Canadian corporate payout policy

RESEARCH PAPERBy :

H.KENT BAKER

Presented By:

Tehzeeb TariqShamsha AllauddinMaimoona RazaSyed Ghazanfar NaqviSyed Asfar Riaz

Presented To:SIR DR. SAAQIB SHARIF

ABSTRACT

The purpose of this study is to examine cash dividends and stock repurchases and their relationship

with earnings in CanadaThe study uses logistic regressions to examine the timing of repurchases and OLS regressions to examine the

level of payout.

Findings

The fraction of dividend-paying firms declines from 1988 to 2001 and then slightly rebounds until the end of the

sample period in 2006. Dividend-only firms pay out significant amounts of cash of both regular dividends and regular repurchase.

INTRODUCTIONde Jong et al (2003). survey the 500 largest non-financial companies listed on the Toronto Stock Exchange (TSX). Their results reveal that firms first decide whether to pay out or not, and then the form of payout.

Kooli and L’Her (2010) use financial and accounting data of Canadian firms from 1985 to 2003 to analyze dividend policy and stock repurchases. they find that such firms use repurchases as a substitute for dividends.

Our study differs we use financial and accounting information of individual firms from 1988 to 2006 to analyze dividend policy and stock repurchases.

We also extend Kooli and L’Her’s study most importantly, while they focus on the choice between dividend and stock repurchases, we examine the level of the payout and its relationship with earnings.

RESEARCH QUESTIONS

Q1. What determine the likelihood of paying dividends?

Q2. Are stock repurchasing replacing dividends in terms of paying out earnings?

Q3. Are earning associated with payout status?

Q4.Do earning affect timing and level of payout?

DISAPPEARING DIVIDENDS AND REPURCHASES

Disappearing dividend puzzle is not limited to USA

From 1989-2002 Denis and Osobov(2008) found similar results in:Canada

France

Germany

Japan

UK

STOCK REPURCHASE

Ikenberry et al. (2000) contend that Canada is the only country outside the USA that has a reasonable sample of stock repurchases

First, Canadian firms, on average, are smaller than US firms

Second, the tax treatment of dividends and capital gains differs substantially between the two countries

Dividends are taxed but tax policy attempts to compensate for this by granting a dividend tax credit for personal income in dividends from

Canadian corporationsAt the beginning of our study period in 1988,

the inclusion rate was 66.66 percent, increased to 75 percent in 1990, and then declined to 66.67

percent in February 2000, and further to 50 percent in October 2000.

IN CANADA, THE TWO WAYS OF STOCK REPURCHASES INCLUDE:

•Normal course issuer bids: The action of a company buying back its own outstanding shares from the markets so it can cancel them

•Substantial issuer bids: The action of a company repurchasing more of its shares than the number permitted under the rules for normal course issuer bids by making a formal bid under securities laws

SAMPLE DESCRIPTION

Our sample consists of Canadian industrial firms listed on the TSX

between 1988 and 2006

A common practice is to exclude financial and utilities firms when

examining corporate payout policy (Fama and French, 2001; Grullon and Michaely, 2002; Baker and Wurgler,

2004; DeAngelo et al., 2004; Skinner, 2008)

s

ANSWERS TO RESEARCH QUESTIONS

THE LIKLIHOOD OF PAYING DIVIDENDS AND THE CATERING EFFECT

During investigating this issue we use regression model and by the help of it we examine the factors that may influence a

firms dividend decision.

GROUPING OF DIVIDEND-PAYING AND REPURCHASING FIRMS

In this we focus on whether stocks repurchases are replacing dividends in terms of paying out earnings.They further divide the sample in the number of dividends and repurchase and report the number of firms and the dollar amount in panel A and B

This table reports the number of Canadian firms and the dollar amount of total payout is each payer group

in two sub periods 1988-1999 and 2000-2006

THE RELATIONSHIP BETWEEN PAYOUT AND EARNINGS

To understand the level of payout, they examine the third question, Are earnings associated with payout status? In this question we examine the pattern of earnings of different payout groups.

Overall, this figure shows a relationship between earnings and payout policies.

Specifically, firms with only regular dividends and firms with regular dividends and regular repurchases have positive and smooth aggregate earnings.

Firms with only occasional repurchases and firms with only regular repurchases have moderately varying aggregate earnings and have losses in some years.

Finally, non-payers have highly volatile aggregate earnings and have losses in most years.

FIRMS REGULARLY PAYING DIVIDENDS AND REPURCHASING

STOCKS Only 57 firms regularly pay dividends and regularly repurchase their stock, their payout constitutes 87.02 percent of all payouts of the five groups.

Therefore, we focus on these firms and investigate our fourth research question

To explore the question on the timing of payout, we use a logistic model with the dependent variable as a repurchase dummy that equals 1 if a firm repurchases stocks in a given year and 0 otherwise.

This suggests that earning and undervaluation is increasingly are

related to the timing of repurchase

They apply linter’s (1956) model for describing corporate dividend

behavior

Dt is the change in dividends;

c(alpha) is the speed of adjustment to the difference between a target dividend payout and last year’s payout;

Dt* is the target dividend payout;

Dt1 is last period’s dividend payout;

Et is earnings before extraordinary and special items;

d is the constant payout ratio;

a is a constant;

and ut is an error term.

For the dividend model, the speed of adjustment increases from 0.332 to 0.568, indicating that dividends are increasingly more responsive to earnings. For the payout model, the speed of adjustment increases from 0.537 to 0.735, suggesting that repurchases are also increasingly more responsive to earnings.

SUMMARYFirst, the results show that the disappearing dividend phenomenon lasts until 2001 but is followed by a reappearing period that continues until the end of 2006. Larger firms with fewer investment opportunities and higher profitability are more likely to pay dividends. Our evidence reveals that firms are more likely to pay dividends when a price premium exists on dividend-paying firms.

Second we found that dividend-only firms make large payouts and repurchase-only firms make small payouts.

CONCLUSION

The implication for practice is that our study reveals the importance of dividends as

the major method to pay out earnings for Canadian corporations. Firms with regular

dividends, regardless of their stock repurchase status, have stable earnings and rarely have losses. They pay out the largest

amount among all Canadian firms. The implication for the society is that our study

confirms the call from a society of investment professionals to pay attention to dividends.