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An empirical analysis of a selling policy to increase dividend income in the investment management of an income trust

University of British Columbia

Trustees of income trusts have generally been given over the period 1959-1971 power to invest trust funds in common stocks. Their objectives are to invest trust funds to produce an income for a life tenant while preserving the capital of the trust for the ultimate remainderman. A clear division between capital and income is required by legal rules and reference is made to selected legal decisions to illustrate the attitude of the courts. A trustee of an income trust cannot accept the attitude o;f indifference between dividend income and capital gains adopted by some individual investors and many academic researchers. It is submitted that it is difficult to construct appropriate investment policies for an income trust through reading recent literature on common stock investment strategies; trustees cannot accept the normal assumption that dividend income and capital gains are equivalent. The general proposition that risk and return are positively related, which Soldofsky and Miller (1969) seek to support could induce a trustee to purchase risky securities. However analysis of their own data reveals a negative relationship between risk and return among American common stocks, roughly over the years 1955-1962. The report by Litzenberger, Joy and Jones (1971) on a policy of investing in low P/E ratio American common stocks is analysed to reveal some difficulties in evaluating their results. In a trust portfolio a stock can come to produce a low dividend yield through stock price appreciation. It could be retained under a Buy and Hold Policy, or sold and the proceeds reinvested in another stock with a larger current dividend yield under an Administrative Policy. An empirical evaluation of these alternative policies was undertaken using stock market data on 108 Canadian firms over the periods April 1960 to September 1964 and January 1965 to June 1969. Any Administrative Policy requires two decision rules, one to initiate sales and one to direct purchases. To isolate the impact of the decision to sell, which was based upon a decline in current dividend yield, a reinvestment policy was adopted employing random selection from those securities then within a desired current dividend yield range. For the first period, Fortran programs were used to produce discounted dividend and capital gains statistics. These were expressed as an average annual discounted yield based upon the capital originally invested, for the Buy and Hold Policy and for 9 differing operational definitions of an Administrative Policy, these latter statistics being grand means based upon twenty trials. From these results 3 hypotheses were developed for testing in a subsequent non-overlapping period. The only hypothesis that survived this test was that an Administrative Policy will increase the dividend yield statistic over that produced by a Buy and Hold Policy. The impact of an Administrative Policy upon the capital gains statistic did vary, being negative in the first period and positive in the second. The ability of an Administrative Policy to increase the dividend yield statistic can be related to two propositions in current financial theory: that companies are slow to translate increased earnings into larger dividends, and that widespread anticipation of larger corporate earnings in the future may cause a share's price.to rise arid its current dividend yield to fall. An Administrative Policy may have produced an increased dividend yield by not holding stocks whose current dividend yield has fallen, during the interval between the market's anticipation of increased earnings, and the payment of normal dividends upon the increased earnings.

Text

2010-01-22

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http://hdl.handle.net/2429/19025

Business Administration

University of British Columbia

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