Empirical capital structure: A review, Foundations and Trends in Finance

Question 1

Lifecycle theory

Answer 1

During the rapid growth stage there are many positive NPV projects, investment banks charges for IPOs, so it is more beneficial to sit on cash to finance all those attractive investment projects -> a few dividends pay out (all money reinvested)

During the maturity period there are a few positive NPV projects -> pay out dividends rather than burn cash in NPV < 0 projects. Likely Agency costs -> impose high dividends payouts as a disciplinary measure

Question 2

De Angelo’s proposition

Answer 2

Payout policy is a trade-off between agency costs and capital raising costs

Question 3

Reasons to pay high dividends

Answer 3

Clientele effect
Low growth companies
Agency costs
Signaling theory
Bird in hand theory

Question 4

Reasons to pay low dividends

Answer 4

High issue costs
Tax effect
Clientele effect
Costs of financial distress
Good growth prospect

Question 5

Advantages of repurchase

Answer 5

Preserving financial flexibility 
Correct stock valuation 
Remove low valuation stockholders 
Allocation of voting rights
Increase reported EPS
Transaction costs saving

Question 6

Why Preserving financial flexibility is a reason of repurchase

Answer 6

• No need for future payments

Question 7

Why Correct stock valuation is a reason of repurchase

Answer 7

• Buy when undervalued

- Exploit shareholders (arguable)

Question 8

Why Remove low valuation stockholders is a reason of repurchase

Answer 8

• Increase the value

- Avoid takeovers

Question 9

Why Allocation of voting rights is a reason of repurchase

Answer 9

• Remove threatening block holders

- Increase management ownership

Question 10

Why Increase reported EPS is a reason of repurchase

Answer 10

• Simply due to fewer shares

- Productivity growth

Question 11

Why Transaction costs saving is a reason of repurchase

Answer 11

Less shareholders => less “paper work”

- Small firms

Question 12

“residual” theory

Answer 12

pays cash when has it left

Question 13

Factors that influence payout

Answer 13

o	Signaling and information distribution
o	Investor’s mental accounting and behavioural biases 
o	Managerial over-confidence and biases
o	Taxes
o	Consumption demand
o	Clientele

Question 14

Signaling and information distribution

Answer 14

 Challenge to M&M irrelevance theorem (Stock prices react to div. announcements)
 Earnings vs payouts (price changes reflect changes in expected level of riskiness of payouts but not always expected earnings)
 Hard to choose how to signal
 Wrong firms pay dividends (should – young, small, do – old, large)
 Mgrs. careful about dividends (reluctant to cut, so often don’t raise) – dividends only a complimentary tool for communication
 Stakeholder relations supported (labour unions)

Question 15

Investor’s mental accounting and behavioural biases

Answer 15

 Demand biases (consume only from dividends)
 Trends/fashion
 Catering theory, but “homemade dividends”

Question 16

Homemade dividends

Answer 16

Homemade dividends is a concept that in liquid markets an investor can alter a company’s dividend policy to match his own cash flow objectives. … It suggests that investors are indifferent between dividends and capital gains because total return on a stock is made up of both dividends and capital gain.

Question 17

Managerial over-confidence and biases

Answer 17

 Convince investors that no agency costs exist

 Overconfident CFOs – lower return projects, pay divs less often, repurchase stock more frequently

Question 18

Clientele

Answer 18

stockholders differ in their desires in divs vs capital gains
 Taxes
 Government regulation
 Transaction costs
 Not realistic – wouldn’t be able to diversify, as pay/don’t pay div. firms similar

Question 19

What about is article

Answer 19

Authors would like to argue in this paper that adding a friction to the Fisherian Model, particularly asymmetric information, yields an FCF-centric theory that explains the timing and the magnitude of payouts over the lifecycle of a corporation.

Question 20

3 Reasons why investors are willing to consume from dividends:

Answer 20

(i) they are unwilling to sell too many stocks now,
(ii) they feel that they might regret in case that share price increases,
(iii) marginal utility from one dollar of dividends exceeds the marginal utility of the tenth dollar of capital gains.

Question 21

Conclusion of the article

Answer 21

Authors conclude that the massive dividends consistently distributed over many decades primarily reflects the corresponding large earnings that dividend payers have generated over the years, and they are not influenced so much by the investor sentiment on firm’s dividend decisions.