Dividend initiation during financial turmoil.

Author:Zhang, Ge
Position:Report - Statistical data

    Dividend is a major subject in corporate finance. Given that 84.1% of the managers consider "maintaining consistency with historic dividend policy" important (Brav et. al. 2005), initiating dividends for the first time becomes a big decision for corporate managers. Once regular dividends are initiated, managers make a significant commitment to maintain the level of dividend payout. Because of this perception, the market reacts quite positively to dividend initiating announcement. From 2003 to 2007, from 50 to 131 firms each year declared dividends for the first time. During the same period, the economy was in expansion and the market moved higher steadily. S&P 500 index went from 855 from the beginning of 2003 to over 1400 at the end of 2007. However, since peaking at over 1500 in October 2007, the index was in a steep decline in 2008 and the first half of 2009. In March 2009, the index had lost over half of its peak value. With the financial sector leading the decline, the whole economy entered a severe recession and this period is widely recognized as the global financial turmoil period.

    During the global financial turmoil, many firms reduced or suspended dividends to preserve cash. For example, on March 16, 2009, Alcoa announced that it would slash dividends by 82%. "Today's actions better prepare Alcoa to manage through a prolonged downturn," said Klaus Kleinfeld, Alcoa's president and chief executive, in a statement. However, there were some firms who decided to initiate dividend during the financial turmoil. The number of firms that started dividend for the first time during 2008 and 2009 was on averages 25 per year, much less than the average of 77 per year from 2003 to 2008. In 2010, this number returned to 50, doubling the level in the previous two years.

    Clearly, given the severe economic recession in 2008 and 2009, it takes some courage and confidence for a company to buck the trend and initiate dividends for the first time. One notable example of dividend initiating firm is Oracle. On March 18, 2009, Oracle announced its first five-cent quarterly dividend in its 23 years as a public company. Safra Catz, Oracle president, said: "We are committed to delivering value to our stockholders through technology innovation, strategic acquisitions, stock repurchases, and now through a dividend." In this case, the dividend initiation is a show of confidence of the Oracle management to its operating model and competitive position. "Though we cannot control the stock market, one thing we can do is give our stockholders a dividend," added Ms. Catz. In this paper, we investigate whether these dividend-initiating firms during the global financial turmoil are any different from dividend-initiating firms during normal economic times. We find that fewer firms initiate dividends during the financial turmoil, but these firms have a higher average dividend yield than their counterparts during normal times. Although we use the stock price at the end of the previous calendar year as the denominator to calculate dividend yield, the higher yield may still be a reflection of depressed stock levels during the financial turmoil.

    The two samples of dividend initiating firms share some similar characteristics, such as market-to-book ratio, firm size, net cash flows, earnings, leverage, R&D spending. There remain some differences. The dividend initiating firms during the financial turmoil have slower growth, but more cash. In the years before dividend initiation, these firms already pay out a large amount to their shareholders through repurchase. Hence, it appears that the quotes from Ms. Catz on Oracle's dividend initiation reflect the typical sentiment of the firms initiating dividends during the financial turmoil. They have been doing repurchase already, but the declining equity market does not bode well for repurchases, and they choose to pay cash dividends in addition.

    We analyze the market reaction to dividend initiation during the financial turmoil. While the market reaction to dividend initiation announcement is overwhelmingly positive in both time periods, we find some interesting difference for the long-run performance after the dividend initiation. Before 2008, the excess returns in the half year after dividend initiations are negatively correlated with the market reaction to the initiation announcement. In other words, the market appears to over-react to the dividend initiation news. During the financial turmoil years of 2008 and 2009, the excess returns in the half year after dividend initiations are positively correlated with the market reaction to the initiation announcement. Thus, the market under-reacts to the dividend initiation news during the global financial turmoil.

    This paper contributes to the literature by extending the literature on dividend initiation to the global financial turmoil. By analyzing the dividend initiating firms during the financial turmoil, we can achieve a better understanding about the dividend initiating firms during both the financial turmoil years and the normal years. We also extend the literature on market reaction to dividend initiation news. While the overall reaction is positive, our results on long-term performance after dividend initiations show that the market reacts differently in the global financial turmoil years.

    This paper is organized as follows: Section 2 presents the data. Section 3 reports the regression results on the market reaction to dividend initiation news. Section 4 concludes the paper.

  2. DATA

    We extract the dividend data from the CRSP database. If a firm does not pay any dividend in the previous year and pays a regular dividend in the current year, we classify this firm as a dividend-initiating firm. In May 2003, President Bush signed the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA 2003 Act), and the legislation slashed the highest dividend tax rate from 38.6% to 15%. Starting in 2003, there is a surge in the number of firms initiating dividends for the first time (Chetty and Saez 2005, Nam, Wang and Zhang 2010). For this reason, we start from 2003 so that all the dividend...

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