Entrepreneurs with benefits: stock appreciation plus high dividend yields.

Author:Shulman, Joel M.

    The debate in the Finance literature regarding dividend irrelevance has existed for many years, though recent evidence suggests that investors' preference for dividend paying stocks may vary over time. In particular, it appears that investors may prefer dividend paying stocks during periods of market contraction. If true, this would suggest that investors introduce a style or sector rotation preference based on expectations of future market conditions. Such behavior may be advantageous if investors could correctly anticipate the future, but few are likely to possess such skill. This paper explores an investment strategy assuming a market naive approach for the long-term investor. In particular, we seek an investment strategy that dominates in both positive and negative markets. Prior evidence shows that entrepreneur-based stock investments outshine peer benchmarks during periods of market expansion (up markets) though trail during negative markets (down capture). This paper adds a dividend yield overlay to a portfolio of publicly-traded entrepreneur stocks and explores the effect during both rising and declining markets. We find that an entrepreneur plus dividend portfolio dominates peer indices in both positive and negative markets. Is this too good to be true?


    A recent article by Fuller and Goldstein (2011) provides evidence that dividends matter more to shareholders, particularly in declining markets. They also suggest that investors generate superior returns during these markets. Their results support DeAngelo and DeAngelo (2006) which discuss the importance of dividends as managers may otherwise destroy wealth through the dissipation of cash flows with frivolous spending (e.g. compensation packages, lavish parties, etc.). Both studies run counter to the classic view of dividend irrelevance postulated by Miller and Modigliani (1961. Other related studies of note include Jagannathan and Wang (2007) who note that shareholders are more likely to review their investments when future projections of the economy are poor or uncertain. Allen, et al. (2003) suggest that "better" firms pay dividends, suggesting that results may vary depending on the ROA, ROE or future earnings associated with the underlying organizations.

    A number of studies including Shulman and Cox (2010), Barontini and Caprio (2006), and Villalonga and Amit (2005), support the notion that firm value is higher with a founder chief executive officer (CEO) rather than under second generation CEOs. Research shows that founder-CEO operated firms provide superior stock returns compared to non-founder CEO firms, McVey and Drako (2005), Cox and Shulman (2008), and Morck, Shleifer and Vishny (1988). This is in contrast to earlier research by Jayaraman, Khoranan and Weiling (2000), Himmelberg, Hubbard and Palia (1999) and Demsetz and Villalonga (2001), providing conflicting evidence suggesting that there are no differences in stock returns between the two sets.

    There are two competing views on how concentrated family ownership might affect the efficiency of a company: the entrenchment effect and alignment effect. The entrenchment effect address the agency conflicts between managers and outside shareholders (Jensen and Meckling 1976) and posits that concentrated ownership creates incentives for controlling shareholders to expropriate wealth from other shareholders Fama (1980). The alignment effect, Wang (2006), insinuates that focalized family ownership enables family members to maintain a long-term presence in the entity and have the enticement to preserve the family name and reputation to create lasting employee loyalty. Further, Krishnan et al (1997) chronicle how rates of top management departures are associated with lower firm performance. Chen and Lee (2008) analyze the financial performance of family-owned ventures and find that the return on assets is higher relative to non-family owned firms. They also discovered that employee remuneration is negatively related to family ownership.

    Founder-controlled firms possess the original owner and manager of the organization. This founder has been endowed with vision and managerial acumen in so far as they have raised the firm from a startup, taken it public, listed the stock on an exchange, and grown it to be a large capitalization, publicly traded corporation. Shulman (2009) builds upon the work of Livingston (2007), Fahlenbrach (2009), Burkart, Panunzi and Shleifer (2003), Barontini and Caprio (2006) provide evidence that there may be a number of other factors, besides founder control, that distinguish entrepreneurial companies from non-entrepreneurial companies. In his paper, Shulman (2009) cites 15 key attributes used to describe Entrepreneurial companies, which we employ here:

  3. Above average organic growth (versus growth through acquisition)

  4. Above average ownership stake among key stakeholders

  5. Low selling, general administrative expense (SG&A)

  6. Above average return on invested capital

  7. Sustainable growth

  8. Manageable debt (relatively modest debt with capacity to repay debt and interest)

  9. Active strategic alliances/partnerships/licensing

  10. Aligned executive...

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