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UBC Theses and Dissertations

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

Abstract

The objective of this thesis is to investigate the numerous aspects of the dividend decision with emphasis on the Canadian situation. Theoretical developments, investors' attitudes towards dividends, and decision criteria to establish the amount are three areas requiring further work. Both old and new unique approaches are utilized in this thesis to elucidate these problem areas. The importance of the dividend decision to the shareholder, the firm, and the economy is first established. Variations in inter-industry ratios and in payout trends are then examined and explained to provide an environment for the subsequent studies. The objectives of the chapter on theory are to sort, relate, and extend (also, to examine the pragmatic implications of) the available and pertinent, theoretical and empirical contributions. The relationship between dividend decision making and traditional theory on capital structure is first described. Extensions thereof and alternative proposals follow. Strict adherence to theory is suggested to be impractical. The Modigliani and Miller approach that dividends have no bearing on cost of capital or share price and are therefore not important is refuted by: 1) logically arranging, and concluding from, criticisms of their-cost of capital argument; 2) examining, consolidating, and validating the early theory that stock values (unlevered equity) are determined by capitalizing a dividend stream; 3) citing results of the published statistical studies, none of which indicate that the pure earnings hypothesis is correct; 4) examining in greater detail the logic presented by the authors. The importance of (1) informational contents as a link between a change in dividends and a change in share price and (2) the length of time following dividend changes is substantiated by analysis of three studies and observation of companies involved in those studies. To determine Canadian investors' attitudes to dividends, four studies, each using paired data (1961 to 1965) from up to 144 Canadian companies, were undertaken. Firms were paired on the basis of financial similarity, especially growth, and payout difference to set apart dividends as a factor influencing the price-earnings ratio. The study using very closely paired stocks was deemed most significant because growth and other comparative measures are almost completely isolated. The results indicate (1) that investors are rational in their attitude to dividend policy (that is, they desire shares of a company that retains earnings if the return on those earnings is demonstrated to be high) and (2) that certain growth firms may increase the market price of their stock in the long-run by lowering their dividend. The dividend decision in practice is then investigated. Legal and discretionary elements are presented. Results of the questionnaire, sent to fifty directors of Canadian companies, show that (1) net profit, (2) present and anticipated need for cash, (3) planned investment projects, (4) past dividends, and (5) expected growth and variability in earnings and sales are considered most important; competitors' payout and existence of control groups, least important. Answers to questions on (1) the existence of a target payout, (2) the primary dividend decision, and (3) important features of a sound policy, as well as additional comments by respondents, provide further insight into the decision procedure. Lintner's classic dividend model is then examined and criticized to establish, with the aid of the questionnaire results, three dividend models which are put in the form of regression equations and tested on appropriate Canadian data in order to elucidate the decision process. Subsequent analyses indicate that profits and company size are consistently and highly significant; long-term debt, future prospects, and depreciation show less consistent but significant influence; investment and cash-need variables are less significant; degree of liquidity and conservatism show no relationship. The dividend decision is then examined at the level of aggregate economics to consider the impact of aggregate variables, and in conjunction with these, government macro-economic policy. This investigation supports the questionnaire conclusions.

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