Description
A dividend is a payment made by a corporation to its shareholders, usually as a distribution of profits.
HONOR PROJECT
Dividend Policy in Mainland China and USA
By Zheng Baiyao 08050325 Finance
An Honours Degree Project Submitted to the School of Business in Partial Fulfilment of the Graduation Requirement for the Degree of Bachelor of Business Administration (Honours)
4/27/2011
Hong Kong Baptist University Hong Kong April 2011
Contents
Abstract ..................................................................................................................................................... 1 Introduction ............................................................................................................................................... 1 Literature Review...................................................................................................................................... 2 National environment & Hypotheses ........................................................................................................ 4 Methodology ............................................................................................................................................. 7 Data and Variables .................................................................................................................................... 8 Regression Analysis .................................................................................................................................11 Discussions ............................................................................................................................................. 18 Conclusions ............................................................................................................................................. 21 Limitation ................................................................................................................................................ 22 References: .............................................................................................................................................. 22
Abstract
The purpose of his project is to examine and compare the level and stability of dividend policy in China and the USA. The main intuition of my analysis is that the various national contexts may imply some significant differences in dividend policy for firms from the two countries. This research is based on earlier research on dividend puzzle, which has developed some interpretations including but not limited to "bird in hand", signaling effect, and pecking order theory. By applying regression, I analyze a sample of 11673 US firms from 1991 to 2007 and 1680 Chinese firms from 1998 to 2007. The most interesting observation is that while dividend payouts are positively related to cash in US firms, the relationship is reversed in China. Also noteworthy is the ambiguous relationship between retained earnings and dividend payout for Chinese companies. In order to test the accuracy of the findings, I split the sample into different years and industries. Similar results are drawn out from the two regressions. Another part of this paper compares the smoothness of dividend policy in the two countries. The sample space is pooled by 11673 US firms and 1680 Chinese firms for the same sample years as the level analysis. The result suggests that the Chinese firms have less sticky dividend policy than the USA firms, which implies a less significant role played by dividend policy in signaling and agency models in China than it does in the USA.
Introduction
How firms determine their dividend policy is one of the core subjects in Corporate Finance. It is interesting to note that while paying out dividend consistently is one of the most important signals of a firm's future earnings in USA, this situation is not that common in China, especially in the mainland market. What's the implication of this phenomenon? What's the average level of dividend payment in the USA, and in Mainland China accordingly? How stable is it? Do the factors influencing the dividend 1
policy of American corporations apply in China as well? In this essay, these questions will be discussed deeper. After years of academic research, empirical study and debate, a strong relationship is found between dividend payments and corporate governance mechanisms. According to my research, however, lots of academic study on dividend policy has been conducted in USA, while only limited researches are based on China. Considering the considerable differences of these two countries in terms of culture, legal environment and finical system, this paper will be written with the main target to compare the level and stability of dividend payment in Mainland China and USA. It is reasonable to surmise that this topic is in interest of professional persons and other involved individuals. This paper will be organized as the following. Section 1 is the introduction of the background and objectives. Followed is a brief literature review in this research area. Then institutional background of these two countries will be discussed basing one several selected macro financial indicators. In the same section, hypotheses will be proposed to be tested later. In section 4, the methodology applied in this project will be introduced. In section 5, I will analyze data and variable in order to find out the results of regression. One group of results indicates the level of dividend payment in relationship with six variables in the two countries. Another group of results tests the the stability of dividend payment in China in comparison with American firms. Lintner empirical model will be applied to conduct the test. Finally a brief discussion basing on the results above will be given.
Literature Review
Why should companies compensate their shareholders by paying cash regularly? What factors affect the dividend policies most? These questions have long been debated among financial economists. Basically, there are four main theories being developed by far to explain the dividend puzzle. Following is the brief introduction to them. 2
The first one is called "Bird in hand", which suggests that high-dividend are paid out by companied to satisfy shareholders' desire for current income. This theory can be understood by intuition, since individuals naturally tend avoid risk in the future and current dividend provide them a sense of security. Yet this argument was challenged by Miller and Modigliani in 1962. In their theoretical model, stocks can be traded without any transaction fees, so that shareholders should in indifferent with dividend payment. However, many people disagree by arguing that in the real world, stock-market is never frictionless. Thus the dividend payment due serves as a compensation. The second important theory is "Signaling effect theory". It is firstly raised by Lintner in 1956 and stimulated a heated debate about dividend policy in academic circles afterwards. After observing
dividend decisions and policies of 28 US companies during the period of 1918 to 1941 and 1926 to 1954. Lintner drew out two significant conclusions: (1) Real-world companies typically set long-term target ratios of dividends to earnings; (2) Managers know that only part of any change in earning is likely to be permanent...dividend changes appear to lag earnings changes by a number of periods.( Stephen , Randolph , Jefrey ,2010, p.599) The basic idea is that a smooth dividend payout ratio serves as a significant signal of the corporate's financial healthy to outsiders, and it and implicates manager's expectation of the firm's further growth .Thus managers should try to avoid dividend reduction. Although dividend signaling is well developed in theory, the limitation reveals when it is applied in reality to predict companies' dividend policy. Thus the new trend theories in this area take more firmspecific factors and macroeconomic variables influence into consideration. One of the representatives is agency problem theory. The most distinctive difference between agency theory and previous ones is that it points out interest conflicts between managers (agents) and shareholders (owners) in reality. If an effective governance mechanism is absent, it would be likely that managers misuse the redundant cash to pursue their own interests rather than maximum shareholders' benefits. By paying dividends, 3
companies can share its earning with their stockholders and at the same time limit the availability of free cash flows to managers. In this way, paying dividend achieves the same consequence as repurchasing stocks, employing external monitors and so on. It is consistent with Easterbrook(1984)'s explanation about the role of dividends in alleviate agency problems. The last but not the least important one is pecking order theory. According to Myers(1984), companies prioritize internal financing over external financing when there is a need of funding raising, considering the higher cost of external capital. Hence, it is reasonable to expect a company in a country with a less developed financial system to reserve dividends rather than pay them out. Since they can be utilized as a source of internal capital in emergency time, the company reduces the risk of raising expensive external capital in financial market.
National environment & Hypotheses
Although various theories mentioned above have been developed and tested in USA, they may not be applied to explain the dividend policy in other parts of the world. It is known that significant differences exist between mainland China and the USA. Among those, differences in macro-economy environment, legal system and financial system development are by no means negligible. With regard to macro-economy environment, these countries have different GDP growth rate, inflation rate and so on. Group 1 data in Table 1 reveals the average data of these factors of USA and China from 1998 to 2007. It is interesting to note that during the past period, while China had enjoyed a high economic growth with GPD growing approximately 10% per year, it limited the inflation rate at 1.32% per year. Compared with China, USA had a lower average GPD growth yet a higher average inflation rate. So I expect that firms in China have better investment opportunities. Group 2 data in Table 1 provides information about the level and maturity of financial system development in the two countries. It is evident that the USA owns a much more developed financial 4
market than the one of China. Firstly, the USA's financial market size is around 18 times larger than Chinese financial market. Then, the total value of shared traded is about 230% of GDP on average in the period, which is 4 times larger than Chinese market capitalization ratio. Finally, stocks are more frequently traded in the USA market than in China, as indicated by the turnover ratio. Legal system also plays an important role in corporate government thus affects the decision of dividend payment. It is expected that in a country with a highly transparent legal system, companies face less severe information asymmetries. Gianni, Luc and Kenichi(2007) constructed a composite corporate governance quality (CGQ) index to quantify the quality of legal system. The CGQ index, calculated from three indicators: Accounting Standards, Earning Smoothing, and Stock Price, measures outcomes of corporate governance in the dimensions of accounting disclosure and transparency. The bigger the index, the more transparent and disclosed the legal system is. Group 3 data in Table 2 indicate that the USA's legal system is more transparent in terms of accounting standards that the one of China.
Hypothesis Basing on the suggestions provided by previous researchers that an adequate and smoothing dividend payment is an important signal of a company's financial health, and the fact that China has a less developed financial market and less transparent legal system than the USA, I would like to come up with the following hypotheses: Hypothesis 1: The level of dividend payment of firms in mainland China is less connected with its actual situation such as profitability, growth and cash. Hypothesis 2: Firms in mainland China have less sticky dividend payments than those in the USA
5
Table 1 National environment Group 1: macro-economy environment Average 98-07 USA 2.859 2.711 Average 98-07 USA 2.63E+13 230.274 167.309 Average 00-03 USA 0.77 China 10.189 1.320 Sources World Bank national accounts data, and OECD National Accounts data files. International Monetary Fund, International Financial Statistics and data files. Sources China 1.45768E+12 58.764 111.392 Standard & Poor's, Global Stock Markets Factbook and supplemental S&P data. Standard & Poor's, Global Stock Markets Factbook and supplemental S&P data. Standard & Poor's, Global Stock Markets Factbook and supplemental S&P data. Sources China 0.52
1 2
GDP growth (annual %) Inflation, consumer prices (annual %) Group 2:financial system development
3 4
Stocks traded, total value (current US$) Stocks traded, total value (% of GDP) 5 Stocks traded, turnover ratio (%) Group 3: legal system
6
CGO
Explanations:
1
Annual percentage growth rate of GDP at market prices based on constant local currency. Aggregates are based on constant 2000 U.S. dollars. GDP is the sum of gross value added by all resident producers in the economy plus any product taxes and minus any subsidies not included in the value of the products. It is calculated without making deductions for depreciation of fabricated assets or for depletion and degradation of natural resources. 2 Inflation as measured by the consumer price index reflects the annual percentage change in the cost to the average consumer of acquiring a basket of goods and services that may be fixed or changed at specified intervals, such as yearly. The Laspeyres formula is generally used. 3 Stocks traded refers to the total value of shares traded during the period. 4 Stocks traded refers to the total value of shares traded during the period. This indicator complements the market capitalization ratio by showing whether market size is matched by trading. 5 Turnover ratio is the total value of shares traded during the period divided by the average market capitalization for the period. Average market capitalization is calculated as the average of the end-of-period values for the current period and the previous period. 6 The CGQ index is a simple average of three indicators, called Accounting Standards (AS), Earning Smoothing (ES), and Stock Price Synchronicity (SPS). These indicators are constructed from accounting and market data for samples of non-financial companies listed in stock markets taken from the Worldscope and Datastream databases.
6
Methodology
The two major methods used in my study are previous study research and regression. The purpose of applying regression is to find out the level and stability of dividend payment in USA, Mainland China. In order to investigate the level of dividend payment, an equation which represents the relationship between dividend payout and the selected ratios is set up: Div =a + ?1*SGR + ?2*TD/TA + ?3*RE/TE + ?4*CASH+ ?5*ROA+ ?6*SIZE Where Div: Dividend payout to sales; SGR: Sales growth rate; TD/TA: Total common equity to total assets; RE/TE: Returned equity to total common equity; CASH: Cash to total assets; ROA: Return to assets SIZE: Natural logarithm of total assets a: Intercept ?: the coefficients between dividend payout and the selected ratios. R Square and p-value are used to test the accuracy and signification of coefficients when applying this equation. Secondly, the smoothness of dividend in different regions is discussed, applying Lintner empirical model. There are two inter-related equations in this model( for firm i): (1)?Dit = ai + ci ( D*it-Di(t-1)?+uit Where D*it: the target dividendat time t; Di(t-1) : the lagged actual dividend; 7
ci: the speed of adjustment (0< ?Dit: the change in the dividend
ci
A dividend is a payment made by a corporation to its shareholders, usually as a distribution of profits.
HONOR PROJECT
Dividend Policy in Mainland China and USA
By Zheng Baiyao 08050325 Finance
An Honours Degree Project Submitted to the School of Business in Partial Fulfilment of the Graduation Requirement for the Degree of Bachelor of Business Administration (Honours)
4/27/2011
Hong Kong Baptist University Hong Kong April 2011
Contents
Abstract ..................................................................................................................................................... 1 Introduction ............................................................................................................................................... 1 Literature Review...................................................................................................................................... 2 National environment & Hypotheses ........................................................................................................ 4 Methodology ............................................................................................................................................. 7 Data and Variables .................................................................................................................................... 8 Regression Analysis .................................................................................................................................11 Discussions ............................................................................................................................................. 18 Conclusions ............................................................................................................................................. 21 Limitation ................................................................................................................................................ 22 References: .............................................................................................................................................. 22
Abstract
The purpose of his project is to examine and compare the level and stability of dividend policy in China and the USA. The main intuition of my analysis is that the various national contexts may imply some significant differences in dividend policy for firms from the two countries. This research is based on earlier research on dividend puzzle, which has developed some interpretations including but not limited to "bird in hand", signaling effect, and pecking order theory. By applying regression, I analyze a sample of 11673 US firms from 1991 to 2007 and 1680 Chinese firms from 1998 to 2007. The most interesting observation is that while dividend payouts are positively related to cash in US firms, the relationship is reversed in China. Also noteworthy is the ambiguous relationship between retained earnings and dividend payout for Chinese companies. In order to test the accuracy of the findings, I split the sample into different years and industries. Similar results are drawn out from the two regressions. Another part of this paper compares the smoothness of dividend policy in the two countries. The sample space is pooled by 11673 US firms and 1680 Chinese firms for the same sample years as the level analysis. The result suggests that the Chinese firms have less sticky dividend policy than the USA firms, which implies a less significant role played by dividend policy in signaling and agency models in China than it does in the USA.
Introduction
How firms determine their dividend policy is one of the core subjects in Corporate Finance. It is interesting to note that while paying out dividend consistently is one of the most important signals of a firm's future earnings in USA, this situation is not that common in China, especially in the mainland market. What's the implication of this phenomenon? What's the average level of dividend payment in the USA, and in Mainland China accordingly? How stable is it? Do the factors influencing the dividend 1
policy of American corporations apply in China as well? In this essay, these questions will be discussed deeper. After years of academic research, empirical study and debate, a strong relationship is found between dividend payments and corporate governance mechanisms. According to my research, however, lots of academic study on dividend policy has been conducted in USA, while only limited researches are based on China. Considering the considerable differences of these two countries in terms of culture, legal environment and finical system, this paper will be written with the main target to compare the level and stability of dividend payment in Mainland China and USA. It is reasonable to surmise that this topic is in interest of professional persons and other involved individuals. This paper will be organized as the following. Section 1 is the introduction of the background and objectives. Followed is a brief literature review in this research area. Then institutional background of these two countries will be discussed basing one several selected macro financial indicators. In the same section, hypotheses will be proposed to be tested later. In section 4, the methodology applied in this project will be introduced. In section 5, I will analyze data and variable in order to find out the results of regression. One group of results indicates the level of dividend payment in relationship with six variables in the two countries. Another group of results tests the the stability of dividend payment in China in comparison with American firms. Lintner empirical model will be applied to conduct the test. Finally a brief discussion basing on the results above will be given.
Literature Review
Why should companies compensate their shareholders by paying cash regularly? What factors affect the dividend policies most? These questions have long been debated among financial economists. Basically, there are four main theories being developed by far to explain the dividend puzzle. Following is the brief introduction to them. 2
The first one is called "Bird in hand", which suggests that high-dividend are paid out by companied to satisfy shareholders' desire for current income. This theory can be understood by intuition, since individuals naturally tend avoid risk in the future and current dividend provide them a sense of security. Yet this argument was challenged by Miller and Modigliani in 1962. In their theoretical model, stocks can be traded without any transaction fees, so that shareholders should in indifferent with dividend payment. However, many people disagree by arguing that in the real world, stock-market is never frictionless. Thus the dividend payment due serves as a compensation. The second important theory is "Signaling effect theory". It is firstly raised by Lintner in 1956 and stimulated a heated debate about dividend policy in academic circles afterwards. After observing
dividend decisions and policies of 28 US companies during the period of 1918 to 1941 and 1926 to 1954. Lintner drew out two significant conclusions: (1) Real-world companies typically set long-term target ratios of dividends to earnings; (2) Managers know that only part of any change in earning is likely to be permanent...dividend changes appear to lag earnings changes by a number of periods.( Stephen , Randolph , Jefrey ,2010, p.599) The basic idea is that a smooth dividend payout ratio serves as a significant signal of the corporate's financial healthy to outsiders, and it and implicates manager's expectation of the firm's further growth .Thus managers should try to avoid dividend reduction. Although dividend signaling is well developed in theory, the limitation reveals when it is applied in reality to predict companies' dividend policy. Thus the new trend theories in this area take more firmspecific factors and macroeconomic variables influence into consideration. One of the representatives is agency problem theory. The most distinctive difference between agency theory and previous ones is that it points out interest conflicts between managers (agents) and shareholders (owners) in reality. If an effective governance mechanism is absent, it would be likely that managers misuse the redundant cash to pursue their own interests rather than maximum shareholders' benefits. By paying dividends, 3
companies can share its earning with their stockholders and at the same time limit the availability of free cash flows to managers. In this way, paying dividend achieves the same consequence as repurchasing stocks, employing external monitors and so on. It is consistent with Easterbrook(1984)'s explanation about the role of dividends in alleviate agency problems. The last but not the least important one is pecking order theory. According to Myers(1984), companies prioritize internal financing over external financing when there is a need of funding raising, considering the higher cost of external capital. Hence, it is reasonable to expect a company in a country with a less developed financial system to reserve dividends rather than pay them out. Since they can be utilized as a source of internal capital in emergency time, the company reduces the risk of raising expensive external capital in financial market.
National environment & Hypotheses
Although various theories mentioned above have been developed and tested in USA, they may not be applied to explain the dividend policy in other parts of the world. It is known that significant differences exist between mainland China and the USA. Among those, differences in macro-economy environment, legal system and financial system development are by no means negligible. With regard to macro-economy environment, these countries have different GDP growth rate, inflation rate and so on. Group 1 data in Table 1 reveals the average data of these factors of USA and China from 1998 to 2007. It is interesting to note that during the past period, while China had enjoyed a high economic growth with GPD growing approximately 10% per year, it limited the inflation rate at 1.32% per year. Compared with China, USA had a lower average GPD growth yet a higher average inflation rate. So I expect that firms in China have better investment opportunities. Group 2 data in Table 1 provides information about the level and maturity of financial system development in the two countries. It is evident that the USA owns a much more developed financial 4
market than the one of China. Firstly, the USA's financial market size is around 18 times larger than Chinese financial market. Then, the total value of shared traded is about 230% of GDP on average in the period, which is 4 times larger than Chinese market capitalization ratio. Finally, stocks are more frequently traded in the USA market than in China, as indicated by the turnover ratio. Legal system also plays an important role in corporate government thus affects the decision of dividend payment. It is expected that in a country with a highly transparent legal system, companies face less severe information asymmetries. Gianni, Luc and Kenichi(2007) constructed a composite corporate governance quality (CGQ) index to quantify the quality of legal system. The CGQ index, calculated from three indicators: Accounting Standards, Earning Smoothing, and Stock Price, measures outcomes of corporate governance in the dimensions of accounting disclosure and transparency. The bigger the index, the more transparent and disclosed the legal system is. Group 3 data in Table 2 indicate that the USA's legal system is more transparent in terms of accounting standards that the one of China.
Hypothesis Basing on the suggestions provided by previous researchers that an adequate and smoothing dividend payment is an important signal of a company's financial health, and the fact that China has a less developed financial market and less transparent legal system than the USA, I would like to come up with the following hypotheses: Hypothesis 1: The level of dividend payment of firms in mainland China is less connected with its actual situation such as profitability, growth and cash. Hypothesis 2: Firms in mainland China have less sticky dividend payments than those in the USA
5
Table 1 National environment Group 1: macro-economy environment Average 98-07 USA 2.859 2.711 Average 98-07 USA 2.63E+13 230.274 167.309 Average 00-03 USA 0.77 China 10.189 1.320 Sources World Bank national accounts data, and OECD National Accounts data files. International Monetary Fund, International Financial Statistics and data files. Sources China 1.45768E+12 58.764 111.392 Standard & Poor's, Global Stock Markets Factbook and supplemental S&P data. Standard & Poor's, Global Stock Markets Factbook and supplemental S&P data. Standard & Poor's, Global Stock Markets Factbook and supplemental S&P data. Sources China 0.52
1 2
GDP growth (annual %) Inflation, consumer prices (annual %) Group 2:financial system development
3 4
Stocks traded, total value (current US$) Stocks traded, total value (% of GDP) 5 Stocks traded, turnover ratio (%) Group 3: legal system
6
CGO
Explanations:
1
Annual percentage growth rate of GDP at market prices based on constant local currency. Aggregates are based on constant 2000 U.S. dollars. GDP is the sum of gross value added by all resident producers in the economy plus any product taxes and minus any subsidies not included in the value of the products. It is calculated without making deductions for depreciation of fabricated assets or for depletion and degradation of natural resources. 2 Inflation as measured by the consumer price index reflects the annual percentage change in the cost to the average consumer of acquiring a basket of goods and services that may be fixed or changed at specified intervals, such as yearly. The Laspeyres formula is generally used. 3 Stocks traded refers to the total value of shares traded during the period. 4 Stocks traded refers to the total value of shares traded during the period. This indicator complements the market capitalization ratio by showing whether market size is matched by trading. 5 Turnover ratio is the total value of shares traded during the period divided by the average market capitalization for the period. Average market capitalization is calculated as the average of the end-of-period values for the current period and the previous period. 6 The CGQ index is a simple average of three indicators, called Accounting Standards (AS), Earning Smoothing (ES), and Stock Price Synchronicity (SPS). These indicators are constructed from accounting and market data for samples of non-financial companies listed in stock markets taken from the Worldscope and Datastream databases.
6
Methodology
The two major methods used in my study are previous study research and regression. The purpose of applying regression is to find out the level and stability of dividend payment in USA, Mainland China. In order to investigate the level of dividend payment, an equation which represents the relationship between dividend payout and the selected ratios is set up: Div =a + ?1*SGR + ?2*TD/TA + ?3*RE/TE + ?4*CASH+ ?5*ROA+ ?6*SIZE Where Div: Dividend payout to sales; SGR: Sales growth rate; TD/TA: Total common equity to total assets; RE/TE: Returned equity to total common equity; CASH: Cash to total assets; ROA: Return to assets SIZE: Natural logarithm of total assets a: Intercept ?: the coefficients between dividend payout and the selected ratios. R Square and p-value are used to test the accuracy and signification of coefficients when applying this equation. Secondly, the smoothness of dividend in different regions is discussed, applying Lintner empirical model. There are two inter-related equations in this model( for firm i): (1)?Dit = ai + ci ( D*it-Di(t-1)?+uit Where D*it: the target dividendat time t; Di(t-1) : the lagged actual dividend; 7
ci: the speed of adjustment (0< ?Dit: the change in the dividend
ci