n t n e r t h e n i n c o r p o r a t e d t h e s e f i n d i n g s i n t o a m o d e l w h i c h he t e s t e d and u s e d f o r p r e d i c t i o n . T h o m p s o n and W a l s h M o r e r e c e n t l y , T h o m p s o n and Wa Is h...( 1 9 63 ) s u r v e y e d 195 m a n u f a c t u r i n g f i r m s to f i n d out how d i -r e c t o r s r a n k e d c e r t a i n f e a t u r e s of a s o u n d c a s h d i v i -de n d p o l i c y . •• • " T A B L E V I I ' HOW 195 A M E R I C A N ' C O M P A N I E S R A N K E D T H E R E L A T I V E I M P O R T A N C E O F C O N T I N U I T Y , R A T E S T A B I L I T Y , A N D S I Z E O F D I V I D E N D F e a t u r e Rank T o t a l c o m p a n i e s C o n t i n u i t y S t a b i l i t y S i z e F i r s t 137 50 11 S e c o n d T h i r d 4 8 , 13 2 !': . 1 2 10 13 17/2 195 195 195 S o u r c e : G. C. T h o m p s o n - and F. I . W a l s h , J r . , " C o m p a n i e s S t r e s s D i v i d e n d C o n s i s t e n c y , " M a n a g e m e n t R e c o r d , v o l . X X V ( J a n u a r y 1963 )., p. 30. T h e i r c o n c l u s i o n s w e r e s i m i l a r to' L i n t n e r ' s, t h a t i s , "... d i v i d e n d p r a c t i c e s ... c a n b e s t be c h a r a c t e r i z e d 10 as c o n s e r v a t i v e and c o n s i s t e n t . " R e a s o n s c i t e d f o r g i v i n g top p r i o r i t y to d i v i d e n d c o n t i n u i t y i n c l u d e d (1) a f e e l i n g of r e s p o n s i b i l i t y t o w a r d s s h a r e h o l d e r s who d e s i r e s t e a d y - i n c o m e , (2) a d e s i r e to b u i l d the c o m -pany's i m a g e and r e p u t a t i o n i n the f i n a n c i a l c o m m u n i t y , (3) m a n a g e m e n t p r i d e , and (4) the s t a g e of the c o m p a n y ' s g r o w t h c y c l e . T h e s u r v e y showed t h a t the f o l l o w i n g f a c t o r s a r e p r i m e i n f l u e n c e r s of d i v i d e n d p r a c t i c e s : (1) c a s h a v a i l a b l e and a n t i c i p a t e d n e e d f o r f u n d s ; 1 1 (2) c o m p a n y ' s p a s t and p r o s p e c t i v e e a r n i n g s ; (3) i n t e r e s t s of s h a r e h o l d e r s ; 1 2 (4) i m o a c t of t a x e s . 10 T hompson, and W a l s h , o_p_. c i t . , p. 3 0. -'-•'-Gash may-be u s e d f o r e x p a n d i n g i n v e n t o r i e s , a c q u i r i n g f i x e d a s s e t s , r e d u c i n g debt o r e x p a n d i n g on r e s e a r c h so t h a t h i g h e r p r o f i t s do not n e c e s s a r i l y m e a n h i g h c a s h b a l a n c e s out of w h i c h d i v i d e n d s w i l l be p a i d . L i b e r a l c a p i t a l c o s t a l l o w a n c e s , a l l o w i n g c o m p a n i e s to d e f e r p a y i n g i n c o m e t a x e s , i f u t i l i z e d , m e a n g r e a t e r cash, f l o w s . . 1^In the C a n a d i a n s i t u a t i o n t h i s w o u l d a p p l y to c a p i t a l g a i n s w h i c h a r e not t a x e d v e r s u s d i v i d e n d s w h i c h a r e t a x e d at. the m a r g i n a l p e r s o n a l t a x r a t e s l e s s t he 20 p e r c e n t c r e d i t . 87 T h e . a u t h o r s a l s o f o u n d t h a t c e r t a i n c r u d e " r u l e s of t h u m b " w e r e u s e d by e x e c u t i v e s s u c h a s : 50 p e r c e n t b e c a u s e i t i s a "... r e a s o n a b l e b a l a n c e ..." and "... o n e - t h i r d to the o w n e r s , o n e - t h i r d r e t a i n e d i n 13 the b u s i n e s s and o n e - t h i r d f o r debt r e t i r e m e n t . " O n l y 35 p e r c e n t of the c o m p a n i e s had d e c l a r e d a s t o c k d i v i d e n d w i t h i n the l a s t f i v e y e a r s . T h e m a i n o b j e c t i o n to s t o c k d i v i d e n d s was the p e r m a n e n t l i a b i -l i t y of f u t u r e d i v i d e n d p a y m e n t s . T h a t i s , i f the o l d d i v i d e n d r a t e was m a i n t a i n e d , a g r e a t e r n u m b e r of s h a r e s w o u l d m e a n a g r e a t e r s t r a i n on f u t u r e e a r n i n g s . O t h e r s o b j e c t e d to s t o c k d i v i d e n d s b e c a u s e t h e y a r e : (1) e x p e n s i v e and t i m e c o n s u m i n g ; (2) w o r t h l e s s ( T h e i r v a l u e i s o f f s e t by r e d u c e d s h a r e p r i c e . ) ; (3) s u b s t i t u t e s f o r c a s h ( S h a r e h o l d e r s c o m -p l a i n e d a b o u t l a c k of c a s h . ) . Q u e s t i o n n a i r e to C a n a d i a n Companie's The q u e s t i o n n a i r e . Q u e s t i o n n a i r e s d e s i g n e d a c c o r d i n g to the r e s u l t s of L i n t n e r , and T h o m p s o n and W a l s h w e r e s e n t , on a c o n f i d e n t i a l b a s i s , to d i r e c t o r s o f C a n a d i a n f i r m s . T h r o u g h the u s e of r a n d o m n u m b e r s , T h o m p s o n and W a i s n , op. c i t . , p. 32. • 88 . t h i r t y c o m p a n i e s , each' w i t h t o t a l a s s e t s o v e r t e n m i l l i o n d o l l a r s , w e r e s e l e c t e d f r o m The F i n a n c i a l P o s t . S u r v e y of: I n d u s t r i a l s 1966. F i f t e e n f i r m s i n the f o r e s t p r o du c t s • i n du s t r y and t e n i n the f o o d i n -d u s t r y w e r e s i m i l a r l y s e l e c t e d . S i n c e s o m e f i r m s i n t h e s e two i n d u s t r i e s o v e r l a p p e d w i t h t h o s e i n the a l l - i n d u s t r i e s s a m p l e , o n l y f i f t y q u e s t i o n n a i r e s w e r e s e n t , i n m.ost c a s e s , to--the • c h a i r - m e n - o f .the b o a r d s of d i r e c t o r s . If a- c h a i r m a n ' was c o n s i d e r e d a f i g u r e h e a d o r i f he r e s i d e d i n a n o t h e r c o u n t r y , - e i t h e r the p r e s i -dent o r v i c e - p r e s i d e n t i n c h a r g e of f i n a n c e was p o l l e d . In e a c h c a s e , the r e q u e s t . f o r i n f o r m a l i o n was s e n t to a m e m b e r of the b o a r d . T h i r t y - t h r e e c o m p a n y o f f i c i a l s r e s p o n d e d ; one o t h e r r e p l i e d w i t h o n l y a l e t t e r . C o p i e s of the o r i g i n a l ' l e t t e r ; , q u e s t i o n n a i r e , and t r a c e r l e t t e r a p p e a r -in .Appendix F .-. ' .Response, to q u e s t i o n one . In the f i r s t q u e s t i o n , d i r e c t o r s w e r e a s k e d to r a t e . f a c t o r s h a v i n g an i n -f l u e n c e on the d i v i d e n d d e c i s i o n .(see T a b l e s V I I I , I X , an d X ) . . M a n y of. t h e s e f a c t o r s a r e i n t e r r e l a t e d . . F o r example,- t h i s y e a r ' s p r o f i t i s i n v e r s e l y r e l a t e d to p r e s e n t a n d a n t i c i p a t e d . n e e d f o r c a s h ; e x p e c t e d • g r o w t h i n e a r n i n g s and s a l e s may be r e l a t e d to p l a n n e d i n v e s t -m e nt p r o j e c t s . 89 S i z e has b e e n s h o w n to be an i m p o r t a n t v a r i a b l e i n the d i v i d e n d d e c i s i o n ( A p p e n d i x D) e v e n f o r f i r m s w i t h o v e r t e n m i l l i o n d o l l a r s i n a s s e t s . It was not i n -c l u d e d i n the l i s t , h o w e v e r , b e c a u s e i-t r e f l e c t s m a n y of the o t h e r f a c t o r s s u c h as p r o f i t s , d e g r e e of r i s k , a n t i c i p a t e d n e e d f o r c a s h , and a b i l i t y to f i n a n c e . D o u b t was e x p r e s s e d - i n s e v e r a l r e p l i e s a b o u t the m e a n i n g of i n t e r n a l r i s k . T h i s was s u p p o s e d to r e -f e r to i n t e r n a l o p e r a t i n g r i s k s s u c h as the c h a n c e of a s t r i k e , p l a n t b r e a k d o w n , i n v e n t o r y s p o i l a g e i n the c a s e of the f o o d i n d u s t r y , o r f i r e s e a s o n and w i n t e r snow i n the f o r e s t i n d u s t r y . T a b l e s V I I I , I X , and X p r e s e n t a s u m m a r y of r e s p o n s e s to the f i r s t q u e s t i o n . T h e s e t a b l e s show how the d i r e c t o r s r a t e d the v a r i o u s f a c t o r s i n v o l v e d i n the d i v i d e n d d e c i s i o n . Net p r o f i t c l e a r l y d o m i n a t e d . F r o m the a l l - i n d u s t r i e s s a m p l e o t h e r f a c t o r s c o n s i d e r e d v e r y i m p o r t a n t i n o r d e r w e r e : (1) p r e s e n t and a n t i c i p a t e d n e e d f o r c a s h ; (2) p l a n n e d i n v e s t m e n t p r o j e c t s ; (3) p a s t d i v i d e n d s ; (4) e x p e c t e d g r o w t h i n e a r n i n g s and s a l e s . E x p e c t e d v a r i a b i l i t y i n e a r n i n g s o r s a l e s , f u t u r e f i -n a n c i n g .plans , c a p i t a l s t r u c t u r e , r a t e of r e t u r n on c a p i t a l , and c o s t of c a p i t a l w e r e r a t e d i m p o r t a n t . F r e -q u e n c y of d i v i d e n d c h a n g e s , a t t i t u d e s of s h a r e h o l d e r s , 90 e f f e c t on p r i c e , u s e of s t o c k s p l i t s and' d i v i d e n d s , and i n t e r n a l r i s k s w e r e of s o m e i m p o r t a n c e . C o m p e -t i t o r s ' p a y o u t r a t i o and the e x i s t e n c e , of c o n t r o l g r o u p s w e r e not c o n s i d e r e d ' to h a v e any w e i g h t e x c e p t by the o c c a s i o n a l d i r e c t o r . S i n c e s t r o n g c o n t r o l g r o u p s e x i s t e d i n o n l y a s m a l l . n u m b e r of the c o m p a n i e s , t h i s l a i t t e r r e s p o n s e - 'was' e x p e c t e d . w e r e b a s i c a l l y s i m i l a r .. H o w e v e r , s o m e d i f f e r e n c e s w e r e a p p a r e n t -and a l t h o u g h the.se a r e not s t a t i s t i c a l l y s i g n i f i c a n t b e c a u s e of the s m a l l s a m p l e s i z e s the r e -s u l t s a r e i n d i c a t i v e .. I n the f o r e s t p r o d u c t s i n d u s t r y s a m p l e , p a s t d i v i d e n d s w e r e r a t e d a l o n g w i t h t h i s y e a r ' s p r o f i t as one of the two m o s t i m p o r t a n t v a r i -a b l e s . T h i s o u t c o m e i s e n t i r e l y . c o m p a t i b l e to L i n t n e r ' s f i n d i n g s f o r l a r g e i n d u s t r i a l c o r p o r a t i o n s . T h e f o r e s t i n d u s t r y i s w e 11, e s t ab l i s he d. and the f o r e m o s t i n d u s t r y i n C a n a d a ; m o s t of the f i r m s a r e l a r g e w i t h .a s t e a d y and f a v o u r a b l e d i v i d e n d r e c o r d ; c o n s e q u e n t l y p a s t d i -v i d e n d s s h o u l d be i m p o r t a n t e s p e c i a l l y b e c a u s e of the i m p a c t of t h e i r i n f o r m a t i o n a l c o n t e n t s . A t t i t u d e s o f s h a r e h o l d e r s ' , as e x p e c t e d , w e r e a l s o c o n s i d e r a b l y m o r e p r o m i n e n t t h a n t h o s e i n d i c a t e d by the a l l - i n d u s -t r i e s s a m p l e . . F u t u r e f i n a n c i n g p l a n s , i n t e r n a l . r i s k s , T h e r a t i n g s of v a r i a b l e s i n the a l l - i n d u s t r i e s s a m p l e and i n the f o r e s t , p r o d u c t s i n d u s t r y s a m p l e 9.1 c a p i t a l s t r u c t u r e , and r a t e of r e t u r n on c a p i t a l w e r e c o n s i d e r e d r e l a t i v e l y l e s s i m p o r t a n t b e c a u s e of the f o r e s t r y f i r m s ' s i z e , . a c c e p t a n c e , and p o s i t i o n i n the i n d u s t r y c y c l e . R e s u l t s of the f o o d i n d u s t r y s a m p l e w e r e v e r y s i m i l a r to t h o s e of the a l l - i n d u s t r i e s s a m p l e . T h i s f a c t i s not s u r p r i s i n g ; i n C a n a d a , f i r m s w i t h i n the f o o d i n d u s t r y a r e l e s s u n i q u e t h a n f i r m s i n the f o r e s t i n d u s t r y ; m a ny f o o d f i r m s a r e r e l a t i v e l y s m a l l , n o n -c y c l i c , and h a v e m a r k e t s l i m i t e d by the p o p u l a t i o n g r o w t h i n C a n a d a . . / . ..' "'' T A B L E V I I I • I M P O R T A N C E OF F A C T O R S I N T H E D I V I D E N D D E C I S I O N F O R A R A N D O M L Y S E L E C T E D G R O U P OF 20 C A N A D I A N : C O M P A N I E S , . E A C H WITH- T O T A L A S S E T S O V E R 10 M I L L I O N D O L L A R S ( D egree of importance I very some not important importance • important Factor . ' - sub sub Total 1 2 total 3 4 total 5 rep lie past dividends 3 10 13 ' 3 ' 3 6 19 this year's profit •9 8 . 17 2 1 3 20 frequency of dividend-• " changes 1 3 4 7 6 13' 2 19 expected growth in. earnings and sales 3 9 12 5 2 7 19 expected variability in earnings or sales . 4 7 - 11 ' 5 4 9 . • • • . 20 competitors' payout -ratio 1 1 1 6 7 12 20 attitudes of shareholders 2 3- 5 10 4 14. 1 20 effect of a dividend change on market price of stock 1 .1. '2 : 4 TO 14 4 20 future financing plans i . equity i i . debt 5 5 6 5 .11 10 7' 7.: 2 :3 9 10 20 20 planned investment projects 4 9 , - 13 2- • -5 7 20 capital structure 3 4 7 4 4 8 - 4 19 rate of return on capital 3 5 . 8 4 6 10 ' .2.. 20 present and anticipated need for cash • 9 5 14 1 5 6 '20 internal risks 1 3 '4 5 4 9 5 ' 18 use of stock splits, dividends, and extras 1 2 •3 4 6 10 • 4 17 relative size of stock ownership by management or other control groups 2 . : 2 4 2 6 12 20 cost of capital .1 1 2 1 1 3 i f -T A B L E I X \ I M P O R T A N C E O F F A C T O R S I N T F E D I V I D E N D D E C I S I O N F O R 10 C A N A D I A N C O M P A N I E S I N T H E F O R E S T P R O D U C T S I N D U S T R Y . Degree of importance . very some ! noT • important importance important ' Total Factor . sub sub replies 1 2 - total -3 4 total 5 past dividends 2 6 8 2 '2 10 this year's profit 6 1 7 3 3 . 10 frequency of dividend changes 1 1 2 4 1 • 5 3 10 expected growth in .* • earnings and sales : . 4' • 2 6 1 2 3 ' : l 10 expected variability' in earnings or sales 3 3 6 2 1 3 l 10 competitors' payout ratio .1' 1 1 ' 1- -•2 9 attitudes of shareholders,. 4. 4 4 -.2 6' , 10 effect of a diwidcndichango on market price' of stock 1 i. ' ,4 4 8 7". 10 future financing plans i . . equity i i . . debt 1 " 3 4 4 4 ; '4-3 1 2 • 5 ' • 5 l l . 10 10 planned investment projects • 1 4 5 . 1. 3 4 V • . 10 capital struc ture 1 1 ' 2 % 3 5" . " 3 ' 10 rate of return on capital • 1 _ 2' 3 ' '• 1 4 5 2 10 present and anticipated ' need for cash 2 5 7 2 1 3 10 internal r i sks 1- 1 2 1. 3 4 8 use of stock spl i ts , dividends, and extras 2 3 5 4 9 relative size of stock ownership by management or .other control groups 1 • 1 • 1 1 2 .7 . 10 cost of capital 2 2 2 T A B L E X r I M P O R T A N C E OF F A C T O R S I N T H E D I V I D E N D D E C I S I O N FOR,8 C A N A D I A N C O M P A N I E S I N T H E F O O T I N D U S T R Y Factor D egree of importance  very some ' not ' important importance important sub' sub 1 2 total 3 4 total 5 Total replies past dividends • ' ' 2 2 4 this year's profit 4 4 8 frequency of dividend changes . 3 3 expected growth in. earnings and sales; 2 4 6•• expected variability in earnings or sales 3 1 4 competitors' payout ratio attitudes of shareholders 2 2' effect of a dividend change on market price of stock 1 1 future financing plans 1 ' i . equity 3 2 5 i i . debt 3 1 4 planned investment projects 6 6 capital structure 2 2 rate of return on capital 1 1 present and anticipated ' need for cash 4 3 7 internal risks 3 3 use of stock splits, dividends and extras - 2 2 relative size of stock ownership by management or other control groups 1 1 2 1 5 2 2 1 2 1 3 1 1 2 2 2 3 2 1 3 4 6 3 4 2 4 6 1 2 2 1 1 4 1 1 3 1 8 7 8 8 •8 8 8 8 7 8 cost of capital 2 2 9.5 R e s p o n s e to q u e s t i o n t w o . T a b l e X I shows a s u m m a r y of r e s p o n s e s to the q u e s t i o n : Do. you have a t a r g e t payou t r a t i o to a i m f o r ? T A B L E X I . N U M B E R O F ' F I R M S W I T H A N D W I T H O U T A T A R G E T P A Y O U T R A T I O Indus t r y S a m p l e . s i z e W i t h t a r g e t payout r a t i o W i t h o u t t a r g e t payout r a t i o P e r c e n t a g e w i t h t a r g e t . A l l i n d u s t r i e s ' F o r e s t i n d u s t r y F o o d i n d u s t r y 20 10 12 5 5 8 5 3 60 50 6 2 The c h o o s i n g of a t a r g e t had no a p p a r e n t r e l a -t i o n s h i p w i t h f i r m s i z e , p r o f i t a b i l i t y - , - c a p i t a l . s t r ue t u r e , o r any o t h e r m e a s u r e a b l e - v a r i a b l e . The r e s u l t s - do i n d i -c a t e , h o w e v e r , that o v e r o n e - h a l f of C a n a d i a n . f i r m s c o n s i d e r , to some degree ' , that the d iv idend - d e c i s i o n i s the a c t i v e p o l i c y v a r i a b l e . E x a m i n a t i o n of the y e a r l y payout da ta of those f i r m s d e c l a r i n g a; t a r g e t r a t i o i n d i c a t e d thait they d i d , i n f a c t , have a f a i r l y c l e a r l y d e f i n e d t a r g e t . Tha t some of these f i r m s d i d not have an a p p a r e n t g o a l may be 96 ' a t t r i b u t e d - to a . s l o w a d j u s t m e n t to the g o a l ( c o n s e r v a -t i s m ) when c o n f r o n t e d w i t h r i s i n g e a r n i n g s . . E x a m i n a -t i o n of the r e m a i n i n g f i r m s u s u a l l y , but not a l w a y s , i n d i c a t e d a c h a n g i n g o r f l u c t u a t i n g p a y o u t r a t i o . R e s p o n s e to q u e s t i o n t h r e e s . T a b l e X I I shows how d i r e c t o r s of C a n a d i a n ~, c o m p a n i e s r a n k e d c e r t a i n f e a t u r e s of a s o u n d c a s h d i v i d e n d p o l i c y . S e v e r a l r e s -p o n d e n t s e x p r e s s e d c o n f u s i o n i n the' d i f f e r e n c e b e t w e e n c o n t i n u i t y • a-nd • s tab i l i t y , and i n d e e d , these two may have b e e n i n t e r p r e t e d d i f f e r e n t l y by the v a r i o u s d i r e c t o r s . C l e a r l y , the two a r e not m u t u a l l y e x c l u s i v e ; d i s c o n -t i n u o u s d i v i d e n d s a r e not s t a b l e ; s t a b l e d i v i d e n d s a r e a l s o c o n t i n u o u s ; but the two may r e p r e s e n t c l e a r l y d i s t i n c t p o l i c i e s . F o r e x a m p l e , do the d i r e c t o r s p l a n to pay c o n s i s t e n t l y e v e r y q u a r t e r b u t not n e c e s s a r i l y at a s t a b l e r a t e o r d o ' t h e y c o n s i d e r a s t a b l e r a t e of' the u t m o s t i m p o r t a n c e ? T h a t a s t a b l e r a t e was i n t e r -p r e t e d to i n c l u d e the p o s s i b i l i t y of a s t e a d y m o v e m e n t i n the u p w a r d d i r e c t i o n w a s . a s s u m e d . A n u n s t a b l e r a t e w o u l d t h e n m e a n f l u c t u a t i n g d i v i d e n d p a y m e n t s . G e n e -r a l l y , t h o s e who r a n k e d s t a b i l i t y f i r s t a l s o c o n s i d e r e d f r e q u e n c y of c h a n g e s i m p o r t a n t , and v i c e v e r s a . . E x t r a d i v i d e n d s may be c o n s i d e r e d a n o n - r e p e t i t i v e b o n u s and w o u l d not c h a n g e the s t a t u r e of a . s t a b l e r a t e . A l t h o u g h s o m e m i x u p was a p p a r e n t , the m a j o r i t y of d i r e c t o r s , p o l l e d i n e a c h of this' t h r e e s a m p l e s a g r e e d 9 7 on the o r d e r of the t h r e e v a r i a b l e s : c o n t i n u i t y , s t a -b i l i t y , and s i z e . T h e s e r e s u l t s c o n f i r m those of the p r e v i o u s l y m e n t i o n e d s tudy by T h o m p s o n and W a l s h . . I n d e e d , the s u m m a r y . o f r e p l i e s by C a n a d i a n d i r e c t o r s i s a l m o s t i d e n t i c a l to the r e s u l t s i n T a b l e V I I , page 8 b . •"• - " T A B L E X I I C A N A D I A N D I R E C T O R S ' R A N K I N G ' O F S I Z E , C O N T I N U I T Y , AND- S T A B I L I T Y Sample ; F e a t u r e . . R a n k "• • T o t a l c o m p a n i e s A l l i n d u s t r i e s C o n t i n u i t y F i r s t 1.3. S e c o n d 5 ' T h i r d 2 20 S t a b i l i t y .6 • . 12 2 20 S i z e • • 1 3 16 20 F o r e s t i n d u s t r y C o n t i n u i t y 9 • ' , .1 0 10 S t a b i l i t y •o. 9 1 10 S i z e . ' 1 " 0 9 . 10 F o o d i n d u s t r y •C o n t i n u i t y . 7 . 1 0 8 S t a b i l i t y 1 5 2 ' [ 8 • S i z e 0 2 6 :• • 8 98 R e s p o n s e to q u e s t i o n f o u r . T a b l e X I I I shows a s u m m a r y of r e s p o n s e s to the q u e s t i o n : Do you c o n -s i d e r that the p r i m a r y d i v i d e n d d e c i s i o n i s : Do we need to change the amount of the d i v i d e n d we a re p re s e n t l y p a y i n g ? A b o u t 40 p e r cent of those r e p l y i n g a n s w e r e d y e s . T h e p r e m i s e . i s that the d i v i d e n d de -c i s i o n i s made i n the f r a m e w o r k ; of n e v e r r a i s i n g a d i v i d e n d i f at some p o i n t of t i m e i n the f u t u r e the d i v i d e n d p a y m e n t w o u l d h a v e ' t o b e ' d e c r e a s e d . T A B L E X I I I D I R E C T O R S ' O P I N I O N O N W H E T H E R T H E N E E D TO C H A N G E T H E D I V I D E N D A M O U N T .IS T H E P R I M A R Y D E C I S I O N ' * I n d u s t r i e s S a m p l e A f f i r m a t i v e N e g a t i v e P e r c e n t a g e s ize ; ; a f f i r m a t i v e A l l i n d u s t r i e s 19 8 .1 1 . 4 2 ' F o r e s t i n d u s t r y 10 4 , 6 . 40 F o o d i n d u s t r y 7 2 • .5 29 Th.e a n s w e r to q u e s t i o n f o u r was found to be somewha t r e l a t e d to the s i z e of the c o m p a n y , the l a r g e r c o m p a n i e s t e n d i n g to r e s p o n d i n the a f f i r m a -t i v e . 99 The r e s u l t s a r e d e f i n i t e l y not c o m p a t i b l e w i t h t h o s e ' o f L i n t n e r who c o n c l u d e d that the q u e s t i o n unde r • c o n s i d e r a t i o n was the m a j o r p o l i c y d e c i s i o n i n t w e n t y -s i x of the t w e n t y - e i g h t f i r m s he i n v e s t i g a t e d and p r o -c e e d e d to base the speed of a d j u s t m e n t c o n c e p t and h i s 1 4 d i v i d e n d , m o d e l on t h i s c o n c l u s i o n . B e c a u s e , i n C a -n a d a , pa s t d i v i d e n d s a r e l e s s i m p o r t a n t and b e c a u s e , i n C a n a d a , m.any f i r m s do not have a t a r g e t payout r a t i o , the L i n t n e r d i v i d e n d m o d e l i s not a p p r o p r i a t e i j i . • • • • to' the C a n a d i a n s i t u a t i o n . . T h i s c o n c l u s i o n does not nega te the i m p o r t a n c e of t h i s ' m a j o r p o l i c y componen t (pas t d i v i d e n d s ) of the . d i v i d e n d d e c i s i o n to many C a n a d i a n f i r m s . . F o r i n -i st jance, the c h a i r m a n of a l a r g e p u l p and p a p e r c o m -pany s t a t e d : No b o a r d of d i r e c t o r s of a p u b l i c c o m p a n y c a n tak'e p r i d e i n b e i n g r e s p o n s i b l e f o r a d i v i d e n d r e -d u c t i o n so t h a t , - i n r e v e r s e , a d i v i d e n d i n c r e a s e i s not l i k e l y ' u n l e s s the p r o s p e c t s a r e f a v o u r a b l e f o r c o n t i n u a t i o n i n the y e a r s to c o m e . ! " 3 A d d i t i o n a l c o m m e n t s ' . The' d i r e c t o r s w e r e a l s o a s k e d fo'r any a d d i t i o n a l c o m m e n t s o r a t t i t u d e s on d i -v i d e n d p o l i c y . R e s p o n s e s to t h i s q u e s t i o n h e l p e d I 4 L i n t n e r , " D i s t r i b u t i o n of, Inc o me s , " p . 107, ^ T h e p r e c i s e s o u r c e s of these c o m m e n t s a r e not s t a t e d b e c a u s e of the c o n f i d e n t i a l n a t u r e of the r e p l i e s . . 100 e l u c i d a t e the n a t u r e of the d i v i d e n d d e c i s i o n i n . C a n a d a . In s e v e r a l i n s t a n c e s these v i e w s were m o r e p e r -t i n e n t than the r e t u r n e d q u e s t i o n n a i r e . F o r e x a m p l e , a t r u s t c o m p a n y p r e s i d e n t who a n s w e r e d w i t h a l e t t e r but no c o m p l e t e d f o r m d i d so to c l a r i f y any m i s c o n -c e p t i o n s about the d i s t i n g u i s h i n g c h a r a c t e r i s t i c s of t h e . d i v i d e n d d e c i s i o n i n that i n d u s t r y .'• He r e m a r k e d : The f o r m i s not p a r t i c u l a r l y p e r t i n e n t to ou r C o m p a n y and t h e r e f o r e I choose to d rop you t h i s n o t e . Our I n d u s t r y has a v e r y s p e c i a l r e a s o n f o r i n -du lg ing , i n a r e t a i n e d e a r n i n g s • p r a c t i c e . U n d e r the T r u s t C o m p a n i e s A c t , C a n a d a , we may a c c e p t on d e p o s i t ' on ly 15 t i m e s our P a i d up ' C a p i t a l ' a n d S u r -p l u s . , I f o u r g r o w t h i s to be, m a i n t a i n e d at the r a t e c o n s i s t e n t w i t h the l a s t n u m b e r of y e a r s , then ou r c a p i t a l base w i l l a l w a y s be unde r p r e s s u r e f o r i n -c r e a s e and t h i s may be a c c o m p l i s h e d o n l y by r e -t a i n e d e a r n i n g s o r by a d d i t i o n a l s u b s c r i p t i o n i n the e x e r c i s e of r i g h t s t o . s h a r e h o l d e r s . • W h i l e the i s s u a n c e of r i g h t s to s h a r e h o l d e r s i s n o r m a l l y w e l c o m e d by t h e m , you w i l l r e c o g n i z e i t Is d i f f i c u l t f o r a c o m p a n y to show a good r e c o r d of i n c r e a s e i n e a r n i n g s pe r s h a r e when the n u m b e r 'of. s h a r e s o u t s t a n d i n g i s . ' b e i n g i n c r e a s e d , m o r e o r l e s s r e g u l a r l y . . H e n c e r e t a i n e d e a r n i n g s , hence d i s t r i b u -t i o n of a p p r o x i m a t e l y 6 0% o f ' n e t e a r n i n g s . , ' The o f f i c i a l of .a t e x t i l e f i r m had t h i s to s a y : T h e s e q u e s t i o n s In, r e g a r d to t h i s c o m p a n y . a r e u n f o r t u n a t e l y a c a d e m i c s i n c e a r e [our] p r o f i t s f o r the pas t few y e a r s a r e b e i n g u sed to r e d u c e a r r e a r s on c l a s s A s h a r e s . C o m m o n d i v f d e n d s cannot be p a i d u n t i l A i s c l e a r e d . 101. One of the m a j o r c o n c l u s i o n s a r i s i n g f r o m both the n o n s p e c i f i c c o m m e n t s and o b s e r v a t i o n of the o t h e r ' a n s w e r s i s the e x i s t e n c e of a c o n s i d e r a b l e i n t e r - i n -d u s t r y d i f f e r e n c e i n the a t t i t u d e t o w a r d s the v a r i o u s d e t e r m i n a n t s , of the d e c i s i o n . T h i s f ac t was bes t - e x -p r e s s e d by the c h a i r m a n and p r e s i d e n t of a l a r g e C a -n a d i a n comp.anyyand a d i r e c t o r of n u m e r o u s o t h e r s . -It i s my e x p e r i e n c e i n the v a r i o u s C a n a d i a n c o m p a n i e s on w h i c h ' I 'am a d i r e c t o r that t h e r e i s f a r m o r e c o r r e l a t i o n i n d i v i d e n d payou t , w i t h i n an i n d u s t r y i n C a n a d a than i n any - e m p i r i c a l s t r u c t u r e . C o n s e q u e n t l y , any d i v i d e n d m o d e l set up to e x p l a i n the m a j o r d e t e r m i n a n t s of d i v i d e n d b e h a v i o u r s h o u l d be a p p l i e d 'on., an i n d u s t r y b a s i s or. s h o u l d be f o r m u l a t e d to take a c c o u n t of d i f f e r e n t i n d u s t r y c h a r a c t e r i s t i c s that have a b e a r i n g on the d i v i d e n d d e c i s i o n ' , s u c h a s , e x p e c t e d f u t u r e g r o w t h a-nd n e e d f o r c a s h . A l t h o u g h the q u e s t i o n n a i r e r e s u l t s i n d i c a t e that d i r e c t o r s c o n s i d e r a hos t o f v a r i a b l e s i n t h e i r d e c i s i o n , s e v e r a l r e s p o n d e n t s c o m m e n t e d that these v a r i a b l e s w e r e s e l d o m s p e c i f i c a l l y m e n t i o n e d , f o r m u l a t e d , o r r a n k e d . F o r e x a m p l e , the c o n t r o l l e r of a l a r g e f i r m i n the b e v e r a g e i n d u s t r y s t a t e d : I am c e r t a i n that you w i l l a p p r e c i a t e the, fac t that each of the p o i n t s c o v e r e d i n the q u e s t i o n n a i r e have not s p e c i f i c a 1 l y , b e en d i s c u s s e d i n tne c o n t e x t t h a t . y o u p h r a s e y o u r - q u e s t i o n n a i r e . H o w e v e r , ob -v i o u s l y , a l l of y o u r p o i n t s have been c o n s i d e r e d by ou r m a n a g e m e n t at v a r i o u s t i m e s . 102 One c h a i r m a n , a l s o a d i r e c t o r of many c o m -p a n i e s , had i n f o r m a t i v e o p i n i o n s on the e f fec t of c o n t r o l g r o u p s . He s u b d i v i d e d these g r o u p s i n to m a -nagemen t and n o n - m a n a g e m e n t and c l a i m e d tha t . t he l a t t e r was a m o r e p o w e r f u l f a c t o r . . He had the. f o l -l o w i n g to say about the f o r m e r . ' I b e l i e v e that the e f fec t of i n t e r n a l m a n a g e m e n t o w n e r s h i p of s t o c k s h o u l d be nega ted i n c o n s i d e -r i n g d i v i d e n d a c t i o n . . .This i s an a r g u m e n t of some v a l i d i t y a g a i n s t s t o c k o p t i o n s w h e r e i n t e r n a l m a -nagemen t i n r e c o m m e n d i n g d i v i d e n d p o l i c y to a B.oard may be s e r v i n g two' m a s t e r s . A n o t h e r s i g n i f i c a n t o u t c o m e i s that m a n a g e -men t s of n u m e r o u s f i r m s r e c o g n i z e the i n f o r m a t i o n a l i m p a c t - of d i v i d e n d s . . F o r e x a m p l e , the p r e s i d e n t of a l a r g e i n t e g r a t e d f o r e s t . p r o d u c t s f i r m d e c l a r e d that one of ..... the two p r i m e c r i t e r i a use-d i n c o n s i d e r i n g . d i v i d e n d p o l i c y of ou r c o m p a n y a r e . . . the need to d e m o n s t r a t e e a r n i n g pow.er and t o t a l p a y i n g c a p a -c i t y . . t. . A l t h o u g h the c o s t of c a p i t a l i s an i m p o r t a n t t h e o r e t i c a l c o n c e p t i n d e r i v i n g the o p t i m u m d i v i d e n d p a y m e n t , . n o t one r e p l y i n d i c a t e d that the c o s t of c a -p i t a l e n t e r e d d i r e c t l y i n to the d e c i s i o n . The s e v e n r e s p o n d e n t s who' r a t e d c o s t of c a p i t a l c o n s i d e r e d i t r e l a t i v e l y i m p o r t a n t , but none of the t w e n t y - f i v e r e s -ponden ts who .were not a s k e d to r a t e i t m e n t i o n e d i t , a l t h o u g h - n u m e r o u s a d d i t i o n a l v a r i a b l e s were of ten l i s t e d . The l o g i c a l i n f e r e n c e to be d e r i v e d f r o m t h i s ; 103 fac t and a d d i t i o n a l c o m m e n t s i s that d i r e c t o r s c o n -s i d e r e d c o s t of c a p i t a l i n a c o n t e x t d i f f e r e n t f r o m that s u g g e s t e d by t h e o r y . S i m i l a r l y , d i r e c t o r s r a t e d f u t u r e f i n a n c i n g p l a n s p r e s u m a b l y b e c a u s e a change i n d i v i -dends w o u l d l i k e l y r e s t r i c t or enhance t h e i r c o m p a n y ' s a.ccess t o , and a f f e c t ' t h e c o s t of f u n d s . But the t h e o r y s t a t e s that w i t h a g i v e n c o s t of c a p i t a l , the l o w e r i t i s i n r e l a t i o n to p r o f i t a b i l i t y , the g r e a t e r s h o u l d be r e t e n t i o n to m a x i m i z e f.ir.-m value- . The s e c r e t a r y and t r e a s u r e r of a l a r g e c h e m i c a l f i r m came the' c l o s e s t to r e l a t i n g p r a c t i c e and t h e o r y . . • The o b j e c t i v e i s to. m a x i m i z e " r e t u r n to s h a r e -h o l d e r " by a t t a i n i n g g r o w t h f i n a n c e d by r e t a i n e d e a r n i n g s , debt and e q u i t y i n the p r o p e r r a t i o s . T h u s , s t i l l a n o t h e r c o n c l u s i o n a r i s i n g f r o m the q u e s -t i o n n a i r e i s that m o s t ' ' d i v i d e n d d e c i s i o n m a k e r s e i t h e r i g n o r e o r a r e i g n o r a n t of s u g g e s t i o n s by a c a d e m i c s . Some of the d i r e;c to r s *dis p l a y e d s t r o n g o p i n i o n on the . r e l a t i o n s h i p of the d i v i d e n d d e c i s i o n to the i n -v e s t m e n t and o t h e r f i n a n c i a l d e c i s i o n s . The r e m a r k s o|f the e x e c u t i v e v i c e - p r e s i d e n t of a l a r g e candy c o m -.pjany a r e c le a r l y . one - s i de d i n t h i s r e g a r d , but they p o r t r a y and e x e m p l i f y an a w a r e n e s s a m o n g m a n a g e m e n t of the i m p o r t a n c e of i n c o r p o r a t i n g many f a c t o r s w i t h s h o r t and l o n g r ange p l a n s and w i t h c o m p a n y o b j e c t i v e s i n the d e c i s i o n - m a k i n g t a s k . E a c h que.s t ion r a i s e d i n y o u r f o r m i s i m p o r t a n t . .1 do not c o n s i d e r that t h e r e i s one p r i m a r y d e c i s i o n 104 to be m a d e . - I n a c t u a l f a c t , d i v i d e n d p o l i c y i s e s t a b l i s h e d by t a k i n g in to c o n s i d e r a t i o n e v e r y f a c t o r a f f e c t i n g the c o m p a n y ' s a c t u a l p e r f o r -.manc'e v i s - a - v i s s h o r t r ange and l o n g r ange p l a n n i n g . . O u r job i s to p r o v i d e the s h a r e h o l d e r w i t h the bes t p o s s i b l e p e r f o r m a n c e that w e , as t h e i r - M a n a g e m e n t , are- c a p a b l e of p r o v i d i n g . P e r h a p s the c h a i r m a n - a n d p r e s i d e n t of a l a r g e s t e e l c o r p o r a t i o n made the m o s t a p p r o p r i a t e c o m m e n t about- the q u e s t i o n n a i r e " and the d i v i d e n d ' d e c i s i o n i n C a n a d a , G e n e r a l l y , the p e r m u t a t i o n s -and c o m b i n a t i o n s of the f a c t o r s you ' enumera te with ' r e s p e c t to d i -v i d e n d p o l i c y a r e so- many that i t i s m o s t d i f f i c u l t to e v a l u a t e them e x c e p t i n the l i g h t of c u r r e n t c o m -- pany and e c o n o m i c c o n d i t i o n s . -I suppose i n a n o t h e r s e v e r a l y e a r s I m i g h t a n s w e r y o u r q u e s t i o n s d i f -f e r e n t l y . T h i s - w o u l d not n e c e s s a r i l y i n d i c a t e a s u b j e c t i v e a t t i t u d e ; i t i s j u s t that c h a n g i n g . c o n d i -t i o n s w o u l d i n f l u e n c e e v a l u a t i o n . I I I . . T H E L I N T N E R 'DIVI-D EN-D • M O D E L D e v e l o p m e n t and R e s u l t s po r a t e L i n t n e r e m b o d i e d h i s m a j o r 15 • • d i v i d e n d - mode l , . f i n d i n g s i n to a c o r -(12) A D U = a i + c i . ( D * i t - . D i ( t l ) ) t u i t Whe r e i i n d i c a t e s the p a r t i c u l a r c o m p a n y t. i n d i c a t e s • t h e y e a r under c o n s i d e r a t i o n A D - | . - - change, i n a,-= c o n s t a n t d i v i d e n d p a y m e n t s L i n t n e r , " D i s t r i b u t i o n o f I n c o m e s , " p . 107 . 105 c^= speed of a d j u s t m e n t f a c t o r D * i t = p r e s e n t d i v i d e n d i f the d i v i d e n d has been ba sed on the t a r g e t payou t r a t i o , r , a p p l i e d to c u r r e n t y e a r ' s p r o f i t a f t e r t axes , P . . ; thus , D * - r P 1 1 i t i t D ^ j . _ -jj = d i v i d e n d s p a i d i n t - 1 u ^ - d i s c r e p a n c y be tween o b s e r v e d d i v i d e n d change and that e x p e c t e d on the b a s i s of the o t h e r t e r m s The m o d e l e x p l a i n e d d i v i d e n d p o l i c y i n 85 p e r cent of the c o m p a n y y e a r s ( t w e n t y - e i g h t c o m p a n i e s i n s e v e n y e a r s , 1947 to 1953) w i t h m o d e r a t e d i s c r e p a n c i e s . The 1 « m o d e l was c o n v e r t e d to an i d e n t i t y : (13) D l t = a u + b P u + d D . ( t _ 1 ) + u . t Whe r e : b = c r d' = 1 - c ' T h i s m o d e l was f i t t e d to data f o r the y e a r s 1918 to 1951 and to data f o r v a r i o u s s u b p e r i o d s w i t h i n t hese y e a r s and p r o d u c e d " . . . e x c e l l e n t c o r r e l a t i o n s , r a n -dom r e s i d u a l s , h i g h l y s i g n i f i c a n t r e g r e s s i o n c o e f f i -c i e n t s o v e r the e n t i r e p e r i o d , 1 9 1 8 - 1 9 5 1 , and a l l 1 7 m a j o r s u b g r o u p s of the y e a r s . " When f i t t e d to data f o r the y e a r s 1918 to 1 9 4 1 , e x c l u d i n g 193 6 and 1937 b e c a u s e of a tax i n d u c i n g the d e c l a r a t i o n of d i v i d e n d s , x u I b i d . , p . 109 . 17 ' I b i d . 106 1 fi-t-he r e s u l t i n g e q u a t i o n s w e r e : D = 3 5 2 . 3 -h 1 5 • + . 70D^_ .^ w i t h p r o f i t s a d j u s t e d f o r i n v e n t o r y g a i n s , and D : 1 0 6 . 0 1 . 1 4 5 P t + . 7 8 8 D t -when p r o f i t s were u n a d j u s t e d . When the f o r m e r was u sed to f o r e -c a s t p o s t w a r b e h a v i o u r , the e s t i m a t e was 2 . 0 pe r cent unde r a c t u a l a v e r a g e d i v i d e n d s , and 2-. 2 . p e r cent o v e r a c t u a l r e t a i n e d e a r n i n g s . C o r r e s p o n d i n g f i g u r e s f o r the e q u a t i o n not a d j u s t e d f o r i n v e n t o r y g a i n s we re 5 .6 and 6 .1 p e r c e n t . i L i n t n e r c o n c l u d e d that " . . . our b a s i c m o d e l i n c o r p o r a t e s the d o m i n a n t d e t e r m i n a n t s of c o r p o r a t e •' ' 19 d i v i d e n d d e c i s i o n s . . . . " .. C r i t i c i s m s D a r l i n g bo th c h a l l e n g e d and ex t ended L i n t n e r ' s f i n d i n g s by i l l u s t r a t i n g the i m p o r t a n c e of c h a n g i n g l i q u i d i t y and e x p e c t a t i o n s . ' I n 1932 , a y e a r c h a r a c -t e r i z e d by a low l e v e l o L b u s i n e s s c o n f i d e n c e and g e n e r a l l y low l i q u i d i t y , ' t h e L i n t n e r m o d e l o v e r e s t i -m a t e d a c t u a l d i v i d e n d s by 2 6 . 7 pe r c e n t . . In 1935 , when e x p e c t a t i o n s and l i q u i d i t y w e r e u p , the m o d e l u n d e r e s t i m a t e d d i v i d e n d s by 14 .3 p e r cent-. A l t h o u g h L i n t n e r - ' s m o d e l s h o w e d a- good o v e r a l l f i t , p r e d i c t i o n s 1 8 I b i d . 1 9' I b i d . , p . 113 . 107 f o r i n d i v i d u a l y e a r s when e x p e c t a t i o n s and l i q u i d i t y p o s i t i o n were i n a s t a t e of t r a n s i t i o n we re c o n c l u d e d 2 0 to be qu i t e i n a c c u r a t e . H o w e v e r , D a r l i n g ' s c l a i m may have been e x a g g e r a t e d b e c a u s e of the e x t r e m i t i e s i n the t i m e p e r i o d u sed fo r h i s s t u d y . O t h e r s have q u e s t i o n e d the r e l i a b i l i t y of L i n t -n e r ' s s a m p l e and w h e t h e r i t m i g h t be a s o u r c e of p o s s i b l e e r r o r s ; they c l a i m e d that i t was s m a l l , h a n d -p i c k e d , and r e p r e s e n t a t i v e of o n l y l a r g e , d i v e r s i f i e d 2 1 c o r p o r a t i o n s . H o w e v e r , the i n i t i a l p u r p o s e of L i n t -n e r ' s s t udy was to p r e d i c t a g g r e g a t e c o r p o r a t e s a v i n g , and i n the A m e r i c a n e c o n o m y l a r g e i n d u s t r i a l c o r p o r a -t i o n s do d e t e r m i n e the b u l k of s u c h s a v i n g . F u r t h e r -m o r e , L i n t n e r was qu i t e a w a r e of t h i s p o t e n t i a l c r i -t i c i s m . He s t a t e d : " . . . the c o m p a n i e s w e r e not s e -l e c t e d as a s a m p l e upon w h i c h to d raw s t a t i s t i c a l c o n -2 2 e l u s i o n s .." 9 o P . G . D a r l i n g , "The I n f l u e n c e of E x p e c t a t i o n s and L i q u i d i t y on D i v i d e n d P o l i c y , " J o u r n a l o f Po l i t i c a l  E c o n o m y , v o l . L X V (June 19 57) , p p . 20 9- 22T. : 2 1 B i c k s l e r , o_p_. c i t . , p . 53 . 2 2 L i n t n e r , D i s t r i b u t i o n s of I n c o m e s , " p . 99 . 108 G r u n f e l d and G r i l i c h e s have q u e s t i o n e d how the L i n t n e r d i v i d e n d h y p o t h e s i s , w h i c h was i n the form, of a m a c r o - m o d e l , c o u l d e v e r e x p l a i n the d i v i d e n d d e c i -s i o n p r o c e s s i n the f i r m , at the m i c r o l e v e l , by a g g r e -2 3 g a t i n g data f o r t w e n t y - e i g h t f i r m s . T a r s h i s , i n an i m m e d i a t e r e p l y to L i n t ne r ' s p a p e r , no ted that the r e s u l t s a p p e a r e d a l i t t l e too good i n the l i g h t of c h a n g i n g c o r p o r a t e and p e r s o n a l i n c o m e taxes and o t h e r f a c t o r s that m i g h t i n f l u e n c e d i v i d e n d 9 A p o l i c y . ^ A s a r e s u l t of t h i s o b s e r v a t i o n T a r s h i s s u g -g e s t e d that a l t e r n a t i v e e x p l a n a t i o n s of L i n t n e r ' s r e -s u l t s may e x i s t . P e r h a p s f i r m s have a d i f f e r e n t t a r g e t payout r a t i o ( r ) and speed of a d j u s t m e n t f a c t o r (c) f o r v a r i o u s l e v e l s of p r o f i t s . F o r e x a m p l e , i f i n p e r i o d t a f i r m i s m o v i n g t o w a r d s r at a r a t e of c and e a r n i n g s i n c r e a s e i n t - ( - l , the f i r m may a p p l y a d i f f e r e n t r and c to t h i s i n c r e m e n t i n e a r n i n g s . T h i s a l t e r n a t i v e h y -p o t h e s i s w o u l d g ive " . . . the s ame s o r t of r e s u l t s as P r o f e s s o r - L i n t n e r ' s . I do not u n d e r s t a n d how i t can be r e j e c t e d . " 2 5 23y. G r u n f e l d and Z . G r i l i c h e s , "Is A g g r e g a t i o n N e c e s s a r i l y B a d ? " R e v i e w of E c o n o m i c s and S t a t i s t i c s , v o l . 42 ( F e b r u a r y I 9 6 0 } , pp . 1- 13 . 2 4 L . T a r s h i s , " C o m m e n t , " A m e r i c a n E c o n o m i c  R e v i e w , v o l . X L V I ( M a y 1956) , p . " T T C 25 I b i d . 109 A s a c o n s e q u e n c e of the T a r s h i s c r i t i c i s m , B r i t t a i n has e l a b o r a t e d on the b a s i c m o d e l by r e -p l a c i n g the f i x e d l o n g - r u n t a r g e t r a t i o by a t a r g e t f u n c t i o n w h i c h v a r i e d o v e r t i m e w i t h tax and o t h e r f a c t o r s . F u r t h e r , net p r o f i t s were r e j e c t e d as a m e a -s u r e of the a b i l i t y to pay d i v i d e n d s and w e r e r e p l a c e d by c a s h f l o w s . C a s h f l o w s a re much m o r e h i g h l y c o r -r e l a t e d w i t h d i v i d e n d s o v e r t i m e than a r e p r o f i t s , as i s i l l u s t r a t e d i n F i g u r e 3 . But F i g u r e 3 and s t a t e m e n t s to the same ef fec t a r e m i s l e a d i n g b e c a u s e , as W e s t o n has w a r n e d , a b i a s e x i s t s i n any s t a t i s t i c a l a t t emp t to c o m p a r e the i n f l u e n c e of c a s h f l o w s on d i v i d e n d s to 9 B the i n f l u e n c e of p r o f i t s on d i v i d e n d s . O t h e r c r i t i c s have s t r e s s e d the m o d e l ' s f a i l u r e to e x p l a i n the t a r g e t r a t i o , why i t v a r i e s be tween f i r m s , and how i t was c h o s e n . ^ I n d e e d , no s y s t e m a t i c a n a l y s i s of the f a c t o r s i n f l u e n c i n g e i t h e r the t a r g e t r a t i o o r the speed of a d j u s t m e n t f a c t o r was m a d e . B e -cause of t h i s , t hese c r i t i c s f e l t the m o d e l was vague i n s p i t e of the v a l i d i t y of the c o n c l u s i o n s . 2 6 W e s t o n and B r i g h a m , M a n a g e r i a l F inane e , p 482 . p . 20 . 2 7 B i c k s l e r , o p . c i t . , p . 5 5 ; B r i t t a i n , o p . c i t . , 60 40 P e r cent 20 0 1957 D i v i d e n d s as a pe of net pr r c e n t a g e of i t s D i v i d e n d o f s as a pe c a s h f l o r c e n t a g e s 5 9 61 Y e a r 63 65 F I G U R E 3 P R O F I T S V E R S U S C A S H F L O W S AS A D E T E R M I N A N T OF T H E D I V I D E N D D E C I S I O N IN T H E U N I T E D S T A T E S , 1 957 TO 1966 S o u r c e : " D i v i d e n d s F e e l the B u s i n e s s W e e k , M a r c h 18, 1967 , p P r e s s u r e , 59 . I l l D h r y m e s and K u r z o b s e r v e d i n a s tudy of e l e c -t r i c u t i l i t i e s that the a g g r e g a t e payou t r a t i o was r e -m a r k a b l y s t a b l e o v e r the y e a r s , yet i n d i v i d u a l f i r m s 9 d i s p l a y e d v a r i a t i o n s i n the payout r a t i o f r o m 0 to 1 .8 . The a u t h o r s s p e c i f i c a l l y c r i t i c i z e d the o r i g i n a l L i n t n e r f o r m u l a t i o n f o r i t s a u t o r e g r e s s i v e n a t u r e and i t s c o n -sequen t l i m i t a t i o n to s h o r t - r u n p r e d i c t i o n s of a g g r e -gate d i v i d e n d s . In s p i t e of these c r i t i c i s m s L i n t n e r ' s w o r k r e -m a i n s the c l a s s i c i n the d i v i d e n d d e c i s i o n a r e a . H i s f o r m u l a t i o n has been more w i d e l y u sed and e x t e n d e d than any o t h e r . L a t e i n 1966 B i c k s l e r c o m m e n t e d : At t h i s po in t i n t i m e , i t i s f e l t that the L i n t n e r m o d e l i s the mos t s u c c e s s f u l a t t emp t to e x p l a i n 9 the d e t e r m i n a n t s of d i v i d e n d b e h a v i o u r of the f i r m . I V . D I V I D E N D M O D E L S A P P L I E D T O C A N A D I A N D A T A P u r p o s e The p u r p o s e of t h i s s e c t i o n i s to t e s t v a r i o u s h y p o t h e s e s b a s e d on the r e s u l t s . o f the q u e s t i o n n a i r e and o b s e r v a t i o n s of f i n a n c i a l da ta a n d , i n t h i s w a y , to P . J . D h r y m e s and M . . K u r z , "On the D i v i d e n d P o l i c y , of E l e c t r i c U t i l i t i e s , " R e v i e w of E c o n o m i c s and S t a t i s t i c s , v o l . X L V I ( F e b r u a r y 1964) , p . 76 . B i c k s l e r , o p . c i t . , p . 56 . 112 i n d i c a t e the n a t u r e of the d i v i d e n d d e c i s i o n i n C a n a d a . A n a l t e r n a t i v e a p p r o a c h to L i n t n e r ' s ' was s e l e c t e d f o r the f o l l o w i n g r e a s o n s : (1) o b s e r v e d i n t e r - i n d u s t r y d i f f e r e n c e s i n d i v i -dend b e h a v i o u r ; (2) doubts as to the i m p o r t a n c e of pas t d i v i d e n d s i n many s e c t o r s of the e c o n o m y ( O v e r o n e - h a l f of the r e s p o n d e n t s d e n i e d that the q u e s t i o n of c h a n g i n g pas t d i v i d e n d s was mos t i m p o r t a n t . ) ; (3) n u m e r o u s c l a i m s that no t a r g e t payou t r a t i o e x i s t e d ; (4) c r i t i c i s m s s u b s e q u e n t to the o r i g i n a l L i n t n e r f o r m u l a t i o n . B e c a u s e the d i v i d e n d p o l i c y of d e c l i n i n g c o m -p a n i e s i s u s u a l l y m o r e o b v i o u s and b e c a u s e f i r m s w h i c h make d i v i d e n d p a y m e n t s out of n e g a t i v e i n c o m e w o u l d not be e x p e c t e d to f o l l o w a l i n e a r e x t e n s i o n of the b e -h a v i o u r o b s e r v e d f o r f i r m s h a v i n g p o s i t i v e i n c o m e , o n l y f i r m s w i t h at l e a s t n e a r - a v e r a g e g r o w t h c h a r a c -t e r i s t i c s we re c o n s i d e r e d . D h r y m e s and K u r z The i n i t i a l and i n t e r m e d i a t e m o d e l s ( d e s c r i b e d i n a l a t e r p a r t of t h i s s e c t i o n ) w e r e adap ted f r o m two used by D h r y m e s and K u r z i n a s tudy of e l e c t r i c u t i l i t y 113 3 0 d i v i d e n d p r a c t i c e s . T h e i r b a s i c m o d e l i s as f o l l o w s : (14) D = a Q - f B o P + B 1 H - B 2 ( L T D ) + B g Z W h e r e : D = amount of d i v i d e n d s p a i d P = p r o f i t I = inv e s t m e n t L T D = i n d e b t e d n e s s Z = c o n t r o l v a r i a b l e B ' s = net r e g r e s s i o n c o e f f i c i e n t s B e c a u s e of i t s i m p o r t a n c e , s i z e was a l s o i n c l u d e d as an i n d e p e n d e n t v a r i a b l e . In o r d e r to i s o l a t e i t s e f fec t and to o v e r c o m e the m u l t i c o l l i n e a r i t y be tween i t and the o t h e r v a r i a b l e s , mos t of the v a r i a b l e s i n c l u d i n g d i v i d e n d s we re n o r m a l i z e d by s i z e . The D h r y m e s and K u r z s tudy c o n c l u d e d tha t : 9 1.. The c o e f f i c i e n t of d e t e r m i n a t i o n , R , was . 530 . 2. P r o f i t s were s i g n i f i c a n t . 3.. S i z e was h i g h l y s i g n i f i c a n t ; s m a l l f i r m s p a i d a r e l a t i v e l y l o w e r d i v i d e n d than l a r g e f i r m s . 4. I n v e s t m e n t and i n d e b t e d n e s s v a r i a b l e s were n e g a t i v e and s i g n i f i c a n t at 10 pe r c e n t . 5. The c o n t r o l v a r i a b l e ( deg ree of g o v e r n m e n t r e g u l a t i o n ) was p o s i t i v e and s i g n i f i c a n t at 5 pe r c e n t . D h r y m e s and K u r z , o p . c i t . , p . 79 . 114 6. Two a d d i t i o n a l v a r i a b l e s , l i q u i d i t y and v a r i -a b i l i t y of i n c o m e , we re i n s i g n i f i c a n t when a d d e d . The a u t h o r s s u g g e s t e d that t h e i r c h o i c e of i n d u s t r y was not a good one b e c a u s e of the s e m i p o l i t i c a l f a c t o r s i n v o l v e d and the d i f f i c u l t y i n q u a n t i f y i n g d i f f e r e n c e s i n the c o n t r o l l i n g pow:e r s of l o c a l r e g u l a t o r y c o m m i s s i o n s . The me thod u sed by D h r y m e s and K u r z to n o r m a -l i z e r e g r e s s i o n e q u a t i o n s was e x a m i n e d fo r s p u r i o u s c o r r e l a t i o n . P e a r s o n was the f i r s t s t a t i s t i c i a n to ob -s e r v e that the c o r r e l a t i o n be tween dependent and i n -dependent r a t i o s h a v i n g a c o m m o n d e f l a t o r can be -l a r g e r than the c o r r e l a t i o n be tween the n u m e r a t o r 3 1 s e r i e s . H o w e v e r , M e y e r and' K u h have e x a m i n e d i n d e t a i l the p r e c i s e q u e s t i o n at hand and have e x p l a i n e d that s u c h s p u r i o u s c o r r e l a t i o n can e x i s t i n any r e g r e s -s i o n a n a l y s i s o n l y when an h y p o t h e s i s p e r t a i n s to u n -d e f l a t e d v a r i a b l e s ; an h y p o t h e s i s f o r m u l a t e d i n t e r m s of r a t i o s such as payout i s b i a s f r e e . F u r t h e r m o r e , i n the ca se of s i z e d e f l a t i o n w i t h c o m p a n y , c r o s s - s e c t i o -n a l d a t a , an u p w a r d b i a s e x i s t s o n l y when some of the . K . P e a r s o n , "On a F o r m of S p u r i o u s C o r r e l a -t i o n w h i c h M a y A r i s e when I n d i c e s A r e U s e d i n the M e a s u r e m e n t of O r g a n s , " P r o c e e d i n g s of the R o y a l S o c i e t y of L o n d o n , v o l . L X ( 1897 ) , p p . "3 8~9"^~4 9~o": 115 v a r i a b l e s . . . a s s u m e n e g a t i v e v a l u e s . . . j l i n d f u r t h e r t h i s b i a s , i f p r e s e n t T j . . . s h o u l d not be v e r y l a r g e . . . s i n c e the s m a l l e r f i r m s , c a n n o t , r e -l a t i v e to the l a r g e r f i r m s , have v a l u e s v e r y f a r f r o m the o r i g i n . T h u s , u n d e r a wide r a n g e - o f c i r c u m s t a n c e s , the r a t i o e s t i m a t e s s h o u l d not be g r e a t l y b i a s ed i n a p p l i c a t i o n s to c r o s s - s e c -t i o n d a t a . I n i t i a l M o d e l S t r u c t u r e . The f i r s t m o d e l , d e p i c t e d i n F i g u r e 4 , was d e s i g n e d to i n c o r p o r a t e s e v e r a l b r o a d c a t e -g o r i e s of e x p l a n a t o r y v a r i a b l e s . Dependent variable Independent variables Common dividends Category (Future , Present prospects p rofits after tax and preferred d ividends A B Size, Present ; and planned investment C Long, Working) term capital debt D F I G U R E 4 I N I T I A L M O D E L J . R. Meyer and E . Kuh, The Investment Decision, An Empir i-cal Study, Cambridge, Massachusetts, Harvard University Press, 1957, pT 2(34; see also C. Christ and G. Orcutt, "Correlation and Regression Estimates When the Data are Ratios, " Econometrica, vol. XXUI (October, 1955), pp. 400-416. Thus no significant bias entered the results of the studies in this Section especially since, for reasons stated, declining companies were not considered. In the all-industries sample only five negative investment variables were present and in the forest products sample, none. Any of the observations of the variable representing cash needs that were negative were set to zero. .i . 116 The c o m p o n e n t s of each of the f o u r c a t e g o r i e s we re e x p e c t e d to have an i m p a c t on the d e c i s i o n to pay c o m m o n d i v i d e n d s . T h e f u t u r e p r o s p e c t s v a r i a b l e (A) was e m b o d i e d i n the m o d e l not o n l y . t o r e f l e c t the i m p a c t of the b u s i n e s s c y c l e and the e x p e c t e d o u t l o o k f o r the f i r m and the i n d u s t r y but a l s o to c o m p l e m e n t the p r e s e n t p r o f i t v a r i a b l e . A c c o r d i n g to the r e s u l t s of the q u e s t i o n n a i r e , d i r e c t o r s do not change the d i -v i d e n d on the b a s i s of p r o f i t a l o n e but mus t be c o n f i -dent of c o n t i n u e d , s t e a d y p r o f i t s . - M e a s u r e m e n t of f u t u r e p r o s p e c t s was o r i g i n a l l y c o n c e i v e d on the p r e -m i s e that m a n a g e m e n t c o n s i d e r s the s a l e s i n c r e a s e i n the c u r r e n t y e a r as w e l l as t h e , s a l e s f o r e c a s t f o r the c o m i n g ye'ar as i n d i c a t i v e of the f u t u r e . B e c a u s e of the h i g h d e g r e e of u n c e r t a i n t y u s u a l l y a s s o c i a t e d 'w i th the d i s t a n t f u t u r e , , l o n g - t e r m e s t i m a t e s we re p r e s u m e d to be h i g h l y c o r r e l a t e d bo th w i t h p r e s e n t s u c c e s s and w i t h the i m m e d i a t e - f u t u r e o u t l o o k . C o n s e q u e n t l y , the s a l e s i n c r e a s e i n t h e y ear that the da ta we re used (1964) was . ave raged w i t h the i n c r e a s e i n the subsequen t y e a r - ( 1965) . The p r o f i t v a r i a b l e (B) r e f l e c t s bo th f i r m e f f i c i e n c y and p a y i n g p o w e r and i s the m a j o r means of c o m m u n i c a t i o n to the s h a r e h o l d e r , a d e t e r m i n a n t of h i s a t t i t u d e and d e m a n d . S i z e and i n v e s t m e n t (C) a l s o r e f l e c t d y n a m i c d e v e l o p m e n t , and m o r e s p e c i f i c a l l y , f i n a n c i a l p o w e r (ease of f i n a n c e ) and t e n d e n c y to g r o w t h . 117 I n v e s t m e n t i n the c u r r e n t y e a r (1964) was a v e r a g e d w i t h that i n the f o l l o w i n g y e a r to a p p r o x i m a t e the i n -v e s t m e n t p r o g r a m ' s i m p a c t on the d r a i n of f u n d s . S i z e was m e a s u r e d by t o t a l a s s e t s . Debt and w o r k i n g c a p i t a l (D) r e f l e c t the c u r r e n t p o s i t i o n , e s p e c i a l l y the e f fec t of c a p i t a l s t r u c t u r e , f i n a n c i a l r i s k , and l i q u i d i t y . The m o d e l a s s u m e d these c o m p o n e n t s to be g i v e n o r p r e d e t e r m i n e d and the dependent v a r i a b l e , d i v i d e n d p a y m e n t s , to be the d e c i s i o n v a r i a b l e . F u r -t h e r , p r e f e r r e d d i v i d e n d s were c o n s i d e r e d e q u i v a l e n t to i n t e r e s t . The r e g r e s s i o n e q u a t i o n w h i c h i s ba sed on the m a t e r i a l i n F i g u r e 4 i s as f o l l o w s : (15) D = a 0 - + B 1 F P f B 2 P + B 3 S + B 4 I N V + B 5 L T D + B g W C A l l v a r i a b l e s excep t s i z e and f u t u r e p r o s p e c t s were n o r m a l i z e d by s i z e . B o t h the i n i t i a l m o d e l and the r e g r e s s i o n equa -t i o n i n c o r p o r a t e d , i n one way or a n o t h e r , a l l f a c t o r s c o n s i d e r e d v e r y i m p o r t a n t by q u e s t i o n n a i r e r e s p o n d e n t s e x c e p t pas t d i v i d e n d s . T h e s e c o u l d not l o g i c a l l y be i n -c l u d e d a l t h o u g h they a p p e a r to r e p r e s e n t m a n a g e m e n t s ' i n h e r e n t c o n s e r v a t i v e n a t u r e . If i n m o s t c a s e s the same independen t v a r i a b l e s r e m a i n e d unchanged o v e r the y e a r s , the d i v i d e n d w o u l d r e m a i n u n c h a n g e d , and the pas t d i v i d e n d w o u l d be h i g h l y c o r r e l a t e d w i t h the 118 c u r r e n t d i v i d e n d and w o u l d be t e r m e d a h i g h l y s i g n i -f i c a n t e x p l a n a t o r y v a r i a b l e . M u c h of the c o n s e r v a t i s m i s a c c o u n t e d f o r by e x p e c t a t i o n s and the d y n a m i c f a c -t o r s ( fu ture p r o s p e c t s and i n v e s t m e n t p l a n s , f o r e x -a m p l e ) . The e l e m e n t of u n c e r t a i n t y w h i c h i s not a c c o u n t e d f o r by the d y n a m i c v a r i a b l e s r e f l e c t s the c o n s e r v a t i s m not e x p l a i n e d by the m o d e l . B e c a u s e of i t s o b s e r v e d i m p o r t a n c e ( A p p e n d i x D) and b e c a u s e of i t s r e l a t i o n to f i n a n c i n g p l a n s , an i m p o r t a n t f a c t o r , s i z e ( a l t h o u g h not l i s t e d on the q u e s t i o n n a i r e fo r r e a s o n s s t a t e d on page 8 9) was added to the r e g r e s s i o n e q u a t i o n . A l s o , bo th f i n a n c i n g and c a p i t a l s t r u c t u r e , w h i c h we re c o n s i d e r e d i m p o r t a n t by d i r e c t o r s , a r e r e f l e c t e d i n the m o d e l by l o n g - t e r m deb t . R e g r e s s i o n r e s u l t s . The m o d e l was t e s t e d w i t h 1964 data f r o m t w e n t y - f i v e c o m p a n i e s i n the f o r e s t p r o -duc ts i n d u s t r y (.see A p p e n d i x G ) . The F i n a n c i a l P o s t  S u r v e y of I n d u s t r i a l s 1966 p r o v i d e d t h i s i n f o r m a t i o n . R e s u l t s of the t e s t i n g a p p e a r i n T a b l e X I V . T A B L E . X I V I N I T I A L M O D E L A P P L I E D TO 25 F I R M S IN T H E F O R E S T I N D U S T R Y , 1964 Variable Net regression Standard F-ratios F-test Partial coefficient error significance correlation level coefficient t-test ' significance level A o 0. 013 B X (FP) - 0. 0995 0. 0411 5.8710 5% 1% B 2 ( P ) 0. 3737 0. 1079 11.9955 1 1 Bg(S) 0. 0598 0. 0262 5,1950 5 1 B 4 ( D 0. 0175 0. 0361 0.2356 not sig. 15 B (LTD) 5 - 0. 0194 0. 0207 0.8861 not sig. 5 B 6(WC) 0. 0005 0. 0134 0.0013 not sig. not R = 0.806 R 2 = 0.648 120 The v a r i a b l e s e x p l a i n e d 65 p e r cent of the 9 v a r i a t i o n i n d i v i d e n d s i n the f o r e s t i n d u s t r y . R was v e r y s i g n i f i c a n t unde r the F - i t e s t . Tha t f u t u r e ' p r o s p e c t s were h i g h l y s i g n i f i c a n t c o u l d be the r e s u l t of one of two s i t u a t i o n s a r i s i n g f r o m e x p e c t e d h i g h p r o f i t s i n the f u t u r e : a c o r r e s -p o n d i n g i n c r e a s e i n d i v i d e n d s or s t i m u l a t i o n of i n v e s t -ment p l a n s and a c o n s e q u e n t need f o r f u n d s . The n e g a -t i v e c o e f f i c i e n t i n d i c a t e d the l a t t e r . A l t h o u g h a h i g h c o r r e l a t i o n w o u l d then be ' expec ted be tween fu tu re p r o s p e c t s and i n v e s t m e n t , the p a r t i a l c o r r e l a t i o n c o e f f i c i e n t be tween the two was not s i g n i f i c a n t . T h i s a p p a r e n t p a r a d o x w o u l d be r e c o n c i l e d i f m u c h of the i n v e s t m e n t u n d e r t a k e n was b a s e d on v e r y l o n g - t e r m e x p e c t a t i o n s and was not n e c e s s a r i l y e x p e c t e d to be p r o f i t a b l e i n the i m m e d i a t e f u t u r e . T h i s s i t u a t i o n may be un ique to the f o r e s t i n d u s t r y and may be the r e s u l t of the s y s t e m of t i m b e r a l l o t m e n t ( s u c h as the g u a r -antee of a m i l l ) i n one o r m o r e of the m a j o r f o r e s t r y p r o v i n e e s . B 2 may be i n t e r p r e t e d as the m a r g i n a l p r o p e n s i t y to pay d i v i d e n d s out of p r o f i t s . F o r e v e r y d o l l a r of p r o -f i t i n c r e a s e the e q u a t i o n ' s po in t e s t i m a t e y i e l d e d a d i -v i d e n d i n c r e a s e of t h i r t y - s e v e n c e n t s . The p o s i t i v e s i g n of Bg i n d i c a t e d that l a r g e r f i r m s pay h i g h e r d i v i d e n d s ; t h i s r e s u l t was e x p e c t e d 121 b e c a u s e l a r g e f i r m s a r e of ten m o r e r e a d i l y a c c e p t e d by i n v e s t o r s and g e n e r a l l y have g r e a t e r ease i n f i n a n -c i n g . S m a l l e r f i r m s a r e f o r c e d to f i n a n c e a l a r g e r p o r t i o n of t h e i r i n v e s t m e n t by i n t e r n a l m e a n s . The i n s i g n i f i c a n c e of the i n v e s t m e n t v a r i a b l e may be a t t r i b u t e d to w e a k n e s s i n the m e a s u r e u s e d . O r , the p e r i o d ' s e x p a n s i o n may have been f i n a n c e d s e p a r a t e l y f r o m o u t s i d e s o u r c e s . O r , the f o r e s t i n -d u s t r y may have been a bad e x a m p l e b e c a u s e of the t r e m e n d o u s e x p a n s i o n by a l m o s t a l l c o m p a n i e s i n the p e r i o d s t u d i e d . . M o r e . l i k e l y h o w e v e r , h e t e r o g e n e o u s r e s u l t s were due to c o n f l i c t i n g n e e d s . G r o w t h o r h i g h i n v e s t m e n t f i r m s not o n l y need o u t s i d e funds and c o n -s e q u e n t l y good r e l a t i o n s w i t h the c a p i t a l m a r k e t ( these needs a r e m u c h l e s s i m p o r t a n t to s t agnan t f i r m s ) , but a l s o may r e c e i v e o t h e r b e n e f i t s f r o m a g e n e r o u s d i v i -dend p o l i c y ( such as s h o r t - r u n p r i c e a p p r e c i a t i o n ) . T h i s t endency f o r h i g h d i v i d e n d s c o n f l i c t s w i t h the i m m e d i a t e need f o r f u n d s . A l t h o u g h l o n g - t e r m debt was i n s i g n i f i c a n t , i t s i n c l u s i o n was i n t e n d e d to r e f l e c t the h y p o t h e s i s tha t ' h i g h l y i n d e b t e d f i r m s w o u l d r e d u c e debt to a p p r o a c h a p r e f e r a b l e ( l e s s r i s k y ) c a p i t a l s t r u c t u r e and w o u l d r e -t a i n e a r n i n g s f o r t h i s p u r p o s e . I n d e e d , the n e g a t i v e c o e f f i c i e n t i n d i c a t e d t h i s t e n d e n c y . P e r h a p s , debt ire..--paymen t i n the p r e s e n t and i m m e d i a t e f u t u r e has g r e a t e r m e a n i n g to d i r e c t o r s . 122 T h a t the l i q u i d i t y v a r i a b l e f a i l e d may s t i l l be c o n s i s t e n t w i t h the h y p o t h e s i s . A l t h o u g h c a s h r e s o u r c e s we re s t a t e d by s e v e r a l d i r e c t o r s to be i m p o r t a n t , the v e r y i m p o r t a n t v a r i a b l e was the p r e s e n t and a n t i c i p a t e d need f o r c a s h . The a s s u m p t i o n that a low w o r k i n g c a -p i t a l p o s i t i o n means a g r e a t e r need f o r c a s h i s p r o -b a b l y i n c a r r e c t . The i n i t i a l m o d e l has e x p l a i n e d , d i v i d e n d p a y -men t s of c o m p a n i e s i n the f o r e s t i n d u s t r y i n t e r m s of p r o f i t s , f u t u r e p r o s p e c t s , and s i z e . B e c a u s e c e r t a i n v a r i a b l e s were c l e a r l y s i g n i f i c a n t and v i c e v e r s a , no a t t emp t was made to use the s t e p w i s e r e g r e s s i o n t e c h -n ique on t h i s m o d e l . The same m o d e l was a p p l i e d to s i x t y f i r m s r a n -d o m l y s e l e c t e d f r o m a l l i n d u s t r i e s ( A p p e n d i x G ) . The h y p o t h e s i s was r e a d i l y a c c e p t e d by the F - t e s t (R = .560) a l t h o u g h the r e s u l t s we re not as s u c c e s s f u l as w i t h the f o r e s t r y f i r m s . ' • The f o ITO'W'ing were o b s e r v e d : 1. P r o f i t s and s i z e we re bo th s i g n i f i c a n t at 1 pe r cent ( F - t e s t ) ; i n d e b t e d n e s s was s i g n i f i c a n t o n l y at 20 pe r cent and the o t h e r s were even l e s s s i g n i f i c a n t . 2. F u t u r e p r o s p e c t s and i n v e s t m e n t s we re h i g h l y c o r r e l a t e d ( p a r t i a l c o r r e l a t i o n c o e f f i c i e n t of .58) s u p -p o r t i n g the t e n t a t i v e e x p l a n a t i o n on page;; 1 2 0 - . : . . ' . 123 3. S i m p l e c o r r e l a t i o n y i e l d e d i n d e b t e d n e s s s i g -n i f i c a n t at 2-jjr pe r cent and fu tu re p r o s p e c t s at 15 p e r c e n t . 4 . . M a r g i n a l p r o p e n s i t y to pay d i v i d e n d s was . 24. . The p r o f i t , s i z e , and l i q u i d i t y v a r i a b l e s in the i n i t i a l m o d e l showed s i m i l a r r e s u l t s to the e q u i v a l e n t v a r i a b l e s i n the D h r y m e s and K u r z m o d e l , but l o n g -t e r m debt and i n v e s t m e n t w e r e m o r e s i g n i f i c a n t i n t h e i r t e s t s . I n t e r m e d i a t e M o d e l S t r u c t u r e . The i n t e r m e d i a t e m o d e l ( a l s o pa t -t e r n e d a f t e r one by D h r y m e s and K u r z ) was d e s i g n e d to t e s t the e f fec t of b a s i c a l l y the same i n d e p e n d e n t v a r i a b l e s as shown i n F i g u r e 4 , page 11-5', but on p a y -out r a t i o . Common dividends = Profits after taxes and preferred dividends (Future , Profitability, Size, Investment, Long, Working) prospects ' term capital debt F I G U R E 5 I N T E R M E D I A T E M O D E L F o u r i ndependen t to i s o l a t e s i z e . v a r i a b l e s were n o r m a l i z e d by s i z e 124 R e g r e s s i o n r e s u l t s . The e x p l a n a t o r y v a r i a b l e s e x p l a i n e d 44 pe r cent of the v a r i a t i o n i n payout r a t i o and the h y p o t h e s i s was s t i l l e a s i l y a c c e p t e d by the F - t e s t . F u t u r e p r o s p e c t s and s i z e were s i g n i f i c a n t , a l t h o u g h not as s i g n i f i c a n t as i n the f i r s t m o d e l . T h e p r o f i t m e a s u r e now r e f e r r e d to p r o f i t a b i l i t y and b e -came much l e s s s i g n i f i c a n t ( s i g n i f i c a n t at 15 pe r c e n t ) , w h i c h i s c o n s i s t e n t w i t h the h y p o t h e s i s that p r o f i t -a b i l i t y i s c o n s i d e r e d to have o n l y some i m p o r t a n c e . The fac t that the c o e f f i c i e n t was n e g a t i v e a l s o s u p p o r t s the t h e o r e t i c a l i m p l i c a t i o n s that g r e a t e r p r o f i t a b i l i t y s h o u l d l e a d to g r e a t e r r e t e n t i o n . I n v e s t m e n t and w o r -k i n g c a p i t a l were s t i l l i n s i g n i f i c a n t , and when these two e l e m e n t s were d r o p p e d ( s t e p w i s e r e g r e s s i o n ) the o v e r a l l r e s u l t s d i d not c h a n g e . L o n g - t e r m debt was s i g n i f i c a n t at 10 pe r cent and had a n e g a t i v e c o e f f i -c i e n t . A g a i n , none of the p a r t i a l c o r r e l a t i o n c o e f f i -c i e n t s be tween the i n d e p e n d e n t v a r i a b l e s were n e a r l y l a r g e enough to w a r r a n t c o m b i n i n g t h e m . The a v e r a g e payout r a t i o was 4 6 per c e n t . T A B L E X V I N T E R M E D I A T E M O D E L A P P L I E D TO 25 F I R M S I N T H E F O R E S T I N D U S T R Y , 1964 Variable Net regression coefficient Standard error F-ratios F-test significance level A o .803 B ^ F P ) 1.3923 . 0.6134 5.1521 5% B 2(P) - 2.5827 1.6120 2.5671 15 Bg(S) 0.7124 0.3921 3.3006 10 B4(I) 0.6916 0.5398 1.6419 20 B 5 (LTD) 0.5818 0.3086 3.5543 • 10 B.(WC) 6 - 0.0718 0.2001 0.1286 not sig. R = 0.662 R 2 = 0.438 126 The i n t e r m e d i a t e m o d e l was a l s o a p p l i e d to the s i x t y f i r m s . H o w e v e r , the h y p o t h e s i s was r e -j e c t e d by the F - t e s t at the 5 pe r cent s i g n i f i c a n c e l e v e l , and none of the v a r i a b l e s we re s i g n i f i c a n t at even the 10 pe r cent l e v e l . The o b v i o u s c o n c l u s i o n was that t h i s m o d e l has adequa te e x p l a n a t o r y a b i l i t y when a p p l i e d to a p a r t i c u l a r i n d u s t r y but f a i l e d to a c c o u n t f o r i n t e r - i n d u s t r y d i f f e r e n c e s . F i n a l M o d e l S t r u c t u r e . The f i n a l m o d e l was i n t e n d e d to ex tend the a n a l y s i s by s t r u c t u r i n g a m o r e r i g o u r o u s and i n c l u s i v e h y p o t h e s i s b a s e d on the i n f o r m a t i o n r e c e i v e d f r o m the r e t u r n e d q u e s t i o n n a i r e s . T h i s h y -p o t h e s i s i s d e l i n e a t e d i n F i g u r e 6 w h i c h shows the i n t e r r e l a t i o n s h i p s be tween many f a c t o r s and t h e i r r e l a t i o n s h i p to the d i v i d e n d d e c i s i o n . The t e r m c o n -s e r v a t i s m r e f e r s to the d e s i r e to s t a y w i t h the o l d d i v i d e n d , that i s , the d i r e c t o r s ' h e s i t a n c y to r a i s e d i v i d e n d s i n s p i t e of a p p a r e n t h i g h p r o f i t s and o t h e r f a v o u r a b l e f i n a n c i a l f i g u r e s . SHARE PRTCE (3) USE OF STOCK SPLITS, DIVIDENDS (3) STRUCTURE OF OWNERSHIP AND CONTROL GROUP (U) PERSONAL TAX POSITION X COMPETITORS' PAYOUT RATIO 1—W BUSINESS CYCLE CONDITIONS UNCERTAINTY AND ATTITUDE TOWARDS SAME -a) SHAREHOLDERS' ATTITUDES (3) INVESTORS' ATTITUDES CAPITAL MARKET DIRECTORS' PERSONAL PRIDE DIRECTORS' BIAS AGAINST DECREASE COMPANY POSITION EXPECTED GROWTH IN EARNINGS AND SALES 1) EXPECTED VARIABILITY IN EARNINGS OR TALES CONSERVATISM OR IMPORTANCE OF PAST DIVIDENDS COST OF CAPITAL CAPITAL STRUCTURE (2) INTERNAL OPERATING RISK 2) PRESENT PROFIT DEPRECIATION COM S PA NY IZE \ FINANCING PLANS (2) (1) (1) DIVIDEND PRESENT A*T> ANTICIPATED NEED FOR CASH 71 PAY LONG TERM DEBT Ti) RE INVENTORY CHANGES INVESTMENT PROJECTS 1 (1) RATE OF RETURN ON CAPITAL 71 MANAGEMENT ABILITY 2) INTERNAL OPERATING RISKS (3) CAPITAL STRUCTURE (2) NATURAL . ADVANTAGES FIGURE 6 STRUCTURE OF THE DIVIDEND DECISION IN CANADA, BASED ON 33 DIRECTORS' STATED OPINIONS Note: Numbers next t o the lower, r i g h t c o r n e r o f some boxes i n d i c a t e the im-portance of the f a c t o r s as ranked by the Canadian d i r e c t o r s ( r a n k i n g of importance: (11 v e r y , (21 c o n s i d e r a b l y , (3) somevhat, (U) n o t ) . 128 The f i n a l m o d e l , F i g u r e 7, i s a c o n d e n s a t i o n of F i g u r e 6 and i s d e s i g n e d (1) to t ake in to a c c o u n t each b r o a d c a t e g o r y of f a c t o r s that has an i m p a c t on the d e c i s i o n and (2) to i n c o r p o r a t e as many of the componen t f a c t o r s as p o s s i b l e in to a m e a s u r e s u i t a b l e fo r c o r r e l a t i o n a n a l y s i s . Dividends = ^(Conservatism, Cash available, Cash needs, Size) Where: Conservatism = I (Expected.growth, Variability in growth, Uncertainty, J Reaction to uncertainty, Shareholders' attitudes) Cash available = j" (Profits, Depreciation) Cash needs = j (Investment, Planned inventory changes, Research, ) Debt reduction or increase, Capital stock changes) Ease of fund access, Low relative transaction costs, Economies of scale = •• (Size) F I G U R E 7 F I N A L M O D E L C o n s e r v a t i s m was m e a s u r e d by the change i n d i v i d e n d s o v e r the change i n p r o f i t s f o r a two y e a r p e r i o d . A l t h o u g h l a c k i n g i n the a b i l i t y to e x p l a i n the i m p o r t a n c e of each c o n t r i b u t i n g v a r i a b l e , t h i s s i n g l e f a c t o r had the advan tage of w e i g h i n g and s y n t h e s i z i n g a l l these v a r i a b l e s in to one f i g u r e . Of the two c o m -ponents of the c a s h - f l o w - m e a s u r e , p r o f i t was e x p e c t e d to have a g r e a t e r i m p a c t b e c a u s e of i t s i n f o r m a t i o n a l q u a l i t i e s . T h u s , the two v a r i a b l e s w e r e u s e d s e p a r a t e l y 129 Of a l l the c o m p o n e n t s of the c a s h - n e e d s v a r i a b l e , i n -v e s t m e n t , funded debt c h a n g e s , and c a p i t a l s t o c k changes w e r e c o n s i d e r e d the m o s t i m p o r t a n t and w e r e c o m b i n e d in to one m e a s u r e . S i z e was a g a i n m e a s u r e d by t o t a l a s s e t s . R e g r e s s i o n r e s u l t s . The m o d e l was e a s i l y a c -c e p t e d ( R . = : . 5 2 0 ) but was o n l y m o d e r a t e l y s u c c e s s f u l when a p p l i e d to the s i x t y f i r m s . P r o f i t s and s i z e w e r e the o n l y v a r i a b l e s s i g n i f i c a n t at the 1 pe r cent l e v e l unde r m u l t i p l e a n a l y s i s . H o w e v e r , a l l v a r i a b l e s e x -cept c o n s e r v a t i s m were s i g n i f i c a n t at 10 pe r cent u n d e r s i m p l e r e g r e s s i o n . The fac t that the c o n s e r v a t i s m v a r i a b l e f a i l e d c o m p l e t e l y may be due to the i n a d e q u a c y of the m e a s u r e . A p e r i o d l o n g e r than two y e a r s w o u l d have been b e t t e r than the two y e a r p e r i o d s i n c e some f i r m s were i n the hab i t of c h a n g i n g the d i v i d e n d amount l e s s o f ten than i n two y e a r i n t e r v a l s . But to the ex ten t that the m e a -s u r e was a d e q u a t e , the r e s u l t s i n d i c a t e that the d e g r e e of c o n s e r v a t i s m has no c o n n e c t i o n w i t h the amount of d i v i d e n d s p a i d ou t . T h i s q u a l i f i e d c o n c l u s i o n w o u l d s u g -gest that pas t d i v i d e n d s a r e c o n s i d e r e d i m p o r t a n t by many b e c a u s e of r e a s o n s s t a t e d on pages 117 .and 118 . The fac t that the d e p r e c i a t i o n v a r i a b l e was not e s p e c i a l l y s i g n i f i c a n t and the p r o f i t v a r i a b l e h i g h l y s i g n i f i c a n t i n d i c a t e d that c a s h flow i s a l e s s d e s i r a b l e 130. b a s i c f a c t o r than p r o f i t . In s p i t e of the i n h e r e n t b i a s i n f a v o u r of c a s h f l o w s , t h i s o b s e r v a t i o n was s u b s t a n t i a t e d i n a s u b s e q u e n t c h e c k where bo th c a s h f l o w s and p r o f i t s we re c o r r e l a t e d ( s i m p l e ) w i t h d i v i -d e n d s . C o m m e n t s The m o d e l s have i n d i c a t e d the r e l a t i v e i m p o r -tance of the m a j o r f a c t o r s i n v o l v e d i n the d i v i d e n d d e c i s i o n i n C a n a d a and have o v e r c o m e c e r t a i n c r i t i -c i s m s of L i n t n e r ' s m o d e l , e s p e c i a l l y those c o n c e r n i n g i t s a u t o r e g r e s s i v e n a t u r e and l a c k of e x p l a n a t o r y a b i l i t y . ' M o r e o v e r , the m e t h o d s have d e m o n s t r a t e d c e r -t a i n d i f f i c u l t i e s i n h e r e n t i n any s t u d y of t h i s n a t u r e . One of these i s the m e a n i n g f u l q u a n t i f i c a t i o n of v a r i -a b l e s u n d e r c o n s i d e r a t i o n , e s p e c i a l l y those c o n c e r n e d w i t h the fu tu re o u t l o o k ; a n o t h e r i n v o l v e s a c c o u n t i n g f o r the i n t e r r e l a t i o n s h i p s b e t w e e n the many v a r i a b l e s . S t i l l a n o t h e r p r o b l e m a r i s e s f r o m the f ac t that the d i v i d e n d d e c i s i o n r e m a i n s a s u b j e c t i v e one , and hence the d e c i s i o n p r o c e s s may v a r y r a d i c a l l y a m o n g n e a r l y i d e n t i c a l f i r m s . T h u s , no m o d e l can a d e q u a t e l y e x p l a i n the m e c h a n i s m f o r a p a r t i c u l a r f i r m on the b a s i s of f i n a n c i a l d a t a . Such a t a sk mus t be le f t to i n t e r v i e w i n g , and s u c h a s t udy w o u l d ex t end in to the b e h a v i o u r a l f i e l d . M o d e l s d e s i g n e d to meet the o b j e c t i v e s , of t h i s s tudy mus t r e m a i n g e n e r a l . C H A P T E R V I I A G G R E G A T E E C O N O M I C S A N D T H E D I V I D E N D D E C I S I O N The au tho r of one of the m o s t p e r c e p t i v e r e s -ponses to the q u e s t i o n n a i r e s u g g e s t e d , when r e f e r r i n g to the l o n g l i s t of f a c t o r s c o m p o s i n g d i v i d e n d p o l i c y , . . . that i t i s m o s t d i f f i c u l t to e v a l u a t e them excep t i n the l i g h t of c u r r e n t c o m p a n y and e c o n o -m i c c o n d i t i o n s . I suppose i n a n o t h e r s e v e r a l y e a r s I m i g h t a n s w e r y o u r q u e s t i o n s ' d i f f e r e n t l y . . . c h a n g i n g c o n d i t i o n s w o u l d i n f l u e n c e e v a l u a t i o n . O c c a s i o n a l r e m a r k s on e c o n o m i c c o n d i t i o n s w e r e a s -s e r t e d by o t h e r s ; s u c h e x p r e s s e d o p i n i o n s have i n s p i r e d t h i s c h a p t e r . The o b j e c t i v e s of the c h a p t e r a r e (1) to look at the d i v i d e n d d e c i s i o n f r o m the l e v e l of a g g r e g a t e e c o -n o m i c s and (2) to c o n s i d e r the i m p a c t of a g g r e g a t e v a r i a b l e s , and i n c o n j u n c t i o n w i t h t h e s e , g o v e r n m e n t 1 m a c r o e c o n o m i c p o l i c y . This chapter does not include an investigation of the entire macroeconomic area which is implicit in Figure 1 and which encom-passes the effect of dividend decisions.,ori''the national economy, and conversely, the effect of government policy on the dividend decision. Any attempt along these lines was rejected because of the scope in-volved and the intensive analysis required. The most complete and r i -gourous, published study on dividends, entitled Corporate Dividend  Policy, was done by John Brittain for the Brookings Institution. This treatise, written in the context of aggregate economics, concluded that depreciation liberality, corporate tax rates, individual tax rates, and interest rates are the four policy tools having an impact on the di-vidend decision in the American economy. The implications for and the intricacies involved with the entire public policy field were also 132 The c o n c l u s i o n on the m a j o r componen t v a r i a b l e s a r i s i n g f r o m the p o l l and a n a l y z e d i n C h a p t e r V I a r e r e p e a t e d h e r e . T h e y i n c l u d e : (1) c u r r e n t p r o f i t s ; (2) p r e s e n t and a n t i c i p a t e d need fo r c a s h ; (3) p l a n n e d i n v e s t m e n t p r o j e c t s ; (4) p a s t d i v i d e n d s ; (5) e x p e c t e d g r o w t h i n e a r n i n g s and s a l e s ; (6) e x p e c t e d v a r i a b i l i t y i n e a r n i n g s o r s a l e s . The d i r e c t o r s were p o l l e d i n M a r c h and A p r i l 1967 . T h e i r t h i n k i n g was l i k e l y c o n d i t i o n e d , i n p a r t , by the c u r r e n t e c o n o m i c s i t u a t i o n ; by the l o n g f a v o u r -ab le e c o n o m i c p e r i o d b e g i n n i n g i n 1962 o r 1963 a n d , as c l e a r l y i n d i c a t e d by the q u e s t i o n n a i r e r e s p o n s e s , by f u t u r e e x p e c t a t i o n s . W i t h r e s p e c t to g e n e r a l e c o n o m i c c o n d i t i o n s , managemen t e x p e c t a t i o n s a r e l a r g e l y s u m m a r i z e d i n c u r r e n t f i n a n c i a l and e c o n o m i c l i t e r a t u r e w h i c h to a c o n s i d e r a b l e ex ten t f a l l s b a c k on m o r e i n t e n s i v e s t u d i e s and f o r e c a s t s such- as those r e p o r t e d by the examined by Brittain. Whether his conclusions are relevant to Canada is another question. The Report of the Royal Commission on Taxation finds no such evidence. Their research staff observed (as stated on pp. 146-148, volume 2) that only changes in capital cost allowances would " . . . probably have . . . [jan] impact . . . . " ; both corporation and personal tax rate changes were concluded to have no effect on the pro-portion of payout. See: Report of the Royal Commission on Taxation, chairman, K. Le M . Carter, Ottawa, Queen's Printer, V3W~ 133 E c o n o m i c C o u n c i l of C a n a d a . 2 A g g r e g a t e d i v i d e n d s i n the p e r i o d of the q u e s -t i o n n a i r e were up 8 p e r cent o v e r the c o r r e s p o n d i n g s i x - m o n t h p e r i o d ( J a n u a r y to June) of 1966 , and a r e c o r d d i v i d e n d y e a r was f o r e c a s t . ^ Seven h u n d r e d t h i r t y - s e v e n m i l l i o n d o l l a r s we re p a i d out by C a n a -d i a n c o m p a n i e s i n the f i r s t h a l f of 1967 . I n d u s t r i a l s and p u b l i c u t i l i t i e s (on ly these two g r o u p s we re c o n -s i d e r e d i n t h i s t h e s i s ) showed an i n c r e a s e of about 5 4 pe r cent o v e r the p r e v i o u s h a l f y e a r . A l t h o u g h these d i v i d e n d i n c r e a s e s w e r e ' s t i l l c o n s i d e r a b l e and were r i s i n g f a s t e r than w o u l d be expec ted f r o m p r o f i t s o r p r o d u c t i v i t y , the g a i n was s i g n i f i c a n t l y l e s s than the 5 14 pe r cent e s t a b l i s h e d i n 19 6.5 o v e r 1964 . E c o n o m i c C o u n c i l of C a n a d a , F i r s t A n n u a l Re -v i e'w , E c o n o m i c G o a Is f o r C ana da t o 1 9 V U , Que en ' 3 P r in te r~ O t t a w a , DecemTJef 19 64; E c o n o m i c C o u n c i l of C a n a d a , S e c o n d A n n u a l R e v i e w , T o w a r d s S u s t a i n e d and  B a l a n c e d E c o n o m i c G r o w t h , Q u e e n ' s P r i n t e r , 011awa , D e c e m b e r 19 6 5; FTconomic C o u n c i l of C a n a d a , T h i r d  A n n u a l R e v i e w , P r-ic e s , P r o d u c t i v i t y and E m p l o y m e n t , Que e n ' s P r i n t e r , O t t awa , N o v e m b e r 1966 . 3 T h e F i n a n c i a l P o s t [ T o r o n t o l , June 10 , 1967 , p . 9. 4 I b i d . 5 The F i n a n c i a l P o s t S u r v e y of I n d u s t r i a l s , A S u r v e y of C a n a d i a n Indus t r i a I Comp an ie s P r epa r e d by the E d i t o r s of the F i n a n c i a l P o s t , T o r o n t o , M a c L e a n -H u n t e r P u b l i s h i n g C o m p a n y L i m i t e d , 1966 , F o r e w a r d . 134 At the t i m e the d i r e c t o r s w e r e p o l l e d , b u s i n e s s a c t i v i t y i n C a n a d a was e x p e c t e d to r i s e but at a s l o w e r p a c e than i t had i n the p r e v i o u s f i v e y e a r s . F i g u r e 8 shows the i n c r e a s e s i n g r o s s n a t i o n a l p r o d u c t f r o m 1961 to 1966 and the g o v e r n m e n t e s t i m a t e d i n c r e a s e f o r 1967 . P r o f i t s we re b e g i n n i n g to d i m i n i s h ( see F i g u r e 9 and T a b l e X V I ) . T h a t w o r k i n g c a p i t a l c o n d i -6 t i o n s had i m p r o v e d and that new i n v e s t m e n t i n 1967 was p r e d i c t e d to d e c r e a s e i n the m a n u f a c t u i n g i n d u s -t r i e s (see F i g u r e 10) i n d i c a t e d a l e s s e r need f o r c a s h . A l e s s e r need f o r c a s h c o u n t e r e d l o w e r p r o f i t s , and hence d i v i d e n d s i n c r e a s e d m o r e than w o u l d be e x p e c t e d on the b a s i s of p r o f i t a l o n e . I b i d 7 P e r cent 6 5 4 0- 1960 66 Y e a r F I G U R E 8 G R O S S N A T I O N A L P R O D U C T I N C R E A S E S , 1960 TO 1966 G O V E R N M E N T E S T I M A T E D I N C R E A S E 1967 (WITH'- '"" ." A D J U S T M E N T F O R P R I C E C H A N G E S ) S o u r c e : The F i n a n c i a l P o s t [Toron to] , June 10 , 1967 , p . 17. 14 12 10 P e r cent 4 0 1963 1964 Y e a r 1965 1966 F I G U R E 9 I N C R E A S E S I N C O M P A N Y P R O F I T S , 1963 TO 1966 S o u r c e : D o m i n i o n B u r e a u of S t a t i s t i c s , N a t i o n a l  A c c o u n t s , Income and E x p e n d i t u r e , F o u r t h Q u a r t e r and Pre l im i n a r y A n n u a 1 Rep o r t f o r 1966 , v o l . 14, no . 4 ( A p r i l 1967) , p . 2 . T A B L E X V I C O R P O R A T I O N S A L E S A N D P R O F I T S A F T E R T A X E S IN C A N A D A , B Y I N D U S T R Y , F I R S T H A L F 1966 A N D 1967 Sales Profits after taxes First half First half First half First half Industry 1966 1967 1966 1967 (millions of dollars) Mines, quarries, & oil wells 1,877 1,937 215 188 Manufacturing industries food & beverage 3,244 3,435 81 60 rubber 311 348 7 9 textile 1,347 1,324 25 15 wood 1,141 1,277 34 28 paper & allied 1,479 1,533 45 42 printing & publishing 625 714 27 38 primary metal 1,297 1,326 71 63 metal fabricating 1,491 1,562 34 29 machinery 1,039 1,162 66 63 transportation equipment 2,610 3,211 111 115 electrical products 1,207 1,296 26 - 1 non-metallic mineral products 523 541 16 5 petroleum & coal products 1,467 1,583 47 50 chemical & chemical products 1,329 1,371 70 61 other 953 1,040 26 30 Totals 20,063 21,723 686 607 Transportation 1,439 1,654 69 • 58 Storage 54 74 2 2 Communication 495 541 46 42 Electric power, gas, & water utilities 435 413 33 38 Wholesale trade 9,286 9,639 115 90 Retail trade 6,589 6,946 66 53 Finance, insurance, & real estate * * 197 198 Service industries * * 65 79 Other non-manufacturing * * 20 7 Totals, all industries * * 1,514 1,362 Sa les f i g u r e s a r e not a v a i l a b l e . S o u r c e : D o m i n i o n B u r e a u of S t a t i s t i c s , C o r p o r a t i o n  P r o f i t s S e c o n d Q u a r t e r 19 6 7 , O t t a w a , Q u e e n ' s P r i n t e r , i y 6 7 . P e r cent 3 6 32 28 24 20 16 12 4 0 4 12 1964 1965 1966 Y e a r 1967 F I G U R E 10 A N N U A L P E R C E N T A G E C H A N G E I N T H E M A N U F A C T U R I N G I N D U S T R Y ' S C A P I T A L E X P E N D I T U R E S ( C U R R E N T D O L L A R S ) , 1964 TO 1966; G O V E R N M E N T E S T I M A T E D C H A N G E , 1967 S o u r c e : D o m i n i o n B u r e a u of S t a t i s t i c s and D e p a r t m e n t of T r a d e and C o m m e r c e , P r i v a te and  P u b l i c I n v e s t m e n t i n C a n a d a , O t t a w a , Q u e e n ' s P r i n t e r , 1 9 6 5 , 196T~, p . 1 1 . 139 B u t , o t h e r l i k e l y e x p l a n a t i o n s f o r these c o n -t i n u e d d i v i d e n d i n c r e a s e s e x i s t . A l a g e f fec t i s e v i -den t . Tha t d i v i d e n d s l a g p r o f i t s , e x e m p l i f i e d i n C h a p t e r III on pages 13 and 14, i s t r ue b e c a u s e of (1) the u n d e s i r a b l e m a r k e t - p r i c e r e a c t i o n a r i s i n g f r o m a d e c r e a s e d d i v i d e n d (see C h a p t e r I V , pages 55 to 59) c o m b i n e d w i t h (2) some u n c e r t a i n t y about the i n d i c a t e d t r e n d i n the c o m p a n y ' s e a r n i n g s . T h u s , c o m p a n y d i r e c t o r s tend to l o w e r the d i v i d e n d amount o n l y a f t e r s e v e r a l y e a r s of r e d u c e d p r o f i t s a n d , c o n -v e r s e l y , to r a i s e the amount o n l y a f t e r they a r e r e a -s o n a b l y c e r t a i n that they w i l l not have to r e d u c e i t . A l s o , s a l e s i n the f i r s t h a l f of 1967 c o n t i n u e d to i n -c r e a s e d e s p i t e l o w e r p r o f i t s (see T a b l e X V I ) . B e -cause of t h i s c o n t i n u e d s a l e s g r o w t h and b e c a u s e of the many new f a c i l i t i e s - c r e a t e d i n the p e r i o d 1963 to 1966 , many c o m p a n y d i r e c t o r s we re of the o p i n i o n that p r o f i t s , a f t e r a p e r i o d of a d j u s t m e n t , w o u l d r i s e . The c h a i r m a n of the l a r g e s t C a n a d i a n f o r e s t p r o d u c t s c o m p a n y , f o r e x a m p l e , s t a t e d : The c o m p a n y i s p a s s i n g t h r o u g h a p e r i o d where it. i s b u r d e n e d w i t h c o s t s of e x p a n s i o n w i t h o u t , as y e t , e n j o y i n g the e n s u i n g b e n e f i t s . ' J . V . C 1 y n e , M a c M i IT an B l o e d e l L i m i t e d , R e p o r t to the S h a r e h o l d e r s f o r the S i x M o n t h s E n d e d June 3U, I 9 F 7 , V a n c o u v e r , (TanacTa , Tuly~2To^ 1 9TT7. ~~ 140 The o u t l o o k f o r s a l e s i n f o r e i g n m a r k e t s was s t r e n g t h e n e d by the m u l t i l a t e r a l t a r i f f c o n c e s s i o n s a r i s i n g f r o m the s i x t h r o u n d of the G e n e r a l A g r e e -ment on T a r i f f s and T r a d e a n d , even b e f o r e the r o u n d was c o m p l e t e d , by o p t i m i s t i c e x p e c t a t i o n s t o w a r d s 8 f a v o u r a b l e r e d u c t i o n s . T o o , mos t e c o n o m i s t s thought that the A m e r i c a n r e c e s s i o n w h i c h p r e v a i l e d i n the q f i r s t h a l f of 1967 was t e m p o r a r y . A s t u t e managemen t of g o v e r n m e n t f i s c a l and m o n e t a r y p o l i c y not o n l y keeps c o m p a n i e s i n C a n a d a c o m p e t i t i v e w i t h those i n o t h e r c o u n t r i e s but a l s o m a i n t a i n s d o m e s t i c , a g g r e g a t e d e m a n d . A n o t h e r c o n -t r i b u t i n g r e a s o n fo r the r e l a t i v e l y h i g h p a y o u t s , t h e r e -f o r e , .was the a p p a r e n t h i g h deg ree of c o n f i d e n c e i n -s p i r e d i n the b u s i n e s s c o m m u n i t y and p r e s s by the F i n a n c e M i n i s t e r and h i s s t a b i l i z i n g p o l i c i e s . F o r e x a m p l e , an e d i t o r i a l i n the M a r c h 22 , 1967 e d i t i o n of the V a n c o u v e r Sun s t a t e d : The men who a t t empt to p l a n , gu ide and i n -f l u e n c e the n a t i o n ' s e c o n o m y a r e o n l y as good as i n f o r m a t i o n at t h e i r d i s p o s a l u n l e s s b l e s s e d w i t h g r e a t l u c k or r e m a r k a b l e i n t u i t i o n . F o r e x a m p l e , s e e : O t t awa C i t i z e n , J u l y 4, 1967 , p . ' 1. 9' F o r - e x a m p l e , s e e : G . F l e e t , " W h y . m a n y e c o - . n o m i s t s see b e t t e r s e c o n d h a l f , " T h e F i n a n c i a l P o s t [To'ronto] , J u l y 22 , 1967 , p . 22; arTcT " S i z e - u p o i B u s i n e s s i n S e c o n d H a l f , " U . S. News & W o r l d R e p o r t , J u l y 17, 1967 , pp . 3 6 - 3 8 . " 141 Such a man i s F i n a n c e M i n i s t e r S h a r p . He h a s , i t a p p e a r s , so f a r , been s u c c e s s f u l . . . . In M,r.: . S h a r p ' s c a se we w o u l d l i k e to t h i n k that e x p e r t i s e and i n t u i t i v e j udgemen t were as much a f a c t o r b e h i n d h i s m o v e s to tame i n f l a t i o n w i t h o u t p r e c i p i t a t i n g r e c e s s i o n . M r . S h a r p may have . . . r e m a r k a b l e v i s i o n . i U In s t a t e m e n t s on budget p o l i c y at the a p p r o x i m a t e t i m e of the q u e s t i o n n a i r e , the F i n a n c e M i n i s t e r a d v o c a t e d , as f i s c a l p o l i c y , a h e f t y d e f i c i t ( see F i g u r e 11) to m a i n -11 t a i n an e x p a n s i o n a r y c l i m a t e . E a r l i e r he had u n d e r -t aken an a p p r o p r i a t e m o n e t a r y p o l i c y and had c r e a t e d a budget s u r p l u s to c o m b a t i n f l a t i o n . M a n y i n C a n a d i a n m a n a g e m e n t p r o b a b l y c o n s i d e r e d h i s m o v e s as an i m -p r o v e m e n t i n m a i n t a i n i n g l o n g - r u n g r o w t h i n e a r n i n g s and s a l e s and the low v a r i a b i l i t y of the s a m e . B o t h of these f a c t o r s w e r e r a t e d by d i r e c t o r s as v e r y i m p o r -tant i n the d i v i d e n d d e c i s i o n . A s c o n c l u d e d i n C h a p t e r V I , d i r e c t o r s d e f i n i t e l y do not r a i s e d i v i d e n d s on the b a s i s of. c u r r e n t p r o f i t ' a l o n e ; they mus t be s u r e of c o n -t i n u e d p r o f i t s . In f a c t , n e a r l y o n e - h a l f of the d i r e c t o r s p o l l e d were of the o p i n i o n that the mos t i m p o r t a n t d e c i -s i o n i n d i v i d e n d p o l i c y was w h e t h e r to change the a m o u n t . A n i n c r e a s e c o u l d not be s a n c t i o n e d i f f u t u r e e c o n o m i c c o n d i t i o n s and p r o f i t s w e r e e x p e c t e d to d e t e r i o r a t e . 10 E d i t o r i a l i n the V ancouve r Sun , M a r c h 2 2 , 1967 , p . 4 . p . 17 . The F i n a n c i a l P o s t [ T o r o n t o ] , June 10 , 1967 . 600 400 -.20 0 0 M i l l i o n D o l l a r s 200 400 600 S u r p l u s D e f i c i t 00 1956 58 6 0 6 2 64 66 F i s c a l Y e a r s E n d i n g M a r c h 3 1 68 F I G U R E 11 G O V E R N M E N T B U D G E T , 19 5 6 TO 1966-G O V E R N M E N T E S T I M A T E D B U D G E T , 1967 A N D 1968 S o u r c e : The F i n a n c i a l P o s t [ T o r o n t o ! , June 10, 1967, p . 17. ; — ! — J 1.43 Not a l l managemen t c o n f i d e n c e , h o w e v e r , can - be a t t r i b u t e d to one m a n . In g e n e r a l , r e c e n t p e r i o d s have been c h a r a c t e r i z e d by a g r o w i n g c o n c e r n and s k i l l w i t h i n the g o v e r n m e n t s e c t o r to s u s t a i n and b a -l a n c e g r o w t h . The S e c o n d A n n u a l R e v i e w of the E c o -n o m i c C o u n c i l of C a n a d a c o n t a i n s the f o l l o w i n g c o m -men t : . . . one of the mos t p r o m i n e n t f e a t u r e s of p o s t -war b u s i n e s s f l u c t u a t i o n s has been the s h o r t e r a v e -r age l e n g t h of c y c l i c a l c o n t r a c t i o n s and the a p p a -r e n t l y l o n g e r d u r a t i o n of b u s i n e s s u p s w i n g s . F u r t h e r m o r e (and p a r t i a l l y as a r e s u l t of g o v e r n -ment f i s c a l and m o n e t a r y p o l i c i e s ) , the l o n g - t e r m ou t -l o o k as r e p o r t e d by the news m e d i a and o f f i c i a l b o d i e s had been o p t i m i s t i c . F o r e x a m p l e , the E c o n o m i c C o u n -c i l of C a n a d a i n i t s T h i r d A n n u a l R e v i e w s t a t e d : Our c o n c e r n i s , r a t h e r , w i t h the u n d e r l y i n g t r e n d s and d e v e l o p m e n t s in the r e c e n t p e r f o r -mance i n r e l a t i o n to the e c o n o m y ' s m e d i u m - a n d l o n g e r - t e r m g o a l s and p o t e n t i a l s , and w i t h the p r o g r e s s and p o l i c i e s r e q u i r e d to a t t a i n t h e s e . F r o m t h i s p e r s p e c t i v e , w:e have c o n c l u d e d that w h i l e i t i s by no means i n c o n c e i v a b l e that the e c o -nomy c o u l d move s l i g h t l y f u r t h e r away f r o m s e v e r a l of i t s g o a l s i n the n e a r - t e r m f u t u r e , the u n d e r -l y i n g s i t u a t i o n - - bo th i n t e r n a l l y and d o m e s t i c a l l y - - s t i l l d i s p l a y s i n d i c a t i o n s of s u f f i c i e n t b a s i c s t r e n g t h and b a l a n c e to make i t u n l i k e l y that the c o u n t r y f ace s the dange r of a p r o l o n g e d or m a j o r d e p a r t u r e f r o m the g o a l s . . . .13 S e c o n d A n n u a l T h i r d A n n u a l 1 2 E c o n o m i c C o u n c i l of C a n a d a , R e v i e w , p . 147. 1 3 E c o n o m i c C o u n c i l of C a n a d a , R e v i e w , p . 229 . 144 The May 1967 i s s u e of Indus t r i a 1 C anada , p u b l i s h e d by The C a n a d i a n M a n u f a c t u r e r s ' A s s o c i a t i o n , had the f o l -l o w i n g to say about C a n a d a ' s f u t u r e : A p o s s i b l e d o u b l i n g of the C a n a d i a n e c o n o m y has been p r e d i c t e d o v e r the nex t 15 y e a r s , g i v e n s t a b l e c o n d i t i o n s at home and a b r o a d . The p r e d i c -t i o n i s ba sed on C a n a d a ' s wealth of both human and n a t u r a l r e s o u r c e s . . . . E x a m i n a t i o n of the above f a c t o r s have h e l p e d to e x p l a i n why m i d y e a r 1967 d i v i d e n d s were at t h e i r p a r - ' t i c u l a r l e v e l of i n c r e a s e . I n d e e d , t h i s b r i e f i n v e s t i -g a t i o n of the d i v i d e n d d e c i s i o n w i t h i n the a g g r e g a t e e c o n o m i c s e t t i n g has s u p p o r t e d and i s i n a c c o r d w i t h the r e s u l t s of the q u e s t i o n n a i r e . 14 " I n d u s t r y '67 C e n t e n n i a l P e r s p e c t i v e , " I n d u s -t r i a l C a n a d a , v o l . 68 (May 1967), p . 110. C H A P T E R V I I I C O N C L U S I O N S T e s t i n g h y p o t h e s e s of d i v i d e n d b e h a v i o u r has been the m a j o r a r e a of c o n c e n t r a t i o n i n t h i s t h e s i s . T h i s p a r t i c u l a r a p p r o a c h was b a s e d on the b e l i e f that m o r e adequa te k n o w l e d g e of the d e c i s i o n p r o c e s s i s a p r e r e q u i s i t e to p r e d i c t i o n , p l a n n i n g , and o p t i m i z i n g . S i m i l a r l y , t h e o r y and i n v e s t o r s ' r e a c t i o n s a r e - a r e a s that cannot be i g n o r e d . Some of the m o r e s p e c i f i c c o n c l u s i o n s a r e : 1. The d i v i d e n d a r e a has f a r r e a c h i n g i m p o r -t a n c e : to the s h a r e h o l d e r , the f i r m , and the e c o n o m y . 2. P a t t e r n s a r e i n d i c a t i v e of bo th c h a n g i n g and d i f f e r e n t c o n d i t i o n s . Some of the r e a s o n s a c c o u n t i n g f o r v a r i a t i o n i n payout o v e r t i m e a r e : c h a n g i n g a t t i -tudes of c o n s u m e r , i n v e s t o r , and m a n a g e m e n t ; l a c k of i n v e s t m e n t o p p o r t u n i t i e s ; , c o m p a n y d i r e c t o r s ' c o n -s e r v a t i v e a p p r o a c h ; need f o r w o r k i n g c a p i t a l ; changes i n the me thod of c a l c u l a t i n g , c a p i t a l c o s t a l l o w a n c e s ; and i n t e r e s t r a t e s : . T h a t A m e r i c a n p a y o u t s a r e h i g h e r and have i n c r e a s e d f a s t e r than those i n C a n a d a i s a t -t r i b u t e d to the m o r e a d v a n c e d i n d u s t r i a l o r g a n i z a t i o n i n the U n i t e d S t a t e s . Of the C a n a d i a n c o m p a n i e s s t u d i e d , t e x t i l e , m e r c h a n d i s i n g , n o n - f e r r o u s m e t a l , and c h e m i -c a l i n d u s t r i e s had the l o w e s t p a y o u t , w h e r e a s t r u s t c o m p a n i e s and p i p e l i n e f i r m s had the h i g h e s t . 146 3. The pu re e a r n i n g s h y p o t h e s i s has been r e -fu ted i n theory , and p r a c t i c e . 4. T r a d i t i o n a l t h e o r y on c a p i t a l s t r u c t u r e i s c o r r e c t b e c a u s e of i m p e r f e c t c a p i t a l m a r k e t s ; hence an o p t i m u m payout r a t i o e x i s t s i n t h e o r y . 5. B o t h the t r a d i t i o n a l t h e o r y on c a p i t a l s t r u c -tu re and the m o d e r n v a l u a t i o n fo rmulae have the same i m p l i c a t i o n f o r o p t i m u m d i v i d e n d payou t ; i n p r a c t i c e , b e c a u s e of i n f o r m a t i o n a l c o n t e n t s and i n v e s t o r i r r a -t i o n a l i t y , a c l e a r - c u t r u l e cannot be f o r m u l a t e d . 6. I n f o r m a t i o n a l c o n t e n t s a r e i m p o r t a n t as a l i n k be tween a change i n d i v i d e n d s and a change i n s h a r e p r i c e ; the l e n g t h of t i m e f o l l o w i n g a d i v i d e n d change i n d i c a t e s the s t r e n g t h of t h i s l i n k a g e . 7. A n i n v e s t i g a t o r u s i n g p a i r e d s t o c k s s h o u l d take s t eps to c a r e f u l l y and c l o s e l y m a t c h the s t o c k s so that the e f fec t of d i f f e r e n c e s i n g r o w t h and o t h e r c o m p a r a t i v e m e a s u r e s i s m i n i m i z e d . 8. C a n a d i a n i n v e s t o r s a r e m o r e r a t i o n a l i n t h e i r p u r c h a s e s , and d i v i d e n d s a r e not as i m p o r t a n t to them i n g r o w t h s i t u a t i o n s as c e r t a i n A m e r i c a n and E n g l i s h s t u d i e s have i n d i c a t e d f o r t h e i r r e s p e c t i v e e c o n o m i e s . 9. In g e n e r a l , i n v e s t o r s a d h e r i n g to low p a y o u t , g r o w t h s i t u a t i o n s we re b e t t e r off f i n a n c i a l l y . : • 147 : 10. B o t h (a) the ex ten t of g r o w t h and (b) the n a t u r e and type of the 1 i n d u s t r y j a r e v e r y i m p o r t a n t f a c t o r s a f f ec t i n g t h e r e t u r n to s h a r e h o l d e r s of low payout c o m p a n i e s . 11. - C e r t a i n growth f i r m s may i n c r e a s e the m a r -ket p r i c e of t h e i r s t o c k i n the l o n g - r u n by l o w e r i n g t h e i r d i v i d e n d . 12 . Q u e s t i o n n a i r e r e s u l t s show that (a) net p r o -f i t , (b) p r e s e n t and a n t i c i p a t e d need f o r c a s h , (c) p l a n -ned i n v e s t m e n t p r o j e c t s , (d) pas t d i v i d e n d s , and (e) e x p e c t e d g r o w t h and v a r i a b i l i t y i n e a r n i n g s and s a l e s a r e c o n s i d e r e d the m o s t i m p o r t a n t v a r i a b l e s i n v o l v e d i n the d i v i d e n d d e c i s i o n . The f o l l o w i n g were r a t e d i m -p o r t a n t : (f) f u tu re f i n a n c i n g p l a n s , (g) c a p i t a l s t r u c t u r e , (h) r a t e of r e t u r n on c a p i t a l , and, ( i ) cos t of c a p i t a l . The f o l l o w i n g , o f . s o m e i m p o r t a n c e : (j) f r e q u e n c y of d i v i d e n d c h a n g e s , (k) a t t i t u d e s of s h a r e h o l d e r s , (1) e f fec t on p r i c e , (m) use of s t o c k s p l i t s and d i v i d e n d s , and (n) i n t e r n a l r i s k s . C o m p e t i t o r s ' payout r a t i o (o) and (p) e x i s t e n c e of c o n t r o l g r o u p s , l e a s t i m p o r t a n t . 13 . M o r e than o n e - h a l f of the f i r m s c l a i m e d a targe.t payout r a t i o , i n d i c a t i n g that the d i v i d e n d d e c i -s i o n i s o f ten the a c t i v e p o l i c y v a r i a b l e . L e s s than one -h a l f c o n s i d e r e d the p r i m a r y d i v i d e n d d e c i s i o n to be w h e t h e r to change the amount p r e s e n t l y p a i d . D i r e c t o r s r a t e d c o n t i n u i t y as the m o s t i m p o r t a n t f ea tu re , of a sound d i v i d e n d p o l i c y , w i t h s t a b i l i t y and s i z e f o l l o w i n g i n t h a t o r d e r . 148 14. A d d i t i o n a l c o m m e n t s f r o m r e s p o n d e n t s i n -d i c a t e d the f o l i o w i n g : a . T h e r e e x i s t s a s i g n i f i c a n t in t e r - i n du s t r y d i f f e r e n c e i n the a t t i t u d e t o w a r d s the v a r i o u s d e t e r -m i n a n t s of the d e c i s i o n . b . A l t h o u g h many v a r i a b l e s a r e c o n s i d e r e d when the d e c i s i o n i s b e i n g m a d e , they a r e s e l d o m s p e c i f i c a l l y m e n t i o n e d , f o r m u l a t e d , o r r a n k e d . c . I n t e r n a l m a n a g e m e n t o w n e r s h i p s h o u l d be nega ted i n c o n s i d e r i n g d i v i d e n d a c t i o n . d . I n f o r m a t i o n a l i m p a c t of d i v i d e n d s i s r e c o g -n i z e d by d i r e c t o r s . e. F i n a n c i a l t h e o r y on d i v i d e n d d e c i s i o n m a k i n g i s not a c k n o w l e d g e d . f. C o m p a n y o b j e c t i v e s and l o n g - r a n g e p l a n n i n g a r e - r e l a t e d to the d i v i d e n d d e c i s i o n p r o c e s s . g . C h a n g i n g , c o m p a n y and e c o n o m i c c o n d i t i o n s i n f l u e n c e e v a l u a t i o n . 15 . S i n c e i n t e r - i n d u s t r y d i v i d e n d b e h a v i o u r was c o n c l u d e d to be d i f f e r e n t , a d i v i d e n d m o d e l to be a c c u -r a t e mus t i n c o r p o r a t e those e l e m e n t s that a r e i n h e r e n t i n the d e c i s i o n and that a r e p e c u l i a r to the i n d u s t r y . 16. R e g r e s s i o n a n a l y s e s have shown that p r o f i t s and s i z e are. c o n s i s t e n t l y and h i g h l y s i g n i f i c a n t ; l o n g -t e r m deb t , f u t u r e p r o s p e c t s , and d e p r e c i a t i o n had 149 i r r e g u l a r i n f l u e n c e ; i n v e s t m e n t and c a s h - n e e d v a r i - . a b l e s u n e x p e c t e d l y s h o w e d l i t t l e r e l a t i o n s h i p w i t h d i v i d e n d s ; d e g r e e of l i q u i d i t y and c o n s e r v a t i s m c l e a r l y showed no r e l a t i o n s h i p . 17. P r o f i t s we re shown to have g r e a t e r i n -f l u e n c e than c a s h f l o w s on the d i v i d e n d s d e c i s i o n . 18. A n o n r i g o r o u s i n v e s t i g a t i o n of d i v i d e n d p o l i c y w i t h i n the a g g r e g a t e e c o n o m i c s e t t i n g at m i d -y e a r 1967 s u p p o r t s the m a j o r q u e s t i o n n a i r e c o n c l u -s i o n s . C o n f i d e n c e i n g o v e r n m e n t a l s t a b i l i z i n g p o l i c i e s a n d , i n the f u t u r e e c o n o m i c c l i m a t e , g e n e r a l l y h i g h l e v e l of i n t e r e s t r a t e s , and e x p e c t a t i o n s of f a v o u r a b l e t a r i f f r e d u c t i o n s a r e some of the a d d i t i o n a l v a r i a b l e s w h i c h e x p l a i n the u n u s u a l l y , h i g h . C a n a d i a n d i v i d e n d s d u r i n g that p e r i o d . B I B L I O G R A P H Y A . B O O K S B a r g e s , A . The E f f e c t of C a p i t a l S t rue tu r e on the C o s t of C a p i t a 1.. E ng ie w o o d C l i f f s , 1\1 . J . , P r e n t i c e - H a l l , ' I nc . , 1963 . B r i t t a i n , J . A-. Co r p o r a t e D i v i d e n d P o l i c y . W a s h i n g t o n , D . C . , The B r o o k i n g s I n s t i t u t i o n , 196 6 . D o b r o v o l s k y , S. P..' C o r p o r a t e I ncome R e t e n t i o n , 1915 -19 4 3 . N e w Y o r k , N a t i o n a l b u r e a u of E c o n o m i c R e -s e a r c h . , 1 9 5 1 . G o r d o n , M . . J -. The I n v e s t m e n t , F i n a n c i n g and V a l u a t i o n of th e C o r p o r a t i o n . . H o m e w o o d , I l l i n o i s , R i c h a r d D . I r w i n , I n c . , 1 y 6 2 . G r a h a m , B . , D o d d , D a n d C o t t l e , S\ S e c h r i t y A n a l y s i s . New Y o r k , M c G r a w - H i l l B o o k C o m p a n y , i y 5 1, I y B ^  . G r e e n e , N . R . "How M u c h R e s p o n s i b i l i t y Does M a n a g e -ment Have f o r the P r i c e L e v e l of the C o m p a n y ' s S t o c k . " R e a d i n g s i n F i n a n c i a l A n a ly si-s and Inves t -•ment M a n a g e m e n t , ed" E . M . L e r n e r , Home wo o d , • I l l i n o i s " ; R i c h a r d D . I r w i n , Inc.",- 1 9 6 3 , pp . 2 1 2 - 2 1 5 . H o l l a n d , D . M . D i v i d e n d s Unde r the Income T a x . P r i n c e -t o n , U n i v e r s i t y of P r i n c e t o n P r e s s , STudy by N a -t i o n a l B u r e a u of E c o n o m i c R e s e a r c h , 1962 . L i n t n e r , J o h n . "The D e t e r m i n a n t s of C o r p o r a t e S a v i n g s . " S a v i n gs i n the M o d e r n E c on o m y . e d . W. W. H e l l e r and o t h e r s , M i n n e a p o 1 i s - ; U n ive r s i t y of M i n n e s o t a P r e s s , 1 9 5 3 , p p . 2 4 6 - 2 6 1 . M e y e r , J . R . and K u h , E . The Inve s tment D e c i s i o n , A n E m p i r i c a 1 S tudy . C a m b r i d g ~ M a s s a c h u s e tt s , H a r v a r d U n i v e r s i t y P r e s s , 1 9 5 7 . P e t e r s o n , W. C . I ncome , E m p l o y m e n t , and E c o n o m i c G r o w t h . New Y o r k , . W. W. No r t o n and C o m p a n y , I n c . , 1962 . P o r t e r f i e l d , J . T . S. I n v e s t m e n t D e c i s i o n s and C a p i t a l C o s t s . . E n g l e wood C l i f f s , W. J . , P r ent i c e - Ha 11, i n c . , 1965 . 151 P o t t e r , C . G . F i n a n c e and B u s i n e s s A d m i n i s t r a t i o n i n C a n a d a . S c a r b o r o u g h " Unt . , P r e n t i c e - H a l l of U a h a d a L t d . , 1966 . Q u i r i n , G . \ D . The _C a p i t a 1' E xp en d i t u r e D e c i s i o n . Home wood , 111 ino i s , R i c h a r d D . Tr w i n , l nc . , 1967 . R o b i c h e k , A . A . and M y e r s , S. C . O p t i m a l F i n a n c i n g . . D e c i s i o n s . New Y o r k , P r e n t i c e - H a l l , I n c . , 196 5 . S o l o mo n , ' E . The T h e o r y o f F i n a n c i a l M a n a g e m e n t . New Y o r k , C o l u m b i a U n i v e r s i t y P r e s s , 1963 . W e s t o n , J . F . and B r i g h a m , E . F . M a n a g e r i a l F i n a n c e . New Y o r k , H o l t , R i n e h a r t and W i n s t o n , I rTc~ 19 6 6. W i l l i a m s , J . B . The T h e o r y of I n v e s t m e n t V a l u e . C a m b r i d g e , H a r v a r d U n i v e r s i t y P r e s s , 19 3 8. B . G O V E R N M E N T P U B L I C A T I O N S The Canada ' C o r p o r a t i o n s A c t . O t t a w a , Q u e e n ' s P r i n t e r , ~~~~ 1965 . ~ D e p a r t m e n t of N a t i o n a l R e v e n u e - T a x a t i o n D i v i s i o n . T a x a t i o n S t a t i s t i c s . P a r t I , O t t a w a , Q u e e n ' s P r i n t e r , 1966 . D o m i n i o n B u r e a u of S t a t i s t i c s and D e p a r t m e n t of T r a d e and: C o m m e r c e . P r i v a t e and P u b l i c I n v e s t m e n t i n  C a n a d a . O t t a w a , Queen ' s ~P~r i n t e r , 1 9 6 5 , 1 9 6 7 . . D o m i n i o n B u r e a u of S t a t i s t i c s . C o r p o r a t i o n P r o f i t s S e c o n d Q u a r t e r 1967 . Ot tawa^ Q u e e n ' s P r i n t e r , 1967 . . D o m i n i o n ' B u r e a u of S t a t i s t i c s . N a t i o n a l A c c o u n t s , Income and E x p e n d i t u r e . O t t awa , Q~ueen's P r i n t e r , 1926- 19BT: : :  E c o n o m i c C o u n c i l of C a n a d a . F i r s t A n n u a l R e v i e w , E c o n o m i c G o a l s f o r C a n a d a to 1 9 7 U . Que en ' s P r i n t e r , O t t awa ,' D e c e m b e r T 9 6 4 . . E c o n o m i c C o u n c i l of C a n a d a . S e c o n d A n n u a l R e v i e w , T o w a r d s Sus t a ine d and B a l a n c e d E c o n o m i c G r o w t h . Queen ' s P r i n t e r , 011.awa~, D e c e m b e r 196b. 152 E c o n o m i c C o u n c i l of C a n a d a . T h i r d A n n u a l R e v i e w , P r i c e s , P r o d u c t i v i t y and " E l h p l o y m e n t . Queen ' s P r i n t e r . , O t t awa , Wovem ber 19 6 6. E c o n o m i c Re p o r t of the P r e s i d e n t . W a s h i n g t o n , D . C . , FT. S". G o v e r n m e n t P r i n t i n g O f f i c e , 1965 . R e p o r t o f the Ro y a 1 C o m m i s s i o n on T a x a t i o n . c h a i r m a n K~. ~Ze~W. C a r t e r / O t t a w a , Q u e e n ' s P r i n t e r , 1967 . C . P E R I O D I C A L S A n t h o n y , R . N . "The T r o u b l e w i t h P r o f i t M a x i m i z a t i o n , H a r v a r d Bus ine s s R e v i e w , v o l . 38 ( N o v e m b e r -D e c e f l i f e I 9 6 0 ) , pp.. 126- 134. A s h l e y , J . W. " S t o c k P r i c e s and C h a n g e s i n E a r n i n g s and D i v i d e n d s , Some E m p i r i c a l R e s u l t s . " Jo u r n a 1 of P o l i t i c a l E c o n o m y , v o l . L X X ( F e b r u a r y 19 6 2 ) , pp . 8 2 - 85 . . — B a r k e r , C . A u s t i n . . " E f f e c t i v e S t o c k S p l i t s . " H a r v a r d ['• B u s i n e s s R e v i e w , v o l . 34 ( J a n u a r y - F e b r u a r y 1956) , p p . 101-1(76. B a r k e r , C . A u s t i n . " E v a l u a t i o n of S t o c k D i v i d e n d s . " H a r v a r d B u s i n e s s R e v i e w , v o l . 36 ( J u l y - A u g u s t 1958) , pp . 9 9 - 1 1 4 . B a r k e r , C . A u s t i n . " S t o c k S p l i t s i n a B u l l M a r k e t . " H a r v a r d B u s i n e s s R e v i e w , " v o l . 35 ( M a y - J u n e 1957) , pp . 7 2- 7 9^ B o d e n h o r n , D . "On the P r o b l e m of C a p i t a l B u d g e t i n g . " T h e J o u r n a l of F i n a n c e , v o l . X I V ( D e c e m b e r 1959) , ppT 473 -492 . B o n e s s , A . J . " A P e d a g o g i c N o t e - o n the C o s t of C a p i t a l . " The J o u r n a l of F i n a n c e , v o l . X I X ( M a r c h 1964) , pp . 9 9 - 10 6 . '" ~~ C h r i s t , C . and O-rcut t , G . " C o r r e l a t i o n and R e g r e s s i o n i E s t i m a t e s When the D a t a A r e R a t i o s . " E c o n o m e t r i c a , v o l . X X I I I ( O c t o b e r 195 5 ) , pp . 4 0 0 - 4 1 6 : • ; D a r l i n g , P . G . "The I n f l u e n c e of E x p e c t a t i o n s and L i -q u i d i t y on D i v i d e n d P o l i c y . " J o u r n a l of P o l i t i c a l E c o n o m y , v o l . L X V (June 19 5 V ) , '• p p . "2D 9- 224 . 153 D h r y m e s , P . J . and K u r z , M . "On the D i v i d e n d P o l i c y of E l e c t r i c U t i l i t i e s . " The R e v i e w of  E c o n o m i c s and S t a t i s t i c s , v o l . X~L VI ( F e b r u a r y i y 64 ) , pp . 7T~-81~. " D i v i d e n d s F e e l the P r e s s u r e . " B u s ine s s W e e k , M a r c h 18, 1967 , pp . 59- 62 . : D o b r o v o l s k y , S. P . " E c o n o m i c s of C o r p o r a t e I n t e r n a l and E x t e r n a l F i n a n c i n g , " The J o u r n a l of F i n a n e e , v o l . X I I . ( M a r c h 1958) , pp.."~3T-T7T D o n a l d s o n , G . " F i n a n c i a l G o a l s : M a n a g e m e n t v s . S t o c k -h o l d e r s . " H a r v a r d B u s i n e s s R e v i e w , v o l . 41 ( M a y -June 1963) , pp . 1 1 6 - 1 2 9 . : D u r a n ' d , D . "The C o s t of C a p i t a l , C o r p o r a t i o n F i n a n c e , and the T h e o r y of I n v e s t m e n t : C o m m e n t . " A m e r i c a n  E c o n Q m i c R e v i e w ' , v o l . X L I X ( S e p t e m b e r 1 y 5 9) , p p . 6 3 y - 65 5. F i s h e r , G . R . "Some F a c t o r s I n f l u e n c i n g S h a r e P r i c e s . " E c o n o m i c - J o u r n a l , v o l . L X X I ( M a r c h 1961) , ' p p . 121-l4~T? F r i e n d , T. and P u c k e t t , M . " D i v i d e n d s and S t o c k P r i c e s . A m e r i c a n - E c o n o m i c R e v i e w , v o l . L I V ( S e p t e m b e r • 1964) , pp . 657- 68 1. ~ ~ ~ G o r d o n ,'. M . . J . ' " D i v i d e n d s , E a r n i n g s , and S t o c k P r i c e s . " The R e v i e w of E c o n o m i c s and S t a t i s t i c s , v o l . X L I vTvTay 195 9) , ~ p . 9 9- 10b . G o r d o n , M . J . " O p t i m a l I n v e s t m e n t and F i n a n c i n g P o l i c y The J o u r n a l of F i n a n c e , v o l . X V I I I ( M a y 1963) , p~pT 2.64- 27 2. " — :  G r u n f e l d , Y . and G r i l i c h e s , Z . "Is A g g r e g a t i o n N e c e s -s a r i l y B a d ? " , The R e v i e w of E c o n o m i c s and S t a -t i s t i c s , v o l . 4 2~lTe b r u a r y T 9 60.) , p p . I"- 1~3T Ha m m e l , J•. E . and H o d e s , D . A. ' " F a c t o r s I n f l u e n c i n g P / E M u l t i p l e s . " F i n a n c i a l A n a l y s t s J o u r n a l , v o l . 2 3 ( Jan u a r y - F e b r u a r y 1 y 6 7 ) , pp . 9D -~W2~. " H a r k a v y , O s c a r . "The R e l a t i o n B e t w e e n R e t a i n e d E a r -n i n g s and C o m m o n S t o c k P r i c e s f o r L a r g e L i s t e d C o r p o r a t i o n s . " The J o u r n a l of F i n a n c e , v o l . V I I I ( S e p t e m b e r 195 377~~pp. 2 8-3-2"9~7. : 154 " I n d u s t r y '67 C e n t e n n i a l P e r s p e c t i v e , " I n d u s t r i a l  C a n a d a , v o l . 68 (May 1-967), pp . 8 3 - 1 1 1 . -L i n t n e r , J o h n . " D i s t r i b u t i o n o f ' I n c o m e of C o r p o r a t i o n s A m o n g D i v i d e n d s , R e t a i n e d E a r n i n g s and T a x e s . " A m e r i c a n E c o n o m i c R e v i e w , P a p e r s and P r o c e e d i n g s , ' . v o l . X L V K M a y 1956) , pp , 9 V- 113 . :  L i n t n e r , J o h n . " D i v i d e n d s , E a r n i n g s , L e v e r a g e , S t o c k P r i c e s -and the S u p p l y of C a p i t a l to C o r p o r a t i o n s . " The Rev iew of E c o n o m i c s and S t a t i s t i c s , v o l . X L I V UTuTgust. 19627, pp . 243 - 26~y~: : M i l l e r , M , H . and- Mo d i g l i a n i , F.. " D i v i d e n d P o l i c y , G r o w t h , and the V a l u a t i o n of S h a r e s . " The J o u r n a l of B u s i n e s s , v o l . X X X I V ( O c t o b e r 1 9 6 i r T ~ p p . 4 1 1 -: M i l l e r , M . H . a n d . M o d i g l i a n i , F . "Some E s t i m a t e s of the C o s t of C a p i t a l to the E l e c t r i c U t i l i t y I n d u s t r y , 1 9 5 4 - 1 9 5 7 . " A m e r i c a n E c o n o m i c R e v i e w , , v o l . L V I (June 1966) , p p . 3 3 3 - 3 TT. ; M o d i g l i a n i , F . and M i l l e r , M . - ' H . . " C o s t of C a p i t a l , C o r p o r a t i o n F i n a n c e , and the T h e o r y of I n v e s t m e n t . " A m e r i c a n . E c o n o m i c R e v i e w , v o l . X L V I I I ( June 1 95 8) , pp . 2 6 1 - 2 9 7 : : M u r p h y , J . . E . J r . " R e l a t i v e G r o w t h of E a r n i n g s pe r S h a r e . " F i n a n e i a 1 A n a l y s t s J o u r n a l , v o l . 22 ( N o -v e m b e r - D e c e m b e r 1 y 6 6 ) , pp"; 7 3 - 76 . P e a r s o n - , K . "On a F o r m of S p u r i o u s C o r r e l a t i o n w h i c h M a y A r i s e w h e n . I n d i c e s A r e U s e d i n the M e a s u r e -ment of O r g a n s . " P r o c e e d i n g s of the R o y a l S o c i e t y .o f L o n d o n , v o l . L X ( l » y 7 ) , p p . - 4 8"F^ ~4 9~6. ; ~ " S i z e - u p of B u s i n e s s i n S e c o n d H a l f . " U . S . News & W o r l d R e p o r t , J u l y 17, 1967 , p p . 3 6- 38 . ~ S m i t h , D . C . " C o r p o r a t e S a v i n g B e h a v i o u r . " The C a n a -d i a n J o u r n a l of E c o n o m i c s and Po 1 i t i c a 1. S c i e n c e , v o l . X X I X ( A u g u s t 1 9 6 3 ) , . ppT~2 9 7 - 3 10 . - ' S o l o m o n , E . " L e v e r a g e and the C o s t of C a p i t a l , " The  J o u r n a l of F i n a n c e , v o l . X V I I I (May 1963) , pp . 2 7 3 - 2 Y y . 155 T a r s h i s , L . " C o m m e n t . " A m e r. i ca n E c o n o m i c Re v i e w , P a p e r s and P r o c e e d ings , v o l . X L V 1 (May 1956) , p . 114. T h o m p s o n , G . C . and W a l s h , F . J . J r . . " C o m p a n i e s ' S t r e s s D i v i d e n d C o n s i s t e n c y . " M a n a g e m e n t R e c o r d , N a t i o n a l I n d u s t r i a l C o n f e r e n c e " B o a r d , i n c . , v o l . X X V ( J a n u a r y 1963) , pp . 30 - 3 6 . W a l t e r , J a m e s E . " D i v i d e n d P o l i c i e s and C o m m o n S t o c k P r i c e s . / " The J o u r n a l of F i n a n c e , v o l . X I ( M a r c h 1 9 5 6 ) , o p . " B - T T : Wal te r ' , J a m e s E.. " D i v i d e n d P o l i c y : I ts I n f l u e n c e on the V a l u e of the E n t e r p r i s e . " The J o u r n a l of F i n a n c e , v o l . X V I I I (May 1963), pp . ~~2~8~0 - 2 9 1 . Weston ' , J . . F . " A T e s t of C o s t C a p i t a l P r o p o s i t i o n s , - " S o u t h e r n E c o n o m i c J o u r n a l , v o l . 13 ( O c t o b e r 1963 ), PP. i o 5 - i n n : W e s t o n , J . F . " R e v i e w . " The J o u r n a l of F i n a n c e , v o l . X V I I I ( S e p t e m b e r 19 63T7~pp. 5 7 9- 5"8"l. : W e s t o n , J . F . "The M a n a g e m e n t of C o r p o r a t e C a p i t a l : A R e v i e w A r t i c l e . " The J o u r n a l of B u s i n e s s , v o l . X X X I V - ( A p r i l 1961),"pp. 129- 1397 — " W i p p e r n , R . F . " F i n a n c i a l S t r u c t u r e and the V a l u e of the F i r m . " The J o u r n a l of F i n a n c e , v o l . . X X I ( D e -c e m b e r 19 6 6T7~"P P . 6 15 - 6~3~3.': ~ D . N E W S P A P E R S r e l , O . K . " D i v i d e n d s v e r s u s R e t a i n e d . E a r n i n g s as a M a r k e t F o r c e . " The C o m m e r c i a l and F i n a n c i a l  C h r o n i c l e , v o l . 176~~C&ugust 2 1 , 19 5'ZTT '. r e l , O . K . . " R e l a t i v e V a l u e of E a r n i n g s : R e t a i n e d and D i s t r i b u t e d . " The C o m m e r c i a l and F i n a n c i a 1 C hr o - . n i c l e , v o l . 18 6~U u 1 y I B , 195 7 ) . F i n a n c i a l P o s t [Toronto"] . June 1 0 , 1967 . B u r B u r The F l e e t , G . "Why many e c o n o m i s t s see b e t t e r s e c o n d h a l f . " The F i n a n c i a l P o s t [ T o r o n t o ] , J u l y 22 , 1967 O t t a w a . C i t i z e n . J u l y 4 , 1967 . S o g a n i c h , J . " P r i c e s and D i v i d e n d s : some a n o m a l i e s s h o w . " The F i n a n c i a l P o s t , A p r i l 1 , 19 67 . The V a n c o u v e r S u n . M a r c h 2 2 , 196 7. E . U N P U B L I S H E D M A T E R I A L B i c k s l e r , J . E . E m p i r i c a l T e s t s o f C o m p a t l b i l i t y of S e l e c t e d E q u i t y Share" P r i c e E"q u a t i o n s w i t h a LTe s  c r i p f i v e D i v i d e n d M o 5 e l . . Me rfTo P a r k , C a l i f o r n i a , S t a n f o r d Re s e a r c h Ins t i t u t e , u n p u b l i s h e d , 1966 . F . . M I S C E L L A N E O U S C 1 yne , J . V .. M a c M i l l a n B i o e d e 1 L i m i t e d , R e p o r t to the S h a r e h o l d e r s for~the S i x . M o n t h i E n d e d June TP", 19 6 7~ V a n c o u v e r , ~ C " a n a l a , J u l y 26 , 196T: The F i n a n c i a l P o s t C o r p o r a t i o n S e r v i c e . F i n a n c i a l S u m m a r y C a r d s . T o r o n t o , M a c L e a n - H u n t e r P u b -l i s h i n g C o m p a n y L i m i t e d , 1966. The F inane i a l P o s t S urvey- of In.du s t r i a I s .. A S u r v e y of C a n a d i a n . I n d u s t r i a l C o m p a n i e s P r e p a r e d by the . E d i t o r s of the. F i n a n c i a l P o s t . T o r o n t o , M a c - L e a n -Hun t e r P u b l i s h i n g C o m p a n y L i m i t e d , 1966 . N i e l s o n , S. M a r k e t V a l u e a n d . F i n a n c i a l S t r u c t u r e i n  the R a i l r o a d . . Industry . . The T r a v e l e r s I n s u r a n c e C o . , O c c a s i o n a l P a p e r N o . 4 , M a r c h , 1 9 6 1 . A P P E N D I X A D I V I D E N D T R E N D S IN C A N A D A A N D I N T H E U N I T E D S T A T E S T A B L E A . I P E R C E N T A G E OF C O R P O R A T I O N P R O F I T S IN C A N A D A P A I D O U T I N D I V I D E N D S TO C A N A D I A N P E R S O N S A N D TO NO N - RE.S ID E NT S ( d o l l a r amoun t s i n m i l l i o n s ) Year Corporation Dividends paid to: Total Proportion Proportion profits Canadian non- of after-tax of dividends after taxes persons residents profits to to Canadian non-residents persons and non-residents 1926 $ 386 $ 93 $ 95 $ 188 48.7% 50.5% 1927 436 95 106 201 46 . lv 52.0 1928 503 106 . 115 221 43: 9 52.0 1929 506 . 112 • 158 . 270 . 53.4 - 58.5 1930 281 _ " 99' . 177 276 98.2 64.1 1931 . 130 97 150 247 190.0 60.7 1932 — 26 130 156 83.3 1933 134 69 • 98 . 167 • .124.6 58.7 1934 243 • 85 104 ' 189 . 77.8 55.0 1935 292 84 120 ' 204 69.9 58.8 1936 392 82 . • • 161 243 62.0 66.2 1937 497 103 166 269 54.1 • 61.7 1938 415 ' 121 175 296 71.3 59.1 1939 583 125 177 302 51.8 58.6 1940 522 160 182 342 65.5 53.2 1941 609 . 150 168 318 52.2 52.8 1942 676 129 170 299 44.2 56.9 1943 641 142 156 298 46'. 5 52.3 1944 636 123 153 276 43,4 55.4 1945 645 119 138 257 39.8 53.7 1946 820 115 205 320 39.0 64.1 1947 1,112 219 248 467 42.0 53.1 1948 1,277 216 249 465 36.4 53.5 1949 1,161 234 317 551 47.4 57.5 • 1950 1,539 358 404 762 49.5 53.0 T A B L E A . I ( c o n t i n u e d ) Dividends paid to: Total. Proportion Proportion Canadian non- of after-tax of dividends persons residents profits to to Canadian non-residents persons and non-residents 1951 $ 1,409 $ 350 $ 370 $ 720 51.1%- 51.4% 1952 T,314 335 334 669 50.9 50.0 1953 1,391 317 317 634 45.6 50.0 1954 1,208 . 284 . 327 61T '50.6 53.5 1955 1,693 307 395 702 41.5 56.2 1956 1,932 330 ' 437 767 39.7 57.0 1957 1,719 354 475 829 . 48.2 57.3 1958 1,760 376 470 846 48.0 55.5 1959" 1,923 393 501 • 894 46.5 56.0 1960 . 1,794. 459 458 917 51.1 49.9 1961 1,815 432 586 1 ,018 56.1 57.6 1962 2,109 544 584 1 ,128 53.6 51.7 1963 2,316 637 614 1 ,251 54.0 49.0 1964 2,823 677 713 1 , 39®? 49.3 51.3 1965 • 3,035 796 751 1 ,547 51:0 48.5 1966 2,997 907 816 1 ,723 57.6 47.4 Year Corporation profits after taxes S o u r c e : A c c o u n t s , I ncome 1926- 1956 ,. 19 6 2 , D o m i n i o n B u r e a u a n d . E x p e n d i tu re TUB 5 , 1 9 6 6 of S t a t i s t i c s , N a t i o n a l O t t awa T~able 50 . 1 u e en ' s P r i n t e r T A B L E A . I I U N I T E D S T A T E S C O R P O R A T E P R O F I T S A N D D I V I D E N D S , . 1929- 1964 ( d o l l a r amoun t s i n b i l l i o n s ) Y e a r . C o r p o r a t e D i v i d e n d s P a y o u t p r o f i t s p e r c e n t a g e a f t e r tax 1929 $ • 8 3 $ 5 . 8 7 0% 1930 2 5 5 . 5 220 193 1 - 1' 3 4 . 1 0 1932 - 3 4 2 . 6 0 193 3 - 0 4 2 . 1 0 1934 1 0 2 . 6 260 1935 2 2 2 . 9 132 1936 4. 3 4. 5 105 1937 4 7 4 . 7 100 1938 2 5^ 3 . 2 13 9 1939 5 0 3 . 8 1 7 6 1940 6 5 4 . 0 62 19 41 • ' 9 4 • : " 4. 5 44 1942 9 . 5 4 . 3 45 1943 •10 . 5 4. 5 43 1944 10 . 4 4 . 7 45 1945 8 . .3 4 . 7 57 1946 "13 . 4 5 . 8 43 1947 18 . 2 6 . 5 3 6 1948 - 20 . 5 7 . 2 35 1949 16 . 0 . 7 . 5 47 1950 22 . 8 9 . 2 40 195 1 19 . 7 9 . 0 46 1952 17 . 2 9 . 0 ' 52 1953 18 . 1 9 . 2 5 1 1954 16'. 8 9 . 8 58 1955 23 . 0 11 . 2 49 1956 23 . 5 12 . 1 51 1957 • 22 . 3 12 . 6 56 1958 18 . 8 12 . 4 66 1959 24 . 5. 13 . 7 56 1960 22 . 0 14 . 5 66 1961 21 . 9 2 1 . 9 69 1962 25 . 0 25 . 0 66 1963 26 . 7 26 . 7 67 1964 3 1 . 6 3 1. 6 63 S o u r c e : . E c o n o m i c R e p o r t of the P r e s i d e n t , W a s h i n g t o n , D . C . , U . .S . Govenme'nt P r i n t i n g O f f i c e , 1 9 6 5 , p . 2 6 6 . • A P P E N D I X B H I S T O G R A M S H O W I N G P A Y O U T R A T I O S O F - 190 C A N A D I A N F I R M S , 1961 TO 1965 S o u r c e : T h e F i n a n c i a l P o s t C o r p o r a t i o n S ' e r v i c e , F i n a n c i a l S u m m a r y C a r d s , T o r o n t o , ' M a c L e a n - H u n t e r P u b l i s h i n g C o m p a n y , 1966 . Numbe r of C o m p a n i e s 1961 P a y o u t R a t i o §1 W e i g h t e d A v e r a g e 1 P a y o u t R a t i o , 1961-1965 P a y o u t R a t i o 11-20 V;.3:r-'40! 51-60 71-80 91-100 over 100 ->"Payout C a t e g o r y i n P e r 'cent F I G U R E B . 1 H I S T O G R A M S H O W I N G P A Y O U T R A T I O S OF 190 C A N A D I A N C O M P A N I E S , 1961 TO 1965 A P P E ' N D I X C H I S T O G R A M S S H O W I N G P A Y O U T R A T I O S B Y I N D U S T R Y , 1961 TO 1965 S o u r c e : The F i n a n c i a l . P o s t C o r p o r a t i o n S e r v i c e , F i n a n c i a 1 S u m m a r y C a r d s , T o r o n t o , M a c L e a n - H u n t e r - P u b l i s h i n g C o m p a n y , 1966 . 4 N u m b e r o f C o m p a n i e s I 1 I 1961 Payout Ratio Weighted Average Payout Ratio, 1961-1965 1965 Payout Ratio Sample size = 11 11-20 31-40" 51-60 ' 71-80' 91-100 over 100 Payout Category in Per cent F I G U R E C . 1 D I S T R I B U T I O N OF R A T I O S I N T H E B E V E R A G E I N D U S T R Y N u m b e r o f C o m p a n i e s 6-5-4-3-2-1-1 1 S a m p l e s i z e z 12 Ift II 11-20 31-40 ' 51-60' 71-80 91V100 over 100 Payout Category in Per cent F I G U R E C . 2 D I S T R I B U T I O N O F R A T I O S IN T H E C H E M I C A L I N D U S T R Y Numb e r of C o m p a n i e s N u m b e r of • 1961 Payout Ratio U Weighted Average I Payout Ratio, 1961-1965 1965 Payout Ratio S a m p l e s i z e 28 11-20 71'.-80 ' 91-100 over 100 Payout Category in Per cent F I G U R E C . 3' D I S T R I B U T I O N O F R A T I O S IN T H E F O ' ^ D I N D U S T R Y 6 _ 5 _ 4 -C o m p a n i e s ^ 2 -1 -S a m p l e s i z e = 17 11-20 31-40 " 5 1-60 ' 71-80 91-100 Payout Category in Per cent F I G U R E C . 4 D I S T R I B U T I O N OF R A T I O S IN T H E P R O D U C T S I N D U S T R Y over 100 F O R E S T 3 -I Nu.m b e r of C o m p a n i e s 1 -| 1961 Payout Ratio -pl Weighted Average El, Payout Ratio, 1961-1965 1965 Payout Ratio 11-20 31-4.0 ' 51-60 71-80 91-100 over 100 Payout Category in Per cent F I G U R E C . 5 D I S T R I B U T I O N O F R A T I O S I N T H E GAS A N D O I L P I P E L I N E I N D U S T R Y Payout Category in Per cent F I G U R E C . 6 D I S T R I B U T I O N OF R A T I O S IN T H E M E R C H A N D I S I N G I N D U S T R Y 11-20 31-40 • 51-60 . 71-80 over 100 Payout Category in Per cent F I G U R E C .7 D I S T R I B U T I O N ' O F - R A T I O S I N T H E P U B L I C U T I L I T Y I N D U S T R Y p i i i : i i ~ i i — 11-20 31-40 51-60 71-80 over 100 Payout Category in Per cent F I G U R E C . 8 D I S T R I B U T I O N O F R A T I O S IN T H E N O N - F E R R O U S M E T A L I N D U S T R Y Numb e r of 5 -4 3 C o m p a n i e s ^ 1 -J 1961 Payout Ratio If] Weighted Average | Payout Ratio, 1961-1965 .;• 1965 Payout Ratio S a m p l e s i z e = 16 11-20 31-40 ' 51-60' 71-80' 91-100" over 100 Payout Category in Per cent F I G U R E C . 9 v D I S T R I B U T I O N O F R A T I O S IN T H E T E X T I L E I N D U S T R Y N u m b e r of C o m p a n i e s 6 A 5 -4 -3 -1 -11-20 1 i S a m p l e s i z e 16 T 31-40 51-60- 71-80 91-100 over 100 Payout Category in Per cent F I G U R E C . 10 D I S T R I B U T I O N O F R A T I O S IN T H E T R U S T C O M P A N Y I N D U S T R Y 169 A P P E N D I X D P A Y O U T R A T I O S F O R D I F F E R E N T S I Z E C A N A D I A N F I R M S , 195 1- 1 962 Y e a r Le gend A s s e t s ( d o l l a r s ) S v m b o 1 100,000,000 and over 25,000,000 - 100,000,000 10,000,000 - 25,000,000 5,000,000 - .10,000,000 1,000,000 - 5,000,000 500,000 - 1,000,000 250,000 - 500,000 100,000 - 250,000 under 100,000 F I G U R E D . 1 P E R C E N T A G E P A Y O U T R A T I O S O F A L L C A N A D I A N P U B L I C F I R M S , C L A S S I F I E D B Y S I Z E ( A S S E T S ) , 1951 TO 1962 S o u r c e : C . C . P o t t e r , F i n a n c e and B u s i n e s s  A d m i n i s t r a t i o n i n C a n a d a , S c a r b o r o u g ET" On t . , P r e n t i c e -n a i l of C a n a d a LTTm i t e d , 1 9 6 6 , pp . 3 7 4 - 3 7 8 A P P E N D I X E P A I R E D C O M P A N I E S T A B L E E . I 72 P A I R S OF C O M P A N I E S H i g h P a y o u t Maple Leaf Mills Ltd. General Bakeries Ltd. Laura Secord Candy Shops Ltd. Canada & Dominion Sugar Co. British Columbia Sugar Refinery Ltd. Canadian Canners Ltd. Walter M . Lowney Co. Ltd. Dominion Dairies Ltd. Silverwood Dairies Ltd. Stafford Foods Ltd. Salada Foods Ltd. Maritime Telegraph & Telephone Co. Ltd. Nova Scotia Light & Power Co. Ltd. MacLaren Quebec Power Co. International Utilities Corp. Canadian Western Natural Gas Co. Ltd. Greater Winnipeg Gas Co. Bell Telephone Co. of Canada United Towns Electric Co. Ltd. Canadian Utilities Ltd. Union Gas Co. of Canada Ltd. Price Co. Ltd. Great Lakes Paper Co. Ltd. MacMillan Bloedel" Ltd. St. Lawrence Corp. Ltd. Beaver Lumber Ltd. Abitibi Ltd. Scott Paper Ltd. Consolidated Paper Corp. Alcan Aluminum Ltd. The Niagara Wire Weaving Co. Ltd. Cominco Ltd. Hahn Brass Ltd. Traders Group Ltd. National Trust Co. The Canada Trust Co. Victoria & Grey Trust Co. Credit Foncier Franco-Canadien Ltd. The Sterling Trust Corp. Low P a y o u t George Weston Ltd. Canada Bread Co. Ltd. Bowes Co. Ltd. Canada Packers Ltd. Atlantic Sugar Refineries Co. Bick's of Canada Ltd. Fanny Farmer Candy Shop Inc. Canadian Food Products Ltd. The Canadian Salt Co. Ltd. Monarch Fine Foods Ltd. Burns Foods Ltd. Quebec Telephone Ltd. Canadian International Power Co. Ltd. Great Lakes Power Corp. Ltd. Northland Central Gas Co. Ltd. Newfoundland Light & Power Co. Ltd. Lakeland Natural Gas Ltd. British Columbia Telephone Co. East Kootney Power Co. Ltd. Maritime Electric Co. Ltd. Calgary Power Ltd. Anglo-Canadian Pulp & Paper Mil ls Ltd. Hinde & Dauch Ltd. British Columbia Forest Products Ltd. Rolland Paper Ltd. Revelstoke Building Materials Ltd. Donohue Brothers Ltd. Bathurst Paper Ltd. Columbia Cellulose Ltd. Canadian British Aluminum Co. Ltd. Phillips Cables Ltd. Noranda Mines Ltd. Industrial Wire & Cable Co. Ltd. Crown Trust Co. Guaranty Trust Co. of Canada Montreal Trust Co. Union Acceptance Corp. Ltd. The Ontario Loan & Debenture Co. Eastern & Chartered Trust Co. T A B L E E . I ( c o n t i n u e d ) H i g h P a y o u t Canada Permanent Mort. Corp. Hudson's Bay Co. G. Tamblyn Ltd. Zeller's Ltd. Lob law Inc. Dominion Stores Ltd. Shop & Save (1957) Ltd. Reitman's (Canada) Ltd. Transmountain Oil Pipeline Co. Trans-Canada Pipelines Ltd. The Alberta Gas Trunkline Co. Ltd. Interprovincial Pipeline Co. Pacific Gas Transmission Co. Texaco Ltd. British American Oil Co. Ltd. Dominion Textile Co. Ltd. The Hamilton Cotton Co. Ltd. Dominion Corset Co. Ltd. .Harding Carpets Ltd. Biltmore Hats Ltd. Scythes & Co. Ltd. The Steel Co. of Canada Ltd. Dominion Steel & Coal Corp. Ltd. Dominion Bridge Co. Ltd. Domtar Ltd. . Canadian Industries Ltd. -Sherwin-Williams Co. of Canada Canadian Crushed & Cut Stone Ltd. Ocean Cement & Supplies Ltd. Canadian General Electric Co. Hiram Walker-Gooderham & Worts Ltd. Crown Cork & Seal Co. Ltd. Chateau-Gai Wines Ltd. Low P a y o u t Laurentide Financial Corp. Ltd. Simpsons-Sears Ltd. Woodward's Stores Ltd. Metropolitan Stores Ltd. National Grocers Co. Ltd. Lob law Co. Ltd. Steinberg's Ltd. Kelly Douglas Ltd. Trans-Prairie Pipe Lines Ltd. Canadian Hydrocarbons Ltd. Supertest Petroleum Corp. Western Pacific Products & Crude Oil Pipelines Ltd. Alberta Gas Co. Royalite Oil Co. Ltd. Shell Canada Ltd. The Wabasso Co. Ltd. Bruck Mil ls Ltd. Exquisite Form Brassiere (Canada) Ltd Consolidated Textile Mil ls Ltd. Harvey Woods Ltd. Dominion Fabrics Ltd. Dominion Foundries & Steel Ltd. Canadian Vickers Ltd. Standard Structural Steel Ltd. Union Carbide Canada Ltd. Chemcell Ltd. International Paints (Canada) Ltd. Lake Ontario Cement Co. Ltd. St. Lawrence Cement Co. Canadian Westinghouse Co. Ltd. Distillers Corp.-Seagrams Ltd. Crush International Ltd. T. C. Brighty & Co. Ltd. T A B L E E . II 28 P A I R S OF C O M P A N I E S E X H I B I T I N G S U P E R I O R G R O W T H H i g h ' P a y o u t Low P a y o u t Maple. .-Leaf Mills Ltd. General Bakeries Ltd. Laura Secord Candy Shops Ltd. Walter M . Lowriey Co. Ltd. Canadian Canners Ltd. Dominion Textile Co. Ltd. The Hamilton Cotton Co. Ltd. Harding Carpets Ltd. Trans Mountain Oil Pipeline Co. Trans-Canada Pipelines Ltd. Crown Cork & Seal Co. Ltd. Alcan Aluminum Ltd. Cominco Ltd. The Steel Co. of Canada Ltd. Dominion Bridge Co. Ltd. Canadian Industries Ltd. Canada Crushed & Cut Stone Ltd. Ocean Cement & Supplies Ltd. Canadian General Electric Co. Price Co. Ltd. MacLaren Quebec Power Co. International Utilities Corp. Greater Winnipeg Gas Co. National Trust Co. The Canada Trust Co. Victoria & Grey Trust Co. Zeller's Ltd. Lob law Lac. George Weston Ltd. Canada Bread Co. Ltd. Bowes Co. Ltd. Fanny Farmer Candy Shop Lie. Bick's of Canada Ltd. The Wabasso Cotton Co. Ltd. Bruck Mil ls Ltd. Textile Mil ls Ltd. Trans-Prairie Pipelines Ltd. Canadian Hydrocarbons Ltd. Crush International Ltd. Canadian British Aluminum Co. Ltd. Noranda Mines Ltd. Dominion Foundries & Steel Ltd. Standard Structural Steel Ltd, Chemcell Ltd. Lake Ontario Cement Co. Ltd. St. Lawrence Cement Co. Canadian Westinghouse Co. Ltd. Anglo-Canadian Pulp & Paper Mil ls Ltd Great Lakes Power Corp. Ltd. Northern & Central Gas Co. Ltd. Lakeland Natural Gas Ltd. Guaranty Trust Co. Montreal Trust Co. Union Acceptance Corp. Ltd. Metropolitan Stores Ltd. National Grocers Co. Ltd. T A B L E E . I l l 27 P A I R S OF C O M P A N I E S C L O S E L Y P A I R E D H i g h P a y o u t Maple Leaf Mills Ltd. Walter M . Lowney Co. Ltd. British Columbia Sugar Refinery Ltd. Dominion Dairies Ltd. Salada Foods Ltd. Stafford Foods Ltd. Pacific Gas Transmission Co. The Hamilton Cotton Co. Dominion Corset Co. Ltd. Scythes and Co. Ltd. Biltmore Hats Ltd. Hudson's Bay Co. Zeller's Ltd. Lob law Inc. Dominion Stores Ltd. Cominco Ltd. The Steel Co. of Canada Ltd. Canadian Industries Ltd. Canadian Crushed & Cut Stone Ltd. Canadian General Electric Co. Price Co. Ltd. Maritime Telegraph & Telephone Co. Ltd. Greater Winnipeg Gas Co. Ltd. International Utilities Corp. Canada Union Gas Co. of Canada Ltd. Canadian Utilities Ltd. National Trust Co. Low P a y o u t George Weston Ltd. Fanny Farmer Candy Shop Inc. Atlantic Sugar Refineries Co. Canadian Food Products Ltd. Burns Foods Ltd. Monarch Fine Foods Ltd. Alberta Natural Gas Co. Bruck Mil ls Ltd. Exquisite Form Brassiere (Canada) Ltd Dominion Fabrics Ltd. Harvey Woods Ltd. Simpsons-Sears Ltd. Metropolitan Stores Ltd. National Grocers Co. Ltd. Lob law Co. Ltd. Noranda Mines Ltd. Dominion Foundries & Steel Ltd. Chemcell Ltd. Lake Ontario Cement Co. Ltd. Canadian Westinghouse Co. Ltd. Anglo-Canadian Pulp & Paper Mil ls Ltd Quebec Telephone Ltd. Lake and Natural Gas Ltd. Northern and Central Gas Co. Ltd. Calgary Power Ltd. Maritime Electric Co. Ltd. Montreal Trust Co. T A B L E E . IV 24 P A I R S OF C O M P A N I E S W I T H A R A T I O D I F F E R E N C E O V E R 35 P E R C E N T H i g h P a y o u t Credit Foncier Franco-Canadien Ltd. MacLaren-Quebec Power Co. Greater Winnipeg Gas Co. Canadian Utilities Ltd. Consolidated Paper Corp. Ltd. Beaver Lumber Ltd. Ocean Cement Ltd. Domtar Ltd. Canadian Industries Ltd. A lean Aluminum Ltd. The Niagara Wire Weaving Co. Ltd. Zeller's Ltd. Lob law Lie. Trans Mountain Oil Pipeline Co. Interprovincial Pipeline Co. Dominion Textile Co. Ltd. Cosmos Imperial Mills Ltd. Dominion Corset Co. Ltd. Scythes & Co. Ltd. Belding-Corticelli Ltd. Laura Secord Candy Shops Ltd. Salada Foods Ltd. Canadian Canners Ltd. Chateau-Gai Wines Ltd. Low P a y o u t The Ontario Loan & Debenture Co. Canadian International Power Co. Ltd. Lakeland Natural Gas Ltd. Maritime Electric Co. Ltd. Columbia Cellulose Ltd. Revelstoke Building Materials Ltd. Lake Ontario Cement Co. Union Carbide Canada Ltd. Chemcell Ltd. Canadian British Aluminum Co. Ltd. Phillips Cables Ltd. Metropolitan Stores Ltd. National Grocers Co. Ltd. Trans Prairie Pipelines Ltd. Western Pacific Products & Crude Oil Pipelines Ltd. The Wabasso Cotton Co. Ltd. Harvey Woods Ltd. Exquisite Form Brassiere Canada Ltd. Dominion Fabrics Ltd. Bruck Mil ls Ltd. Bowes Co. Ltd. Burns Foods Ltd. Bick's of Canada Ltd. T. C. Bright & Co. L td . A P P E N D I X F C O P I E S OF (1) TWO L E T T E R S R E Q U E S T I N G C O O P E R A T I O N . A N D . (2) A C C O M P A N Y I N G Q U E S T I O N N A I R E S T H E U N I V E R S I T Y O F BRITISH C O L U M B I A V A N C O U V E R 8, C A N A D A FACULTY OF COMMERCE AND BUSINESS ADMINISTRATION March 25, 1967 Oear Sirs I am presently working on a thesis en t i t l e d The Dividend  Decision with Emphasis on the Canadian Situation in order to f u l f i l the requirements for the degree of Master of Business Administration from the University of B r i t i s h Columbia. I would appreciate your comments on some of the factors that you consider important i n deciding on the dividend that you pay to the holder of common shares. For convenience, I have enclosed a questionnaire. The information would be kept confidential; that i s , the company name would not be mentioned in the thesis or elsewhere. I have requested this same information from twenty-nine other companies. I would be grateful for your help and cooperation on t h i s . Thank you in anticipation of a favorable response. Yours sincerely Curtis J. Copeland Enclosure DIVIDEND DECI5IQN QUESTIONNAIRE Please return to: Curtis J . Copeland Faculty of Commerce and Business Administration The University of B r i t i s h Columbia Vancouver 8, Canada 1. Factors that you consider most important in deciding on the company dividend to holders of common shares. Please -rate the factors on the l i s t If other factors apply, please state them. very important some importance not important 1 2 3 4 5 a. past dividends b. this year's p r o f i t c. frequency of dividend changes d. expected growth in earnings and sales e. expected v a r i a b i l i t y in earnings or sales f. competitors' payout ratio g. attitudes of shareholders h. effect of a change of divided'' on market price of stock — i . future financing plans i . equity i i . debt j . planned investment projects k. capital structure 1. rate of return on capital m. present and anticipated need for cash n. internal risks o. use of stock s p l i t s , dividends and extras — -p. relative size of stock ownership by management or other control groups q r s 2. Do you have a target payout ra t i o to aim for? Yes No 3. Please rank the relative importance of the following: Rank Size of dividends Continuity of dividends S t a b i l i t y of dividends 4. Oa you^consider that the primary dividend decision i s : Do we need to change the amount of the dividend we are presently paying? Yes No_ 5. Other comments, i f any: T H E U N I V E R S I T Y O F BRITISH C O L U M B I A V A N C O U V E R 8, C A N A D A FACULTY OF C O M M E R C E A N D BUSINESS ADMINISTRATION Apr i l 15, 1967 Dear Sirs Several weeks ago I sent a l e t t e r to you requesting your opinion an certain factors you consider important i n deciding on the dividend you pay to common shareholders. In the event that my origi n a l l e t t e r and questionnaire were not received or have been misplaced I have enclosed another copy of the questionnaire. The information i s desired for a thesis en t i t l e d The Dividend  Decision with Emphasis on the Canadian Situation undertaken to f u l f i l l the requirements for the degree of Master of Business Administration from the University of B r i t i s h Columbia. The information would be kept confidential; that i s , the company name would not be mentioned i n the thesis or elsewhere, I would be grateful for your help and cooperation. Thank you in anticipation of a favourable response. Yours sincerely Curtis J . Copeland Enclosure DIVIDEND DECISION QUESTIONNAIRE Please return to: Curtis J. Copeland Faculty of Commerce and Business Administration The University of British Columbia Vancouver 8, Canada 1. Factors that you consider most important in deciding on the company dividend to holders of common shares. Please -rate the factors on the l i s t If ether factors apply, please state them. very important some importance not important 1 2 3 4 5 a. past dividends b. this year's profit c. frequency of dividend changes d. expected growth in earnings and sales e. expected variability in earnings or sales f. competitors' payout ratio g. attitudes of shareholders h. effect of a change of divider*'1 on market price of stock i . future financing plans i . equity i i . debt j . planned investment projects k. capital structure 1. rate of return on capital m. present and anticipated need for cash n, internal risks o. use of stock splits, dividends and extras p. relative size of stock ownership by management or other control groups q , cu_t of ccpitcl r. s 2. Do you have a target payout ratio to aim for? Yes No 3. Please rank the relative importance of the following: Rank Size of dividends ________________________ Continuity of dividends ___________________________ Stability of dividends 4. Da you''consider that the primary dividend decision i s : Do we need to change the amount of the dividend we are presently paying? Yes No 5. Other comments, i f any: A P P E N D I X G F I R M S U S E D F O R M O D E L T E S T I N G T A B L E G . I 25 F I R M S IN T H E F O R E S T P R O D U C T S I N D U S T R Y A b i t i b i P a p e r C o . L t d . Sco t t P a p e r L t d . Bo w a t e r s M e r s e y P a p e r C o . L t d . C o n s o l i d a t e d P a p e r C o r p o r a t i o n L t d . P r i c e C o . L t d . A n g l o - C a n a d i a n P u l p and P a p e r M i l l s L t d . G r e a t L a k e s P a p e r C o . L t d . B a r b e r - E l l i s of C a n a d a L t d . S t . L a w r e n c e C o r p o r a t i o n L t d . Donohue B r o t h e r s L t d . M a c M i l l a n B l o e d e l L t d . D r y d e n P a p e r C o . L t d . F r a s e r C o m p a n i e s L t d . B r i t i s h C o l u m b i a F o r e s t P r o d u c t s L t d . B a t h u r s t P a p e r L t d . C a n a d i a n W a l l p a p e r M a n u f a c t u r e r s L t d . T h o m p s o n P a p e r B o x C o . L t d . H i n d e & D a u c h L t d . R o l l a n d P a p e r C o . L t d . G l o b e E n v e l o p e s L t d . L i v i n g s t o n Wood M a n u f a c t u r i n g L t d . C r e s t b r o o k T i m b e r L t d . E r i c F l o o r i n g & Wood P r o d u c t s L t d . C o l u m b i a C e l l u l o s e C o . L t d . B e a v e r L u m b e r C o . L t d . T A B L E G . II 60 F I R M S IN A L L I N D U S T R I E S B e v e r a g e s H i r a m W a l k e r G o o d e r h a m - W o r t s L t d . C r u s h I n t e r n a t i o n a l L t d . C h e m i c a l s C h e m c e l l L t d . R e i c h o l d C h e m i c a l s (Canada) L t d . J e f f e r s o n L a k e P e t r o c h e m i c a l s of C a n a d a L t d . C o n s t r u c t i o n C a n a d a C e m e n t C o . L t d . Ocean C e m e n t & S u p p l i e s L t d . Canada C r u s h e d and Cut Stone L t d . B r i t i s h A m e r i c a n C o n s t r u c t i o n & M a t e r i a l s L t d . S t a n d a r d P a v i n g & M a t e r i a l s L t d . R e v e l s t o k e B u i l d i n g M a t e r i a l s E l e c t r i c a l ~ C a n a d i a n W e s t i n g h o u s e C o . L t d . N o r t h e r n E l e c t r i c C o . L t d . C A E I n d u s t r i e s L t d . F o o d s t u f f s L e s L a i t e r i e s L e c l e r c I n c . C a n a d a P a c k e r s L t d . C a n a d i a n C a n n e r s L t d . Ocean F i s h e r i e s L t d . F o r e s t P r o d u c t s C r e s t b r o o k T i m b e r L t d . A b i t i b i P a p e r C o . L t d . B a r b e r - E l l i s of C a n a d a L t d . M a c M i l l a n B l o e d e l L t d . B r i t i s h C o l u m b i a F o r e s t P r o d u c t s L t d . I r o n and S t e e l A i g o m a S t e e l L t d . C a n a d a V i c k e r s L t d . A t h n e s I m p e r i a l L t d . M a s s e y F e r g u s o n L t d . F a r a n o L t d . I n g e r s o l l M a c h i n e and T o o l C o . L t d . Wajax L t d . T A B L E G . I I ( c o n t i n u e d ) M e r c h a n d i s i n g S i m p s o n s - S e a r s L t d . R e i t m a n ' s (Canada ) L t d . R o c k o w e r of C a n a d a L t d . Shop & Save 1957 L t d . Oshawa W h o l e s a l e L t d . C a n a d i a n T i r e C o r p o r a t i o n L t d . M a r s h a l l W e l l s L t d . W m . S t a i r s , Son & M o r r o w L t d . M i s c e l l a n e o u s Neon P r o d u c t s of C a n a d a L t d . Non F e r r o u s M e t a l s U o m i n c o L t d . P h i l l i p s C a b l e s L t d . O i l and P i p e l i n e s A n g l o - C ana d i a n O i l s L t d . T e x a c o C a n a d a L t d . I n t e r p r o v i n c i a l P i p e l i n e C o . T r a n s C a n a d a P i p e L i n e s L t d . A l b e r t a N a t u r a l Gas C o . P r i n t i n g and P u b l i s h i n g T o r o n t o S t a r Sou tham P r e s s M o o r e C o r p o r a t i o n L t d . L a w s o n and Jones L t d . P u b l i c U t i l i t i e s New B r u n s w i c k T e l e p h o n e C o . . M a c . l a r e n P o w e r & P a p e r C o . I n t e r n a t i o n a l U t i l i t i e s C o r p o r a t i o n I n l a n d N a t u r a l Gas C o . T e x t i l e s S~c ott L a S a l l e L t d . C o n s o l i d a t e d T e x t i l e M i l l s H a r d i n g C a r p e t s L t d . T r a n s p o r t a t i o n The Whi te P a s s and Y u k o n C o r p o r a t i o n L t d . S t r a i t s T o w i n g L t d . K e n t i n g A v i a t i o n L t d . 

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