Financial exibility and the choice between dividends and ... · total payouts and the division of...
Transcript of Financial exibility and the choice between dividends and ... · total payouts and the division of...
Journal of Financial Economics 57 (2000) 355}384
Financial #exibility and the choice betweendividends and stock repurchasesq
Murali Jagannathan!, Cli!ord P. Stephens!,*,Michael S. Weisbach"
!University of Missouri, Columbia, MO 65211, USA"University of Illinois, Champaign, IL 61802-6980, USA
Received 19 January 1999; received in revised form 9 November 1999
Abstract
This paper measures the growth in open market stock repurchases and the manner inwhich stock repurchases and dividends are used by U.S. corporations. Stock repurchasesand dividends are used at di!erent times from one another, by di!erent kinds of "rms.Stock repurchases are very pro-cyclical, while dividends increase steadily over time.Dividends are paid by "rms with higher `permanenta operating cash #ows, whilerepurchases are used by "rms with higher `temporarya, non-operating cash #ows.Repurchasing "rms also have much more volatile cash #ows and distributions. Finally,"rms repurchase stock following poor stock market performance and increase dividendsfollowing good performance. These results are consistent with the view that the #exibilityinherent in repurchase programs is one reason why they are sometimes used instead ofdividends. ( 2000 Elsevier Science S.A. All rights reserved.
JEL classixcation: G32; G35
Keywords: Payout policy; Stock repurchases; Dividends
qWe would like to thank Jim Brickley, Harry DeAngelo, Stuart Gillan, Kevin Hallock, JarradHarford, Ron Howren, David Ikenberry, Ed Kane, Laurie Krigman, Harold Mulherin, RonOaxaca, Neil Pearson and Bill Schwert (the editor), as well as seminar participants at Arizona,Illinois, Maryland, Missouri, New Mexico, Oklahoma, UC-Riverside, and Washington Universityfor their helpful comments. The NSF (Grant SBR-9616675) provided "nancial support.
*Corresponding author. Tel.: #1-573-884-0945; fax: #1-573-884-6296.
E-mail address: [email protected] (C.P. Stephens).
0304-405X/00/$ - see front matter ( 2000 Elsevier Science S.A. All rights reserved.PII: S 0 3 0 4 - 4 0 5 X ( 0 0 ) 0 0 0 6 1 - 1
1This agrument does not say anything about the reason for these expectations. Rather, at leastsince 1956 when Lintner published his famous paper, "rms have been making such implicitcommitments with their dividends and market expectations have grown very strong. As an illustra-tion of these strong expectations, FPL Group in 1994 decreased their dividend by 32% andsimultaneously announced their intention to pay out the cash as a repurchase instead. FPL's stockfell by 13.7% on the announcement of this change. (See Esty and Schreiber (1995) for more detail.)
1. Introduction
One of the most signi"cant trends in corporate "nance during the 1990s is theincreasing popularity of open market stock repurchase programs. Between 1985and 1996, the number of open market repurchase program announcements byU.S. industrial "rms has increased 650% from 115 to 755, and their announcedvalue has increased 750% from $15.4 billion to $113 billion. Correspondingly,dividends have only risen by a factor of just over two during the same period;aggregate dividends for all industrial "rms listed on Compustat have risen from$67.6 billion to $141.7 billion. Repurchases are clearly an increasingly importantmethod of paying out cash to shareholders.
In this paper, we examine "rms' decisions to distribute cash #ows and theirchoices between paying out cash #ows in the form of dividends or stockrepurchases. Our goal is to assess the increasing importance of repurchases inpayout decisions and to isolate factors that a!ect the choice between repur-chases and dividends. Out primary hypothesis is that dividends represent anongoing commitment and are used to distribute permanent cash #ows, whilerepurchases are used to pay out cash #ows that are potentially temporary.Repurchases thus preserve "nancial #exibility relative to dividends because theydo not implicitly commit the "rm to future payouts.
At least since Lintner (1956), "rms have been reluctant to cut dividends andhave been greeted by a signi"cantly negative stock market reaction when theydo; Ghosh and Woolridge (1988) and Denis et al. (1994) report an average stockprice decline of about 6% on the three days surrounding the announcement ofa dividend cut. Repurchases, on the other hand, involve no such commitment orrisk. Firms sometimes announce programs but fail to repurchase any shares.Even if a "rm completes a program, it is under no explicit or even implicitobligation to begin another new repurchase program. Given these marketexpectations, stock repurchases would be a sensible way for "rms to pay outcash #ows that have a high likelihood of not being sustainable.1
In Section 2 of the paper, we discuss the construction of a database ofrepurchase announcements and actual share repurchases for all U.S. public"rms for the period 1985 to 1996. We begin with an initial sample of allrepurchases programs announced from 1985 through 1996, as reported bySecurities Data Company (SDC). Since it is not always possible to determinewith publicly available information exactly how many shares a particular "rm
356 M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384
purchased in a given year, we construct estimates of the upper and lower boundsof the number of shares repurchased by each of these "rms that are listed onboth Standard and Poor's Compustat database and the Center for Research inSecurities Prices (CRSP) tapes. We use these estimates to calculate estimates oftotal payouts and the division of these payouts between dividends and stockrepurchases.
In Section 3, we provide estimates of aggregate repurchases, as well as theaggregate value of other forms of payouts. We do so both to test the aggregateform of the #exibility hypothesis that repurchases are more pro-cyclical thandividends and because our estimates of repurchases are improvements on thosein the literature. At an economy-wide level, we "nd that actual share repurchaseshave increased over our sample period and represent an economically importantsource of payouts. Over the period 1985 to 1996, aggregate actual sharerepurchases by industrial "rms total between $249 billion and $339 billion. Thiscorresponds to 53 to 72% of announced repurchase levels and 20 to 27% ofaggregate dividends.
In contrast to dividends, which grow smoothly, aggregate share repurchasesare volatile and vary considerably with the business cycle. Firms increase theirrepurchases disproportionately relative to dividends during boom times andreduce them more during recessions. Even though dividends continue to makeup the majority of total payouts, repurchases are responsible for much of theyear-to-year variation. Overall, repurchases have not replaced dividends as theprimary payout vehicle. Even in 1996, which was the largest year for repurchasesin this sample, dividends amounted to more than double the total actual sharerepurchases and 126% of the total announced share repurchases. Firms are stillgenerally increasing dividends every year; the fact that they are doing so and notincreasing repurchases even faster suggests that there still is a dividend puzzle.
Section 4 of the paper considers the cross-sectional determinants of payoutpolicy. We "rst reexamine Lintner's (1956) famous arguments. Lintner's premiseis that managers prefer to increase dividends regularly and avoid decreasingdividends if possible. These arguments predict that dividend increases will bemade by "rms with higher and more stable cash #ows, that dividend increaseswill be related to permanent but not necessarily to temporary components ofcash #ow, and that dividend decreases will be less frequent than increases andaccompanied by very poor performance. We test these predictions empiricallyand "nd them supported by the data. Our evidence is also consistent with therecent empirical work on the relation between dividend changes and futureearnings (see Bernartzi et al., 1997; DeAngelo et al., 1996). Although dividendsappear to be paid out of permanent earnings, we "nd little evidence of sub-sequent earnings improvements following dividend increases.
We then test the "nancial #exibility hypothesis cross-sectionally. In particu-lar, we expect to observe "rms choosing repurchases rather than dividends whenthe value of "nancial #exibility is highest; i.e. when there is a high likelihood that
M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384 357
2Guay and Harford (2000) report similar conclusions using a di!erent empirical approach.
3See, for example, Hulbert (1997). Putting their money where their mouths are, Forbes, April 21,1997.
4Although "rms are not required to announce share repurchases, the announcement of a "rm'sintent to repurchase shares on the open market (or through privately negotiated transactions) is one ofthe safe harbor provisions under the stock price manipulation provisions of the Securities andExchange Act. Additionally, a "rm must satisfy the four criteria detailed in S.E.C. rule 10b-18 of theSecurities and Exchange Commission's antimanipulation guidelines. These four criteria are: (1) on anyone day, "rms may not purchase more than 25% of the average daily volume of their own sharesduring the prior four weeks, block trades and privately negotiated transactions are exempt from thisguideline; (2) "rms may not purchase their own shares at the open, or during the last one-half hour oftrading; (3) "rms may not purchase their own shares at a price higher than the last independent bid, orthe last reported sale price; and (4) all purchases on a single day must be executed through the samebrokerage "rm. This rule was adopted in 1982 and caused an increase in the number of open marketrepurchase programs adopted due to the resolution of the legal ambiguity (see Ikenberry et al., 1995).
5 In terms of observable costs, dividend increases may also appear to be essentially costless;however, a dividend increase provides an explicit commitment to increase current payouts and animplicit commitment to keep future payouts at this increased level. An open market repurchaseannouncement provides no such commitments and there is no evidence of a reputational penalty forthose "rms failing to follow through with their announced repurchase program.
the cash #ows being paid out are temporary. We construct empirical measures ofwhether cash #ow is more or less likely to be temporary, and use these measures topredict whether a payout-increasing "rm is more or less likely to increasedividends, repurchases, or both in any given year. Such temporary cash #ows arelikely to occur when a "rm's cash #ows are made up of a higher proportion ofnon-operating income relative to operating income, when a "rm's earningsvolatility prior to the repurchase is high, and when the "rm's future cash #ows areexpected to decrease. In our data, each of these measures increases the likelihoodof a "rm using repurchases rather than dividends as a means of distributing cash#ows. These "ndings suggest that managers tend to use dividends to pay outpermanent cash #ows and repurchases to pay out temporary cash #ows.2
2. Measuring share repurchases
Although open market stock repurchases are increasingly common and haverecently received much publicity, they are surprisingly di$cult to measure.3A "rm can legally repurchase its own stock whenever it chooses withoutannouncing its intention to do so; however, by announcing a repurchaseprogram the "rm protects itself from liability under the stock price anti-manipulation provision of the Securities and Exchange Act.4 Since announcinga repurchase program is essentially costless to the "rm, making such an an-nouncement would appear to be the dominant strategy for "rms that areplanning to repurchase stock.5 There is little evidence of "rms repurchasing
358 M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384
6 In recent years it has become common for "rms to disclose the number of shares repurchased ontheir 10-Ks and 10-Qs. In 1995 approximately 75% of a random sample of "rms announcing openmarket repurchase programs made such disclosures. However, this appears to be a relatively recentphenomena; prior to 1992 very few "rms disclosed any details of their repurchasing activities andalmost none of the "rms reported the number of shares repurchased on their 10-Ks or 10-Qs.
7SDC now includes actual share repurchases in their database back through 1994, but this is notthe "gure generally reported in the popular press.
their own stock without having an announced program in place. Announce-ments are generally made to the various wire services, which are then collectedin the Securities Data Company (SDC) database and are often reported in TheWall Street Journal and other business publications. SDC releases the aggregatedollar value of the repurchase announcements in its database to non-sub-scribers, and this number is often quoted as a measure of total stock repurchases(see Hulbert (1997); Hylton (1995); Power 1995)).6
In fact, there are a number of reasons why the total released by SDC does notaccurately measure actual stock repurchases.7 First and foremost, the an-nouncements are simply a statement of the "rm's intention to repurchase itsstock; the "rm is in no way obligated to do so. While the majority of "rms followthrough with their announced open market repurchase programs, a signi"cantnumber of "rms repurchase few or no shares. Stephens and Weisbach (1998)document that while most "rms repurchase at least the number of sharesoriginally announced over the subsequent three years and frequently repurchasemore shares than originally announced, a signi"cant number of "rms repurchasevery few or no shares. Generally, those "rms repurchasing more shares thanoriginally announced initiate subsequent repurchase programs or announceexpansions of their existing programs, so it is reasonable to think of theannounced value as an upper bound on the amount the "rm will repurchase ina particular program.
Second, the aggregate dollar value of announced repurchase programsreported by SDC overstates the total value of the announced repurchaseprograms due to the way that the SDC constructs this "gure. SDC includesannouncements from a variety of sources, including wire services and The WallStreet Journal, so repurchase programs that are announced in more than one ofthe sources on di!erent days are included multiple times by SDC. In addition,SDC includes announcements of withdrawn programs and privately negotiatedrepurchases into its "gure. The privately negotiated repurchases are generallyannounced after the transaction has taken place and do not usually re#ect anyintention to repurchase additional shares.
Since share repurchases in the open market are neither observable at the timeof the transaction nor are they always directly measurable subsequently, it isimpossible to know with publicly available information exactly how many
M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384 359
8 If the "rm holds the shares as Treasury stock or retires the shares, then the value reported by theCompustat aggregation is an accurate re#ection of the cost of acquiring the shares. However, if theshares are subsequently distributed to employee bene"t plans, used for the exercise of stock optionsor reissued then this aggregation will also capture any change in market value since the time of theinitial repurchase.
shares were repurchased for all "rms. Since 1984, "rms have been required toreport the value of their repurchases on their Statement of Cash Flows and thisitem is included in the Compustat database as `Purchases of Common andPreferred Stocka (data item d115). However, this variable is an aggregation ofmany other types of transactions and overstates actual share repurchases,sometimes substantially. This aggregation includes conversions of other classesof stock into common stock, purchases of Treasury stock, retirements of commonor preferred stock, and redemptions of redeemable preferred stock. The purchasesof Treasury stock also include privately negotiated repurchases and self-tendero!ers in addition to open market repurchases. The privately negotiated transac-tions are often considerable; during our sample period there are $53.2 billion inprivately negotiated repurchases. Additionally, this aggregation will in someinstances misrepresent the cost of a repurchase.8 The combined overstatement ofrepurchases as reported to Compustat is potentially signi"cant.
Stephens and Weisbach (1998) suggest an alternative method of measuringshare repurchases, using the monthly decreases in shares outstanding asreported by CRSP adjusted for non-repurchase activity a!ecting sharesoutstanding such as stock splits and dividend reinvestment plans. Monthlydecreases in shares outstanding are not o!set with subsequent increases inshares outstanding since it is possible, even when a "rm is actively repurchasingshares, for shares outstanding to increase as the result of exercise of executivestock options, distribution of Treasury shares to employee bene"t plans or evencontemporaneous stock issues. We improve on the Stephens and Weisbach(1998) CRSP measure of share repurchases by adjusting for new stock issues;22 of the "rms in our sample issue new seasoned equity while having anactive open market repurchase program in place. It is not always possible,however, to determine how many shares were reissued to employee bene"t plansor through the exercise of executive stock options. Hence, this measure willunderestimate of share repurchases by the amount of shares contemporaneouslyreissued.
3. Estimates of aggregate repurchases and payouts
3.1. Repurchase announcements
Table 1 presents estimates of the aggregate values of the various types of sharerepurchase announcements. The "rst column contains the number and value of
360 M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384
Tab
le1
SDC
repu
rcha
sepro
gram
anno
unc
emen
ts
This
table
pre
sents
the
num
beran
dva
lue
ofa
llre
purc
hase
progr
amsan
nounc
edby
indu
strial"rm
san
dre
por
ted
by
the
Sec
uritie
sD
ata
Com
pany
(SD
C)
forth
eper
iod
1985
thro
ugh
1996
.Theth
reem
ostco
mm
on
met
hods
use
dby"rm
sto
repurc
has
eth
eirst
ock
(Dutc
hau
ctio
ns,s
ingl
e-price
tend
ero!er
san
dop
enm
arke
tre
purc
has
epro
gram
s)ar
epre
sente
d.The"rs
tfo
ur
colu
mns
pre
sent
the
num
ber
and
valu
eofal
lop
enm
arket
,priva
tely
nego
tiat
ed,D
utc
hau
ctio
nan
dte
nde
ro!
erre
purc
has
epro
gram
anno
unce
men
ts,re
spec
tive
ly.The
last"ve
colu
mns
pre
sent
alte
rnat
ive
mea
sure
sof
the
actu
alsh
ares
repur
chas
edsu
bse
quen
tto
the
repu
rchas
epr
ogra
man
nounc
emen
t.C
olum
n5
isth
eag
greg
ate
valu
eofs
har
esre
pur
chas
edon
the
ope
nm
arket
using
the
mea
sure
pro
pose
dby
Ste
phen
san
dW
eisb
ach
(199
8).T
heva
lue
ofsh
are
repu
rchas
esus
ing
this
mea
sure
for
onl
y"rm
sal
solis
ted
inth
eC
om
pust
atdat
abas
eis
report
edin
colu
mn
6.C
olu
mn
7pre
sents
the
aggr
egat
eva
lue
of`P
urc
has
esofC
om
mon
and
Pre
ferr
edSto
cka
(dat
aitem
d11
5)from
the
Com
pust
atdat
abas
efo
r"rm
sw
ith
announ
ced
repu
rchas
epro
gram
s;co
lum
n8
repo
rts
this
mea
sure
less
the
valu
eofD
utch
auct
ion
and
tende
ro!er
repur
chas
es.C
olum
n9
repo
rts
this
mea
sure
for
only"rm
sth
atan
nou
nced
anope
nm
arke
tre
purc
hase
pro
gram
.A
llva
lues
are
inm
illio
ns
ofdo
llars
.
Ope
nm
arket
repu
rchas
esM
easu
res
ofac
tual
open
mar
ket
shar
ere
pur
chas
es
12
34
56
78
9
Distinct
SD
Can
nounc
emen
tsP
riva
tely
nego
tiat
ed
Dut
chau
ctio
nre
pur
chas
epro
gram
s
Singl
e-price
tende
ro!
erre
purc
has
esC
RSP
mea
sure
ofsh
are
repurc
has
es
CR
SPre
purc
has
es}"rm
slis
ted
on
Com
pust
at
Val
ueof
stoc
kre
purc
has
esre
port
edby
Com
pust
at
Com
pust
atre
purc
has
es}
less
Dut
chau
ctio
n,se
lfte
nder
&priva
tely
nego
tiat
ed
Com
pust
atre
purc
has
es}"rm
sw
ith
announ
ced
open
mar
ket
repur
chas
epro
gram
sY
ear
dV
alue
dV
alue
dV
alue
dV
alue
1985
115
15,4
1655
4,14
65
1,09
269
16,6
395,
100
4,83
950
,418
28,5
418,
886
1986
161
19,8
5449
5,51
79
2,22
858
7,93
312
,924
12,2
3947
,253
31,5
7614
,485
1987
606
41,0
1934
2,79
18
1,49
457
5,74
111
,120
10,5
6857
,298
47,2
7228
,888
1988
183
28,5
1758
3,62
419
7,51
652
12,0
9438
,578
36,3
2054
,784
31,5
5028
,302
1989
356
52,5
7491
3,11
619
4,98
581
3,32
224
,970
24,5
9759
,995
48,5
7233
,539
1990
567
24,9
8898
2,81
09
1,93
166
6,42
926
,281
25,7
0643
,342
32,1
7225
,234
1991
211
13,8
7293
4,00
74
739
664,
290
9,07
69,
005
28,0
4819
,012
16,3
6119
9235
427
,835
671,
676
61,
597
471,
091
10,1
269,
940
34,0
5329
,689
19,1
6219
9332
428
,831
702,
210
560
443
553
16,6
6716
,111
37,1
6833
,801
24,6
3519
9454
753
,238
851,
065
1195
143
3,98
120
,532
19,7
0443
,102
37,1
0429
,502
1995
574
52,3
4385
12,9
518
1,44
434
1,55
335
,690
35,1
3278
,427
62,4
7946
,486
1996
755
112,
792
739,
334
172,
339
443,
576
47,3
1844
,533
91,9
8276
,733
63,3
21
Tota
l4,
753
471,
279
858
53,2
4712
026
,920
660
67,2
0225
8,38
224
8,69
462
5,87
047
8,50
133
8,80
1
M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384 361
9 In addition, programs are included into this category multiple times if the program is reported inmore than one source. There are a total of 93 repeat announcements and 34 withdrawn programsincluded in the SDC database, which are excluded from our statistical analysis. SDC's policy is torelease only the total number and value from this category in their database to nonsubscribers,which has resulted in somewhat larger values reported in the press than are reported here.
10SDC started collecting repurchase announcements in 1985, so there is not a comprehensivelisting of program announcements prior to 1985. However, it does appear that both the number andvalue of programs was substantially smaller prior to this point. For example, Vermaelen (1981) "ndsthat only 198 NYSE "rms initiated open market repurchase programs between 1970 and 1978.Grinblatt and Titman (1998) indicate that the dollar value of repurchases reported by Compustat issubstantially smaller prior to 1985 as well (p. 521).
distinct open market repurchase announcements as listed by SDC. SDC groupsall announcements relating to open market programs into one category. Inaddition to announcements of open market programs, SDC includes announce-ments of program withdraws and privately negotiated stock purchases.9 Wereport the number and value of privately negotiated repurchases, as well andDutch auction and single-price tender o!er repurchases in Columns 2, 3, and4 of Table 1.
Table 1 indicates that share repurchases have large #uctuations determinedby economy-wide factors. In 1985, there were only 115 announcements ofprograms, compared with 755 in 1996.10 In 1987 there was a sharp increase inprogram announcements, with 606 announcements. Many repurchase programswere initiated subsequent to the October market crash; 507 of the 606 repur-chase programs announced in 1987 occurred after October 19 with 400 of theseoccurring between October 19 and October 31. The late 1980s contained a largenumber of announcements of open market programs, with a high of 567 in 1990.There was a decrease during the recession years of the early 1990s, with 211announcements in 1991, 354 announcements in 1992 and 324 in 1993. However,since 1993 repurchase announcements have increased rapidly.
The relative popularity of other types of programs has also shifted over time.In the late 1980s, self-tender o!ers and Dutch auctions were relatively popularsince many were used as takeover defenses. Another reason for the prevalence ofself-tender o!ers was the leveraged recapitalizations common during this period.The largest years for self-tender o!ers, in value terms, were 1985 and 1988. Twocases led directly to such a large "gure for 1985, Unocal's $4.2 billion repurchaseand Union Carbide's $3.3 billion repurchase; Allegis' repurchase $2.8 billion wasthe largest repurchase in 1988. In the 1990s, there have been more privatelynegotiated transactions, with their values rising substantially in 1995 and 1996.
3.2. Values of repurchases
We present estimates of the dollar values of actual repurchases in Columns 5through 9 of Table 1. As discussed above, it is not always possible to know from
362 M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384
11This "nding contradicts the conclusions of Netter and Mitchell (1989). One potential explana-tion for the di!erence in "ndings is that Netter and Mitchell use just the change in the number ofshares during the year as their measure of repurchases, while we use the month-to-month change.This approach understates repurchases if there is any redistributions of shares during the year, whileours understates it only if shares are redistributed in the same month (or quarter, if the "rm onlyreports its outstanding shares quarterly).
publicly available data exactly how many shares a "rm repurchased in a givenyear. We present the CRSP repurchase measure suggested by Stephens andWeisbach (1998) with an adjustment for secondary equity o!erings occurringduring the program in Column 5. This measure provides a lower bound on thevalue of the repurchases. The total of $258 billion of repurchases is approxim-ately 55% of the total announced value of $471 billion. This value understatesthe ultimate quantity of repurchases from these programs because it does notinclude all of the repurchases from programs begun at the end of the sampleperiod. Since the two largest years for repurchase announcements were 1995 and1996, together making up more than 35% of the value of all announcements, thetotal completion rate is likely to be similar to the 70 to 80% completion ratesfound by Stephens and Weisbach (1998).
The estimates of aggregate actual share repurchases in Column 5 of Table1 suggest that repurchases vary substantially over time. The "rst few years of thesample appear to contain relatively few repurchases. However, we do not havedata on program announcements prior to 1985, so the estimate for 1985 is likelyto be particularly low since it only re#ects repurchases from programs begunduring that year. The post-crash announcements of 1987 led to a large numberof repurchases in 1988, 1989, and 1990. 11 Repurchases slowed noticeably in theearly 1990s and increased substantially in the mid-1990s. The numbers inColumn 5 measure aggregate repurchases for all programs from "rms on theCRSP tape. We are interested in relating these "gures to other variables takenfrom Compustat; therefore, we present the CRSP measure for the subset of "rmsthat are also on Compustat in Column 6 of Table 1. These numbers are similar,although slightly smaller, than those for the entire CRSP sample.
While the CRSP measure understates repurchases, the "gure reported onCompustat overstates them because it includes a number of other items inaddition to repurchases. We present Compustat's aggregate number inColumn 7 of Table 1. This "gure is considerably larger than the CRSP measurepresented in Column 6. We adjust the Compustat number in two ways tomeasure actual repurchases more accurately. First, since the Compustat "gureincludes Dutch auctions, privately negotiated deals, and self-tender o!ers, wesubtract them from the total and present the results in Column 8 of Table 1.Second, we restrict our calculations to include only "rms that we know areactively repurchasing stock. Stephens and Weisbach (1998) "nd that most "rmsrepurchase all of the stock they ultimately will during the two years subsequent
M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384 363
to the initiation of a program. Consequently, we de"ne a "rm-year as having anactive program as one in which a program is announced during that calendaryear or one of the two previous years. We present the aggregate repurchasemeasure for "rms with active programs de"ned this way in Column 9 of Table 1.
The estimates in Column 9, representing the Compustat repurchase measurefor "rms with active programs, are larger but of the same order of magnitude asthe CRSP measure for the same group of "rms presented in Column 6. This"nding is not surprising given that the Compustat measure overstates repur-chases while the CRSP measure understates it. A potentially troubling issue isthat the aggregate Compustat repurchase measure is so much larger than themeasure restricted to "rms with active programs; the total di!erence betweenthe two columns is around $240 billion even after adjusting for Dutch auctionsand self-tender o!ers. This di!erence could simply be due to the fact that theCompustat variable includes other components in addition to the repurchasevariable. Alternatively, it could occur because a substantial number of "rmsrepurchase stock without an announced repurchase program or repurchaseprogram announcements are missing in the SDC database. We do not wish todismiss this possibility, especially given that the incentive to announce a pro-gram for repurchasing comes from the safe harbor provisions of SEC Rule10b-18 and that "rms with repurchase programs appear to violate other provis-ions of this act (see Cook et al., 1997a).
Either of these possibilities implies that "rms are repurchasing stock withouta repurchase program listed by SDC. If so, the CRSP measures of actual sharerepurchases that only considers "rms with such programs will understateaggregate repurchases. To gauge the extent of such understatement, we calculatethe CRSP measure of repurchases based on drops in the number of sharesoutstanding for all "rm-years without active programs, but with positive repur-chases reported by Compustat. The total aggregated over all years, whichshould re#ect the total value of privately negotiated repurchases, self-tendero!ers, Dutch auction repurchases, and unannounced open market repurchasesduring our sample period, is $82 billion. This "gure, which admittedly is anunderestimate, is nonetheless substantially smaller than the sum total of theprivately negotiated repurchases, self-tender o!ers, and Dutch auctions sugges-ting that the number of "rms repurchasing stock without a program listed onSDC is relatively small.
Another issue is which of the two measures, the CRSP measure from Column6 or the Compustat-based measure from Column 9, more accurately re#ectsactual repurchases. To compare the accuracy of these two measures we rely onsurvey data from Cook et al. (1997a,b), who requested data on actual repur-chases from all "rms starting programs in 1993 and received such data from 64"rms. Of these 64 "rms, 35 had data on both CRSP and Compustat. Wecompare our measures of repurchases to each of the 64 "rm-years reportingpositive repurchases in the Cook et al. data set. The median CRSP measure is
364 M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384
12We use medians rather than means because there appear to be a number of outliers that wouldmake interpretation of averages di$cult. For example, there were seven cases in which "rmsreported positive repurchases to Cook et al. (1997a,b) but reported zero on their "nancial statementfor the variable that includes repurchases. There were two cases where the Stephens and Weisbach(1998) measure, which should understate repurchases, is greater than 500% of repurchases reportedin the survey, which potentially means that the corporations only reported a fraction of their actualrepurchases in their response to the request for data.
68% of the median dollar value reported in the Cook et al. data, while themedian Compustat measure is 113% of that value. 12 We interpret this "ndingas supportive of our argument that the CRSP measure underestimates repur-chases while Compustat overstates repurchases, and suggests that the Compus-tat measure adjusted for program announcements is likely to be more accurate.
Table 2 documents the magnitude of several alternative payout methods. The"rst three columns contain the estimates of aggregate repurchases: the CRSPmeasure for all "rms for which it can be computed, the CRSP measure for "rmslisted on Compustat, and the Compustat measure for all "rms with active openmarket repurchase programs. The table also contains aggregate dividends for"rms listed on Compustat and privately negotiated repurchases, self-tendero!ers, and Dutch auctions from SDC. Total payouts are the sum of aggregatedividends for "rms listed on Compustat and the dollar value of open marketrepurchases, privately negotiated repurchases, self-tender o!ers, and Dutchauctions from SDC.
It is clear from Table 2 that repurchases are growing rapidly, but thatdividends remain the predominate payout device. In 1996, dividends stillaccount for 65% of total payouts, compared to 69% in 1985. In 1985, dividendspaid by industrial "rms listed on Compustat were between 8 and 13 times thevalue of actual share repurchases and 450% of the announced value of all sharerepurchase programs. At the end of the sample period dividends for industrial"rms remain between 2 and 3 times as large as actual repurchases, regardless ofwhether one uses the underestimate or the overestimate to calculate repur-chases, and 125% of the dollar amount of announced share repurchases. Whilerepurchases have not nearly replaced dividends, the value of share repurchaseshas increased much more dramatically than the value of dividends. Even thoughrepurchases are growing rapidly, dividends are as well; dividends for Compustatindustrial "rms grew almost 25% between 1992 and 1996 and have more thandoubled over our entire sample period.
As has been recognized since at least Lintner (1956), dividends have histori-cally been characterized by relatively steady growth. This description appears tocharacterize our sample period as well. Aggregate dividends paid by industrial"rms listed on Compustat increased fairly steadily during our sample. Totalpayouts, however, were much more volatile than dividends. They dropped ina number of years, and, in fact, did not surpass 1988 levels until 1995. The sourceof this volatility is the other components of payouts, especially open market
M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384 365
Tab
le2
Pay
outm
easu
res
and
payo
ut
tech
niq
ues
This
table
pro
vides
com
par
isons
ofth
eag
greg
ate
valu
eof
alte
rnat
ive
pay
out
mea
sure
san
dte
chniq
ues
.C
olu
mn
1is
the
aggr
egat
eva
lue
of
shar
esre
pur
chas
edon
theopen
mar
ket
using
them
easu
repro
pose
dby
Ste
phen
san
dW
eisb
ach
(199
8).T
heva
lueofs
hare
repurc
has
esus
ing
this
mea
sure
foronl
y"rm
sal
solis
ted
inth
eC
om
pust
atda
tabas
eis
repor
ted
inco
lum
n2.
Colu
mn
3pre
sents
the
aggr
egat
eva
lue
of`P
urc
has
esofC
omm
on
and
Pre
ferr
edSto
cka(
dat
aitem
d11
5)from
the
Com
pust
atdat
abas
efo
r"rm
sw
ith
annou
nce
dre
purc
hase
pro
gram
s.The
tota
lagg
rega
team
oun
tofd
ivid
endspai
dfo
ral
l"rm
slis
ted
on
the
Com
pust
atIn
dust
rial
,Full
Cov
erag
ean
dR
esea
rch"le
sar
epre
sente
din
colu
mn
4.C
olum
ns
5th
rough
7ar
eth
eto
talva
lues
ofpriva
tely
nego
tiat
edst
ock
repurc
has
es,D
utc
hau
ctio
nre
purc
hase
san
dse
lf-te
nder
o!er
repur
chas
es,r
espec
tive
ly,a
sre
port
edby
Sec
urities
Dat
aC
ompan
y(S
DC
).The
tota
lpay
outs
pre
sente
din
colu
mn
8ar
eth
esu
mof
allopen
mar
ket
repur
chas
es,d
ivid
ends,
priva
tely
neg
otiat
edre
purc
has
es,D
utc
hau
ctio
nre
pur
chas
esan
dse
lf-ten
der
o!er
repu
rcha
ses.
All
valu
esar
ein
mill
ions
ofdolla
rs.
12
34
56
78
Yea
r
Ope
nm
arket
shar
ere
purc
hase
s}
CR
SPm
easu
re
CR
SPm
easu
reof
shar
ere
purc
hase
s}
"rm
slis
ted
onC
ompu
stat
Com
pust
atre
purc
hase
s}
"rm
sw
ith
anno
unce
dre
pur
chas
epr
ogra
ms
Agg
rega
tediv
iden
dsfo
ral
l"rm
sre
port
edon
Com
pust
at
Priva
tely
nego
tiat
edre
purc
has
es
Sel
f-te
nde
ro!er
repu
rchas
esD
utch
auct
ion
repu
rchas
es
Tot
alpay
outs"
colu
mns
3#4#
5#6#
7
1985
5,10
04,
839
8,88
667
,602
4,14
616
,639
1,09
298
,365
1986
12,9
2412
,239
14,4
8577
,574
5,51
77,
933
2,22
810
7,73
719
8711
,120
10,5
6828
,888
86,5
432,
791
5,74
11,
494
125,
457
1988
38,5
7836
,320
28,3
0210
3,99
63,
624
12,0
947,
516
155,
532
1989
24,9
7024
,597
33,5
3910
2,44
73,
116
3,32
24,
985
147,
409
1990
26,2
8125
,706
25,2
3410
7,71
82,
810
6,42
91,
931
144,
122
1991
9,07
69,
005
16,3
6110
7,77
54,
007
4,29
073
913
3,17
219
9210
,126
9,94
019
,162
107,
089
1,67
61,
091
1,59
713
0,61
519
9316
,667
16,1
1124
,635
109,
811
2,21
055
360
413
7,81
619
9420
,532
19,7
0429
,502
117,
426
1,06
53,
981
951
152,
925
1995
35,6
9035
,132
46,4
8614
2,11
812
,951
1,55
31,
444
204,
552
1996
47,3
1844
,533
63,3
2114
1,68
79,
334
3,57
62,
339
220,
257
Tota
l25
8,38
224
8,69
433
8,80
11,
271,
786
53,2
4767
,202
26,9
201,
757,
984
366 M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384
repurchases. At least at the aggregate level, repurchases appear to make upa disproportionately large share of the short-term #uctuations in payouts, whiledividends represent a more permanent component.
4. Firm-level analysis of payouts
4.1. Hypothesis development
To complement this aggregate evidence, we now analyze the factors a!ectingpayouts at the "rm level. Cross-sectional work on payout policy dates at least toFama and Babiak (1968), who "nd strong empirical support for the Lintnermodel of dividends during the period from 1946 to 1964. This sectionreexamines the Fama and Babiak results on a more recent sample. In addition,we empirically examine the factors that lead "rms to choose between dividendsand repurchases, focusing on the #exibility arguments discussed above.
Lintner (1956) argued that managers pay dividends out of long-run, sustain-able earnings. A company with stable earnings would thus tend to pay outa higher dividend than an otherwise similar growth "rm. His interviews withmanagers indicated that they like to increase dividends regularly and viewcutting dividends as extremely costly. They are therefore reluctant to makea dividend increase that will subsequently have to be reversed.
The Lintner model suggests a number of testable hypotheses regardingdividend behavior. Dividend-paying "rms should be larger than non-dividendpaying "rms, and should have higher and more stable cash #ows. Dividendincreases should be related to the permanent components of cash #ow, but notnecessarily to the temporary components of cash #ows. Dividend decreasesshould be relatively rare and occur only when "rms have truly bad performance.Subsequent to dividend increases or decreases, the good or bad operatingperformance should continue.
There are a number of non-mutually exclusive factors that potentially in#u-ence "rms in their choice between dividends and stock repurchases. Two suchfactors, taxes and employee stock options, are e!ectively unobservable to us.Although the tax system treats dividends and repurchases the same at thecorporate level, stock repurchases are generally tax-advantaged at the personallevel. The magnitude of this tax advantage depends on the cost bases andmarginal tax rates of the shareholders, which are not generally public informa-tion. However, it seems unlikely that taxes explain the more recent increase inrepurchase activity, since the tax advantage of repurchases was substantiallyreduced in 1986, approximately corresponding to the beginning of the currentrepurchase wave.
Fenn and Liang (1997), Jolls (1998), and Weisbenner (1998) stress the import-ance of employee stock options in the decision to repurchase stock rather than
M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384 367
13An alternative would be a `specially designated dividenda, which is commonly thought of as aninstitution for paying out such cash #ows. DeAngelo et al. (2000) document that specially designateddividends historically have been much more `regulara than their name implies, suggesting that "rmshistorically used them to pay out recurring rather than unusual cash #ows. In addition, theseauthors "nd that most "rms replaced their specially designated dividends with regular dividendslong before the current repurchase wave, suggesting that the repurchases studied here are nota replacement for such specially designated dividends.
increase dividends. Employee stock options could in#uence payout decisions fortwo reasons. First, employee options create incentives for stock repurchasesrather than dividends because the value of an option declines when a stock goesex-dividend but not when a company repurchases shares. Second, Weisbenner(1998) emphasizes that managers prefer to use repurchased rather than newly-issued shares for employee options to avoid diluting earnings per share. How-ever, directly controlling for the impact of executive options in our empiricalwork is infeasible given our sample size, since data on executive stock optionsare not available in machine-readable form. Nonetheless, the combination ofthese two option-induced reasons is undoubtedly an important factor in thecurrent repurchase trend.
Perhaps the most commonly discussed motive for repurchases concernsasymmetric information. Dann (1981), Vermaelen (1981), and Ikenberry et al.(1995) suggest that stock prices rise on the announcement of a repurchaseprogram. In addition, Comment and Jarrell (1991) "nd that the abnormalreturns observed around the announcement of a repurchase program are in-versely related to recent stock price performance leading up to the repurchaseannouncement. These results are consistent with the view that asymmetricinformation is an important motive for stock repurchases.
We, like Guay and Harford (2000), focus on the impact of the cash #ow'spermanence on the choice between dividends and repurchases. We hypothesizethat dividends will be used to pay out cash #ows that are likely to be permanent,while stock repurchases will be used for cash #ows that are not likely to be ableto be sustained inde"nitely.13
This view leads to a number of testable predictions. First, when there is moreuncertainty about future cash #ows, we expect the "rm to utilize repurchases toa greater extent. Second, since operating cash #ows tend to be more permanentthan non-operating cash #ows, we expect a positive relation between operatingincome and dividends, while repurchases are more likely to be related tonon-operating income. Third, if repurchases are more likely to re#ect temporarycash #ows, we hypothesize that dividend-increasing "rms will have largersubsequent cash #ows than repurchasing "rms. Finally, if "rms repurchase stockbased on management's belief that the stock is undervalued, we would expectthat "rms selecting repurchases would have lower stock returns prior to thepayout change.
368 M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384
4.2. Variable construction
There are a number of variables that are likely to be related to the decision topay out cash #ows. Using Compustat, we construct proxies of these variables forthe periods before and after each potential payout increase. Our primary interestis the determinants and method of cash payouts. Consequently, our analysisfocuses on cash #ow and its components: operating income, non-operatingincome, and capital expenditures. In order to reduce noise induced by year-to-year variations in many of the variables, we use three-year averages unlessotherwise noted. Average values for years !3 through !1 relative to the payoutchange are used for variables prior to the payout change; average values for years0 through #2 relative to the payout change are used for the variables subsequentto the payout change. The sample for our cross-sectional analysis is limited to theperiod from 1985 to 1994 to allow for measurement of subsequent cash #ows.
We use the book value of total assets (data item d6) in the year prior to thepayout change (year !1) as our measure of "rm size. Operating income is theaverage ratio of operating income (data item d13) to total assets. Non-operat-ing income is the average ratio of non-operating income (data item d61) to totalassets. The standard deviation of operating income is the standard deviation ofthe ratio of operating income to total assets measured over the 5-year periodfrom year !4 through 0. Capital expenditures is the average ratio of capitalexpenditures (data item d128) to total assets. The lagged dividend payout ratiois the prior year's ratio of total dividends (data item d21) to net incomeavailable to common shareholders (data item d237). The market-to-book ratiois the average ratio of the market value of equity, given by the year-end price pershare (data item d24) multiplied by the number of shares outstanding (dataitem d25), to the book value of equity (data item d62). The debt ratio is theaverage ratio of long-term debt (data item d9) to total assets. Institutionalownership is the percentage of shares outstanding owned by institutions in theyear prior to the payout change obtained from Compact Disclosure and is onlyavailable from 1991 through 1994. The increase in dividends divided by themarket value of equity is the ratio of total dividends for the prior year minustotal dividends for the current year to the market value of equity. The increase inrepurchases divided by the market value of equity is the announced value of theopen market repurchase program obtained from SDC to the market value ofequity, given by the year end price per share (data item d24) multiplied by thenumber of shares outstanding (data item d25). Stock returns are computedfrom CRSP.
4.3. Univariate diwerences
Table 3 presents univariate statistics on the di!erences between "rms thatchoose di!erent payout methods. Column 1 provides statistics for the entire
M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384 369
Tab
le3
Firm
char
acte
rist
ics
acco
rdin
gto
pay
out
met
hod
This
tabl
epro
vides
mea
ns(m
edia
nsin
par
enth
eses
)ofv
ario
us"rm
char
acte
rist
icsfo
rth
eca
tego
ries
ofposs
ible
pay
outco
mbi
nations
.Col
um
n1
consist
sof
all"rm
-yea
rslis
ted
onSta
ndar
dan
dP
oor's
Com
pust
at(C
ompu
stat
)ta
pes
from
1985
thro
ugh
1994
;ut
ilities
and"nan
cial"rm
sar
eex
clud
edin
all
cate
gories
.Colu
mn
2co
ntai
ns"rm
-yea
rsw
ith
incr
ease
dto
talp
ayou
tsre
sultin
gfrom
eith
erin
crea
sing
divi
dend
s,in
itia
ting
are
purc
hase
prog
ram
,orbot
h;
the
sam
ple
inco
lum
n2
isth
euni
on
ofth
esa
mple
sin
colu
mns
3,4
and
5.C
olum
n3
cont
ains"rm
-yea
rsw
ith
initia
tion
sor
expa
nsions
ofre
pur
chas
epro
gram
s.C
olu
mn
4co
nta
ins"rm
-yea
rsw
ith
both
repu
rchas
esan
ddiv
iden
din
crea
ses.
Colu
mn
5co
ntai
ns"rm
-yea
rsw
ith
div
iden
din
crea
ses.
Col
um
n6
conta
ins"rm
-yea
rsw
ith
noch
ange
incu
rren
tpay
outle
vels;t
he"rm
sm
usthav
epositive
pay
out
s,but
div
iden
dsha
veno
tch
ange
d.C
olu
mn
7co
nta
ins
"rm
-yea
rsw
ith
nopa
youts
(nei
ther
div
iden
dsno
rst
ock
repu
rchas
es)in
eith
erth
ecu
rren
tor
prior
year
.Colu
mn
8co
nta
ins"rm
-yea
rsw
ith
dec
reas
esin
tota
lpa
youts
;th
esa
mpl
ein
colu
mn
8is
the
uni
on
ofth
esa
mple
sin
clud
edin
colu
mns
9an
d10
.C
olu
mn
9co
ntai
ns"rm
-yea
rsw
ith
no
repur
chas
ean
nounc
emen
tin
thecu
rren
tye
ar,b
utw
ith
are
pur
chas
ein
itia
tion
orex
pan
sion
inth
epriorye
ar.C
olu
mn
10co
nta
ins"rm
-yea
rsw
ith
divi
dend
dec
reas
es;
ther
ear
e30"rm
-yea
rsw
ith
both
divi
den
ddec
reas
esan
dre
pur
chas
ede
crea
ses(a
sde"ned
forco
lum
n9)
incl
uded
inth
isco
lum
n.D
ivid
end
incr
ease
san
ddec
reas
esar
ede"
ned
on
aper
shar
ebas
isad
just
edfo
rst
ock
split
san
din
clude
onl
yre
gula
rdi
vide
nds
asre
port
edby
CR
SP
.A
llst
atistics
are
com
pile
dfrom
data
obta
ined
from
Com
pus
tatunl
essoth
erw
ise
stat
ed;i
nord
erto
reduc
enoise
indu
ced
by
year
-to-y
earva
riat
ionsin
man
yofth
eva
riab
les,
we
use
thre
e-ye
arav
erag
esun
less
other
wise
stat
ed.A
vera
geva
lues
for
year
s!
3th
roug
h!
1re
lative
toth
epa
yout
chan
gear
eus
edfo
rva
riab
lespr
iorto
pay
outc
hange
;ave
rage
valu
esfo
rye
ars0
thro
ugh
#2
rela
tive
toth
epay
outch
ange
areus
edfo
rth
eva
riab
lessu
bse
que
ntto
the
pay
out
chan
ge.F
irm
size
isto
talas
sets
(dat
aitem
d6)
inth
eye
arpr
ior
toth
epay
out
chan
ge(y
ear!
1).O
per
atin
gin
com
eis
the
aver
age
ratio
ofoper
atin
gin
com
e(d
ata
item
d13
)to
tota
lass
ets.
Non-o
per
atin
gin
com
eis
the
aver
age
ratio
ofn
on-
oper
atin
gin
com
e(d
ata
item
d61
)to
tota
lass
ets.
The
stan
dard
dev
iation
ofop
erat
ing
inco
me
isth
est
anda
rddev
iation
ofth
era
tio
ofop
erat
ing
inco
me
(dat
aitem
d13
)to
tota
lass
etsm
easu
red
over
the
5-ye
arpe
riod
from
year
!4
thro
ugh
0.C
apital
expe
ndi
ture
sis
the
aver
age
ratio
ofca
pital
expe
ndi
ture
s(d
ata
item
d12
8)to
tota
las
sets
.The
lagg
eddi
vide
ndpay
out
ratio
isth
eprior
year's
ratio
of
tota
ldiv
iden
ds(d
ata
item
d21
)to
net
inco
me
avai
labl
eto
com
mon
shar
ehol
ders
(dat
aitem
d23
7).The
mar
ket-
to-b
ook
ratio
isth
eav
erag
era
tio
ofth
em
arket
valu
eof
equi
ty,g
iven
by
the
year
-end
price
persh
are
(dat
aitem
d24
)multip
lied
by
the
num
berof
shar
esou
tsta
ndin
g(d
ata
item
d25
),to
the
boo
kva
lue
ofeq
uity
(dat
aitem
d62
).The
deb
tra
tio
isth
eav
erag
era
tio
ofl
ong-
term
debt(d
ata
item
d9)
toto
tala
sset
s.In
stitutiona
low
ners
hip
isth
epe
rcen
tage
ofsh
ares
outs
tand
ing
owned
by
inst
itutions
inth
eye
arpr
ior
toth
epa
youtch
ange
from
Com
pac
tD
iscl
osure
.The
prior
year
mar
ket
retu
rns
are
the
CR
SPm
onth
lyre
turn
sge
om
etrica
llycu
mula
ted
for
the
year
prior
(yea
r!
1)to
the
year
inques
tion
;cu
rren
tye
arm
arke
tre
turn
sar
eth
eC
RSP
month
lyre
turn
scu
mula
ted
forth
ecu
rren
tye
ar(y
ear0)
.The
incr
ease
indiv
iden
ds/
mar
ket
valu
eofe
qui
tyis
the
ratio
ofto
taldiv
iden
ds
for
the
prio
rye
ar(y
ear!
1)m
inus
tota
ldi
vide
nds
for
the
curr
ent
year
(yea
r0)
toth
em
arket
valu
eofeq
uity.
The
incr
ease
inre
pur
chas
es/m
arke
tva
lue
ofeq
uity
isth
ean
nou
nce
dva
lue
ofth
eope
nm
arke
tre
purc
hase
pro
gram
obta
ined
from
SDC
toth
em
arke
tva
lue
ofeq
uity
.
370 M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384
Firm
char
acte
rist
ics
Full
sam
ple
Firm
sin
crea
sing
tota
lpa
youts
Firm
sre
purc
has
ing
shar
es
Firm
sre
purc
has
ing
and
incr
easing
div
iden
ds
Firm
sin
crea
sing
div
iden
ds
Firm
sno
tch
angi
ngcu
rren
tpa
youts
Firm
sth
atha
vem
ade
no
payo
uts
inprior
or
curr
ent
year
s
Firm
sdec
reas
ing
tota
lpa
youts
Firm
sde
crea
sing
repurc
has
es
Firm
sdec
reas
ing
div
iden
ds
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
Obse
rvat
ions
54,0
035,
873
1,48
572
33,
665
3,75
442
,023
2,35
31,
073
1,28
0
Prior
orpa
yout
chan
ge:
Firm
size
(inm
illio
ns
ofdo
llors
)87
0.30
41,
939.
978
983.
450
3,56
8.77
71,
999.
777
1,67
1.83
858
1.39
81,
142.
695
979.
937
1,28
7.04
(40.
265)
(290
.1)
(109
.15)
(836
.23)
(345
.45)
(225
.23)
(20.
16)
(146
.64)
(119
.29)
(188
.10)
Oper
atin
gin
com
e(%
)6.
906
21.1
5819
.128
22.4
0121
.695
17.1
402.
309
15.6
2618
.248
13.3
16(1
1.93
)(1
9.79
)(1
6.99
)(2
1.03
5)(2
0.25
)(1
5.58
)(8
.70)
(13.
50)
(16.
76)
(11.
51)
Non
oper
atin
gin
com
e(%
)2.
124
1.72
52.
116
1.60
91.
616
1.69
02.
302
1.95
52.
106
1.82
9(1
.37)
(1.3
7)(1
.71)
(1.3
05)
(1.2
8)(1
.25)
(1.3
9)(1
.44)
(1.5
75)
(1.3
35)
Stan
dard
dev
iation
of12
.791
(5.6
88)
10.2
914.
025
4.31
95.
693
15.4
298.
892
10.2
047.
747
oper
atin
gin
com
e(%
)(6
.49)
(3.6
9)(6
.18)
(2.9
3)(3
.34)
(4.3
3)(8
.06)
(5.7
4)(5
.835
)(5
.59)
Cap
ital
expen
ditu
res
(%)
11.3
599.
497
11.2
198.
627
9.00
38.
955
12.1
099.
984
10.6
159.
259
(6.5
5)(7
.465
)(7
.53)
(7.4
85)
(7.4
4)(7
.13)
(6.1
8)(6
.64)
(7.1
3)(6
.30)
Lag
ged
divi
dend
pay
out
12.1
7232
.079
15.7
539
.585
37.3
0946
.279
4.98
531
.482
17.9
843
.528
ratio
(%)
(0.0
)(2
4.41
)(0
.0)
(30.
98)
(29.
025)
(28.
82)
(0.0
)(8
.905
)(0
.0)
(23.
36)
Mar
ket
-to-
book
ratio
2.24
72.
297
2.27
22.
548
2.25
71.
685
2.36
41.
764
2.04
51.
505
(1.6
9)(1
.9)
(1.7
78)
(2.1
49)
(1.9
05)
(1.4
30)
(1.7
38)
(1.3
8)(1
.613
)(1
.189
)
Deb
tra
tio
(%)
24.6
3318
.247
20.4
3116
.472
17.7
5320
.376
25.1
8722
.751
20.7
9624
.436
(18.
382)
(16.
115)
(16.
93)
(15.
27)
(16.
1)(1
8.03
5)(1
8.74
)(2
0.47
)(1
7.59
)(2
2.27
)
M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384 371
Tab
le3
(con
tinu
ed)
Firm
char
acte
rist
ics
Full
sam
ple
Firm
sin
crea
sing
tota
lpa
youts
Firm
sre
purc
has
ing
shar
es
Firm
sre
purc
has
ing
and
incr
easing
div
iden
ds
Firm
sin
crea
sing
div
iden
ds
Firm
sno
tch
angi
ngcu
rren
tpa
youts
Firm
sth
atha
vem
ade
no
payo
uts
inprior
or
curr
ent
year
s
Firm
sdec
reas
ing
tota
lpa
youts
Firm
sde
crea
sing
repurc
has
es
Firm
sdec
reas
ing
div
iden
ds
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
Inst
itutiona
low
ners
hip
(%)
25.0
2742
.566
35.4
8650
.338
44.8
5940
.792
17.4
1632
.788
35.4
4928
.811
(18.
875)
(44.
06)
(33.
885)
(53.
49)
(47.
08)
(40.
61)
(9.5
1)(3
1.62
)(3
4.54
)(2
6.55
)
Prior
year
stock
retu
rns
0.12
80.
185
!0.
011
0.15
80.
259
0.11
80.
120
0.08
40.
222
!0.
064
(0.0
10)
(0.1
49)
(!0.
080)
(0.1
11)
(0.2
07)
(0.0
76)
(!0.
032)
(0.0
10)
(0.1
35)
(!0.
114)
Incr
ease
indiv
iden
ds/
0.00
0.57
50.
003
0.71
90.
764
0.10
10.
04!
2.27
5!
0.01
0!
4.29
6m
arket
valu
eof
equi
ty(%
)(0
.0)
0.39
9(0
.0)
(0.4
70)
(0.5
25)
(0.0
61)
(0.0
)(!
0.38
0)(0
.0)
(!2.
383)
Incr
ease
inre
purc
has
es/
**
7.97
26.
397
**
**
!6.
746
*
mar
ket
valu
eof
equi
ty(%
)*
*(5
.704
)(4
.953
)*
**
*(!
5.64
7)*
Subse
que
ntto
payo
utch
ange
:O
per
atin
gin
com
e(p
ost
)(%
)4.
082
18.9
8514
.752
20.9
1420
.139
14.2
490.
747
10.0
3713
.082
7.48
4(1
0.03
)(1
8.27
6)(1
3.99
3)(1
9.80
4)(1
9.33
7)(1
3.25
7)(7
.865
)(9
.382
)(1
2.91
8)(7
.451
)
Non-
oper
atin
gin
com
e1.
716
1.27
21.
536
1.07
41.
205
1.17
21.
858
1.15
41.
359
0.98
3(p
ost
)(%
)(0
.977
)(0
.907
)(1
.110
)(8
.368
)(0
.853
)(0
.783
)(1
.027
)(7
.87)
(0.9
85)
(0.6
42)
Cap
ital
expen
ditu
res
(post
)(%
)10
.879
9.49
19.
690
8.69
49.
569
8.31
311
.601
7.02
68.
494
5.79
1(5
.455
)(7
.397
)(6
.371
)(7
.362
)(7
.814
)(6
.273
)(4
.994
)(4
.492
)(5
.786
)(3
.476
)
Cur
rentye
arst
ock
retu
rns
0.06
40.
211
0.10
70.
252
0.24
20.
095
0.03
3!
0.06
9!
0.08
0!
0.05
6(0
.0)
(0.1
66)
(0.0
40)
(0.2
12)
(0.1
96)
(0.0
51)
(!0.
068)
(!0.
133)
(!0.
147)
(!0.
116)
372 M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384
14Dividend increases and decreases are de"ned on a per share basis adjusted for stock splits andinclude only regular dividends as reported by CRSP.
sample, which consists of all "rm-years on Compustat from 1985 through 1994excluding utilities and "nancial "rms. Column 2 presents the means andmedians for "rm-years with increased total payouts. Columns 3, 4 and 5 breakdown the payout-increasing "rm-years: Column 3 includes observations withinitiations or expansions of repurchase programs, Column 4 contains cases withdividend increases in addition to an initiation or expansion of a repurchaseprogram, and Column 5 includes the "rm-years with dividend increases but nonew repurchase program.14 Column 6 presents the means and medians for"rm-years with positive payouts that remain constant from the previous year,while Column 7 includes observations for "rm-years with no payouts (neitherdividends nor stock repurchases) in either the current or prior year.Column 8 presents the means and medians for "rm-years with decreases in totalpayouts. Columns 9, and 10 break down these payout-decreasing observations:Column 9 contains observations with no repurchase announcement in thecurrent year, but with a repurchase initiation or expansion in the prior year,while Column 10 presents the means and medians for "rm-years with dividenddecreases. The 30 "rm-years in which both dividends and repurchases decreaseare included with the dividend decreases in Column 10.
4.3.1. Dividend changesTable 3 allows us to examine the empirical predictions of the Lintner model
discussed above. The results are consistent with the predictions of this model.Firms making payouts are substantially larger than "rms that have not madepayouts in the current or prior year. Dividend-increasing "rms have higheroperating incomes and similar non-operating incomes than "rms that do notchange payouts. Given that operating cash #ows are relatively permanent whilenon-operating incomes are more temporary, this "nding suggests that dividendincreases are funded out of permanent cash #ows. The standard deviation ofoperating income, a proxy for the stability of cash #ows, is lower for thedividend-increasing "rms than for the "rms making no change to existing (butpositive) payouts. The standard deviation of operating income for the "rmskeeping current payouts constant is lower than the standard deviation ofoperating income for "rms that have not historically made any payouts. Sub-sequent to the payout change, dividend-increasing "rms continue to havesubstantially higher operating income than "rms that do not change payouts,which is in turn higher than subsequent operating income for "rms that have nothistorically paid dividends. These di!erences are signi"cant at the 1% levelusing two-tailed test of means and a Wilcoxon nonparametric test. Allthese results are consistent with the predictions of the Lintner model discussedabove.
M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384 373
15This di!erence is potentially due to taxes: If low-tax investors purchase stocks of dividend-paying companies and high-tax investors purchase stocks of repurchasing companies, then stock-holders of dividend-paying "rms will prefer "rms to increase dividends and stockholders ofnon-dividend paying "rms prefer to increase repurchases. Many thanks to a referee for suggestingthis possibility.
Finally, the Lintner view suggests that "rms will avoid dividend decreases if atall possible, so that dividend decreases will be less frequent than increases andassociated with genuinely poor performance. The data in Table 3 are consistentwith this view. There were 1,280 cases in which the nominal dividend per sharedecreases; in comparison, there are 4,388 cases of dividend increases (723 ofthese observations also repurchase stock in the same year). However, thedividend decreases were much larger than the increases (4.3% of equity valuecompared to 0.76% of equity value). In these cases, the "rms are indeed in"nancial di$culty. During the year prior to dividend decreases, the average "rmpaid out 43.53% of net income as dividends. The average operating income toassets was substantially lower for these "rms than for "rms keeping payoutsconstant or increasing them. Subsequent to the payout decrease, the averageoperating income over assets for these "rms decreases to 7.48%, just over a thirdof the average for dividend-increasing "rms.
4.3.2. The choice between stock repurchases and dividendsTable 3 also documents systematic di!erences between the dividend-increas-
ing and repurchasing "rms. Dividend-increasing "rms are generally larger thanrepurchasing "rms. Prior to the payout increase, dividend-increasing "rms havehigher operating cash #ows. However, consistent with the "nancial #exibilityhypothesis, non-operating cash #ows are higher for repurchasing-increasing"rms than for dividend-increasing "rms. The standard deviation of the operat-ing income for the repurchasing "rms is about twice as high as for the dividend-increasing "rms, suggesting that cash #ows for repurchasing "rms are substan-tially more uncertain than they are for dividend-increasing "rms.
Perhaps the most striking number in Table 3 is the dividend payout ratioprior to the decision. The average dividend payout ratio for "rms that increasedboth dividends and repurchases is 39.6% and is 37.3% for "rms that increaseonly dividends. In comparison, the average lagged dividend payout for repur-chasing "rms is only 15.8% and the median is zero.15 In fact, the median "rmincreasing repurchases previously did not pay out any dividends at all. Thislarge di!erence suggests that dividend-increasing "rms are following a historicalpolicy of paying out cash #ows, while repurchases are less frequent eventsallowing "rms to pay out a cash surpluses that are likely to be temporary.
Subsequent to the payout increase, operating income is substantially andstatistically signi"cantly higher for the dividend-increasing "rms than for therepurchase increasing "rms. Non-operating income continues to be higher for
374 M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384
repurchasing "rms than for either of the other payout-increasing types, withboth di!erences statistically signi"cant at the 1% level. These results are consis-tent with the view that repurchases are used to pay out temporary cash #owswhile dividends are used to pay out permanent ones.
Another di!erence between repurchases and dividends concerns the size of thepayouts. Firms increasing repurchases announce programs with announcedtargets equal to about 8% of equity value. Given that they typically buy about75% of this target over the subsequent two or three years (see Stephens andWeisbach, 1998), this value implies an increase in annual payouts of about 2%to 3% of equity value. In contrast, dividend increases are much more commonbut average only 0.76% of equity value. Repurchases allow "rms to distributelarge quantities of cash to shareholders relatively quickly. Thus, the quantity ofcash a "rm wants to distribute is likely to be an important factor in choosingbetween dividends and repurchases.
One of the common explanations of stock repurchases is that they occur whenmanagers believe their stock is undervalued (see Dann, 1981; Vermaelen, 1981).Consistent with this view is evidence that "rms tend to announce programsfollowing poor stock market performance (see Comment and Jarrell, 1991;Stephens and Weisbach, 1998). This result holds in our sample as well; theaverage stock return for "rms that announce repurchase programs but do notincrease dividends during the year prior to the announcement is !1.1% andthe median is !0.8%. In contrast, the average return for "rms announcingdividend increases but not a repurchase program is 25.9% and the median is20.7%. This large di!erence is statistically signi"cant at the 1% level.
Table 3 also presents the mean and median level of institutional ownership foreach category. These observations are consistent with the view that institutionsprefer established companies that have performed well recently. Firms that areincreasing payouts have substantially higher institutional ownership than "rmskeeping payouts constant or decreasing them. Among the payout-increasing"rms, the ones increasing repurchases but not dividends have the lowest levels ofinstitutional ownership. One explanation of this "nding is that many institu-tions are tax-exempt, so that they do not share in the tax bene"ts of repurchases.Given this interpretation, this result is consistent with the arguments of Allenet al. (1998), who suggest that one motive of dividend payments is to attractinstitutional investors that will subsequently provide monitoring bene"ts to the"rm.
Overall, the univariate comparisons in Table 3 suggest that dividend-increas-ing and repurchasing "rms are noticeably di!erent. Repurchasing "rms havemore uncertain cash #ows and have not historically had high payout ratios.They have lower operating incomes but higher non-operating incomes. Firmstend to increase repurchases following poor stock-market performance whilethey tend to increase dividends following good performance. Finally, institu-tions tend to favor dividend-paying over repurchasing "rms.
M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384 375
16Weisbenner (1998) uses multinomial logit similarly to estimate the impact of stock optionprograms on the choice between repurchases and dividends.
4.4. Multivariate diwerences
The univariate comparisons suggest that there are di!erences between "rms'payouts depending on the "rms' characteristics. Since, these characteristics arecorrelated with one another we examine these di!erences in a multivariatecontext.
To do so, we estimate a model in which "rm characteristics predict payoutpolicy. One complicating factor is that there are many potential choices ofpayout methods, roughly corresponding to the columns of Table 3. Given thatthese choices do not have a clear ordering, a natural approach to this problem isa multinomial logit model.16
The multinomial logit model assumes that the probability of an outcome> isgiven by:
Prob(>"j)"eb@
j xi
1#+Jk/-
eb@kxi
for j"1, 2,2, J, (1)
and
Prob(>"0)"1
1#+Jk/-
eb@k xi
. (2)
Each bjis a vector of dimension equal to the number of independent variables,
which can be estimated by maximum likelihood. These estimates are conve-niently expressed in terms of the log odds of any two outcomes, which equal:
lnCP
ijPikD"x@
i(b
j!b
k). (3)
The coe$cient on each independent variable in this equation equals the di!er-ence between the bs for two di!erent outcomes. The p-value on such a coe$cientprovides a test of the hypothesis that the independent variable a!ects theprobability of each outcome in the same manner.
Tables 4 and 5 provide estimates of a multinomial logit models predictingpayout method choices. The di!erence between the two tables is that Table5 includes institutional ownership as an independent variable, which limits thenumber of observations since our institutional ownership data is not availablefrom Compact Disclosure before 1991. Each model reported here groups payoutchoices into four categories: increasing only repurchases, increasing only divi-dends, increasing both repurchases and dividends, or not increasing payouts.We limit the categories because we are primarily interested in the choicebetween dividends and repurchases. Adding more outcome types complicates
376 M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384
both the estimation and the reporting of our results, since each additional choicerequires one extra parameter per choice per independent variable. To ensurethat limiting the model in this fashion does not a!ect the inferences we drawfrom our results, we have also estimated similar models allowing for payoutdecreases to be a separate choice and models allowing for repurchase decreasesand dividend decreases to be separate choices. The results reported below arerobust to these speci"cations.
The coe$cients reported in Tables 4 and 5 are estimates of the log-oddsbetween each pair of categories. The multivariate results tell a similar story tothe multivariate results. The category of "rms that do not increase payouts aresmaller and have worse operating income both before and after the potentialpayout increase than any of the payout-increasing categories. Higher standarddeviations of operating income also predict a higher probability of not payingout cash. Within the categories of "rms that do increase payouts, higheroperating incomes increase the probability of a dividend increase, whilehigher standard deviations of operating incomes increase the probability ofrepurchases. One univariate result that does not hold here concerns non-operating income prior to the potential payout, which, in a multivariate context,is not signi"cantly related to the choice between dividends and repurchases.However, the non-operating income subsequent to the payout change is signi"-cantly positively related to the likelihood of repurchases. Finally, dividend-increasing "rms and "rms that both increase dividends and repurchases havesigni"cantly higher market returns than repurchasing "rms for both prior andcurrent years.
Finally, the results reported in Table 5 incorporate the impact of institu-tional ownership, similar to DeAngelo et al. (2000). Institutional ownership iscorrelated with both the "rm's decision to increase payouts and the choice ofpayout methods. Similar to the univariate results, "rms that increase payoutshave signi"cantly higher institutional ownership than "rms that do not increasepayouts. In addition, dividend-increasing "rms have higher institutional owner-ship than repurchasing "rms.
Overall, our multivariate analysis is consistent with the univariate compari-sons discussed earlier and both generally support the hypothesis that the"nancial #exibility inherent in open market repurchase programs is an impor-tant consideration in the choice of payout methods.
5. Conclusions
In this paper we analyze the recent rise in open market stock repurchases. Westart with a complete listing of program announcements supplied by SDC. Fromthese announcements, we construct a database consisting of both an underesti-mate and an overestimate of actual repurchases for every Compustat "rm
M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384 377
Tab
le4
Oper
atin
gan
dst
ock
perfor
man
cech
arac
terist
ics
a!ec
ting
a"rm's
choi
ceofpay
out
met
hod
This
tabl
epre
sent
sth
ere
sults
from
estim
atio
nofa
multin
omia
llo
git
mode
lofva
rious
oper
atin
gch
arac
terist
ics
and
stoc
kre
turn
sth
ough
tto
pred
ict
a"rm's
choic
eof
alte
rnat
ivem
etho
dsof
distr
ibut
ing
cash#ow
sin
agi
ven
year
.Eac
hco
lum
npr
ovid
esth
epar
amet
eres
tim
ates
obt
ained
from
thelo
g-od
dsra
tios
.The"rs
tco
lum
nco
mpar
es"rm
-yea
rsw
ith
no
incr
ease
inpa
yout
sto"rm
-yea
rsin
whi
chpay
outs
incr
ease
thro
ugh
the
useofr
epurc
has
es,i
ncre
ased
div
iden
dsorbo
th.T
he
seco
ndco
lum
nco
mpar
es"rm
-yea
rsw
ith
repurc
hase
prog
ram
initia
tionsorex
pan
sionsto
the
other
pos
sible
outc
om
es.T
he
third
colu
mn
com
par
es"rm
-yea
rsw
ith
both
stock
repur
chas
esan
ddiv
iden
din
crea
sesto
theoth
eral
tern
ativ
esan
dth
efo
urt
hco
lum
nco
mpa
res"rm
-yea
rsw
ith
div
iden
din
crea
ses
toth
eot
her
alte
rnat
ives
.All
indep
enden
tva
riab
les
are
the
sam
eas
de"ned
inT
able
3. Firm
-yea
rsw
ith
Firm
-yea
rsw
ith
repur
chas
eF
irm
-yea
rsw
ith
no
repur
chas
ean
nounce
men
tsan
dF
irm
-yea
rsw
ith
incr
ease
inpay
out
san
nou
nce
men
tsdiv
iden
din
crea
ses
div
iden
din
crea
ses
Coe$
cien
tp-
valu
eC
oe$
cien
tp-
valu
eC
oe$
cien
tp-
valu
eC
oe$
cien
tp-
valu
e
Firm
-yea
rsw
ith
no
incr
ease
inpa
youts
Inte
rcep
t3.
329
0.00
04.
024
0.00
02.
353
0.00
0Firm
size
!14
.021
0.01
0!
31.1
720.
000
!17
.918
0.00
0O
per
atin
gin
com
e(p
rior)
!2.
971
0.00
0!
7.35
90.
000
!6.
836
0.00
0N
on-
ope
rating
inco
me
(prior)
!3.
159
0.01
3!
2.65
70.
324
!1.
297
0.37
6Pay
out
ratio
(prior)
0.02
80.
618
!0.
126
0.00
0!
0.12
10.
000
Std.d
evia
tion
ope
rating
inco
me
2.56
70.
000
30.5
740.
000
27.6
990.
000
Oper
atin
gin
com
e(p
ost
)!
2.61
90.
000
!7.
052
0.00
0!
6.19
20.
000
Non-
ope
rating
inco
me
(post
)!
2.86
10.
037
4.33
10.
059
2.61
10.
066
Prior
year
stoc
kre
turn
0.59
30.
000
0.32
40.
007
!0.
046
0.03
9C
urr
entye
arst
ock
retu
rn!
0.05
40.
470
!0.
588
0.00
00.
545
0.00
0
Firm
-yea
rsw
ith
repu
rchas
ean
noun
cem
ents
Inte
rcep
t!
3.32
90.
000
0.69
40.
000
!0.
976
0.00
0Firm
size
14.0
210.
010
!17
.150
0.00
3!
3.89
60.
481
Oper
atin
gin
com
e(p
rior)
2.97
10.
000
!4.
389
0.00
0!
3.86
40.
000
Non-
ope
rating
inco
me
(prior)
3.15
90.
013
0.50
20.
863
1.86
10.
317
378 M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384
Pay
out
ratio
(prior)
!0.
028
0.61
8!
0.15
40.
015
!0.
149
0.31
3Std
.de
viat
ion
ope
rating
inco
me
!2.
567
0.00
028
.008
0.00
025
.133
0.00
0O
per
atin
gin
com
e(p
ost
)2.
619
0.00
0!
4.43
10.
000
!3.
571
0.00
0N
on-
ope
rating
inco
me
(post
)2.
861
0.03
77.
192
0.00
55.
472
0.00
3Prior
year
stoc
kre
turn
!0.
593
0.00
0!
0.26
70.
064
!0.
638
0.00
0C
urre
ntye
arst
ock
retu
rn0.
054
0.47
0!
0.53
40.
000
!0.
491
0.00
0
Firm
-yea
rsw
ith
repu
rchas
ean
noun
cem
ents
and
div
iden
din
crea
ses
Inte
rcep
t!
4.02
40.
000
!0.
694
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0!
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00.
000
Firm
size
31.1
720.
000
17.1
500.
003
13.2
540.
001
Oper
atin
gin
com
e(p
rior)
7.35
90.
000
4.38
90.
000
0.52
30.
417
Non-
ope
rating
inco
me
(prior
)2.
657
0.32
4!
0.50
20.
863
1.35
90.
631
Pay
out
ratio
(prior)
0.12
60.
000
0.15
40.
015
0.04
30.
657
Std
.de
viat
ion
ope
rating
inco
me
!30
.574
0.00
0!
28.0
080.
000
!2.
874
0.11
0O
per
atin
gin
com
e(p
ost
)7.
052
0.00
04.
431
0.00
00.
860
0.20
3N
on-o
pera
ting
inco
me
(post
)!
4.33
10.
059
!7.
192
0.00
5!
1.72
10.
484
Prior
year
stoc
kre
turn
!0.
324
0.00
70.
267
0.06
4!
0.37
00.
002
Cur
rentye
arst
ock
retu
rn0.
588
0.00
00.
534
0.00
00.
042
0.66
7
Firm
-yea
rsw
ith
div
iden
din
crea
ses
Inte
rcep
t!
2.35
30.
000
0.97
60.
000
1.67
00.
000
Firm
size
17.9
180.
000
3.89
60.
481
!13
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per
atin
gin
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e(p
rior)
6.83
60.
000
3.86
40.
000
!0.
523
0.41
7N
on-
ope
rating
inco
me
(prior
)1.
297
0.37
6!
1.86
10.
317
!1.
359
0.63
1Pay
out
ratio
(prior)
0.12
10.
000
0.14
90.
013
!0.
043
0.65
7Std
.de
viat
ion
ope
rating
inco
me
!27
.699
0.00
0!
25.1
330.
000
2.87
40.
110
Oper
atin
gin
com
e(p
ost
)6.
192
0.00
03.
571
0.00
0!
0.86
00.
203
Non-o
pera
ting
inco
me
(post
)!
2.61
10.
066
!5.
472
0.00
31.
721
0.48
4Prior
year
stoc
kre
turn
0.04
60.
039
0.63
80.
000
0.37
00.
002
Cur
rentye
arst
ock
retu
rn0.
545
0.00
00.
491
0.00
0!
0.04
20.
667
Obse
rvat
ions
16,0
47Log-
likel
ihood
!9,
157
M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384 379
Tab
le5
Oper
atin
gan
dst
ock
perfor
man
cech
arac
terist
ics
a!ec
ting
a"rm's
choi
ceofpay
out
met
hod
This
tabl
epre
sent
sth
ere
sults
from
estim
atio
nofa
multin
omia
llo
git
mode
lofva
rious
oper
atin
gch
arac
terist
ics
and
stoc
kre
turn
sth
ough
tto
pred
ict
a"rm's
choic
eof
alte
rnat
ivem
etho
dsof
distr
ibut
ing
cash#ow
sin
agi
ven
year
.Eac
hco
lum
npr
ovid
esth
epar
amet
eres
tim
ates
obt
ained
from
thelo
g-od
dsra
tios
.The"rs
tco
lum
nco
mpar
es"rm
-yea
rsw
ith
no
incr
ease
inpa
yout
sto"rm
-yea
rsin
whi
chpay
outs
incr
ease
thro
ugh
the
useofr
epurc
has
es,i
ncre
ased
div
iden
dsorbo
th.T
he
seco
ndco
lum
nco
mpar
es"rm
-yea
rsw
ith
repurc
hase
prog
ram
initia
tionsorex
pan
sionsto
the
other
pos
sible
outc
om
es.T
he
third
colu
mn
com
par
es"rm
-yea
rsw
ith
both
stock
repur
chas
esan
ddiv
iden
din
crea
sesto
theoth
eral
tern
ativ
esan
dth
efo
urt
hco
lum
nco
mpa
res"rm
-yea
rsw
ith
div
iden
din
crea
ses
toth
eot
her
alte
rnat
ives
.All
indep
enden
tva
riab
les
are
the
sam
eas
de"ned
inT
able
3. Firm
-yea
rsw
ith
Firm
-yea
rsw
ith
repur
chas
eF
irm
-yea
rsw
ith
no
repur
chas
ean
nounce
men
tsan
dF
irm
-yea
rsw
ith
incr
ease
inpay
out
san
nou
nce
men
tsdiv
iden
din
crea
ses
div
iden
din
crea
ses
Coe$
cien
tp-
valu
eC
oe$
cien
tp-
valu
eC
oe$
cien
tp-
valu
eC
oe$
cien
tp-
valu
e
Firm
-yea
rsw
ith
no
incr
ease
inpa
youts
Inte
rcep
t3.
642
0.00
05.
326
0.00
03.
389
0.00
0Firm
size
16.6
890.
311
!16
.708
0.01
5!
15.7
680.
000
Oper
atin
gin
com
e(p
rior)
!2.
011
0.00
0!
6.91
50.
000
!6.
599
0.00
0N
on-
ope
rating
inco
me
(prior)
!2.
842
0.23
8!
1.39
10.
817
6.20
30.
059
Pay
out
ratio
(prior)
0.17
90.
108
!0.
052
0.90
9!
0.00
80.
719
Std.d
evia
tion
ope
rating
inco
me
1.10
90.
065
27.4
570.
000
25.4
230.
000
Oper
atin
gin
com
e(p
ost
)!
2.49
50.
000
!5.
288
0.00
0!
4.90
60.
000
Non-
ope
rating
inco
me
(post
)!
5.59
40.
007
!2.
243
0.75
6!
5.31
90.
121
Inst
itutiona
low
ner
ship
!0.
021
0.00
0!
0.03
60.
000
!0.
026
0.00
0Prior
year
stoc
kre
turn
0.69
70.
000
0.58
10.
011
0.02
40.
706
Curr
entye
arst
ock
retu
rn!
0.18
50.
104
!0.
889
0.00
0!
0.62
70.
000
Firm
-yea
rsw
ith
repu
rchas
ean
noun
cem
ents
Inte
rcep
t!
3.64
20.
000
1.68
40.
000
!0.
253
0.21
7Firm
size
!16
.689
0.31
1!
33.3
970.
056
!32
.457
0.05
2O
per
atin
gin
com
e(p
rior)
2.01
10.
000
!4.
904
0.00
0!
4.58
80.
000
Non-
ope
rating
inco
me
(prior)
2.84
20.
238
1.45
10.
819
9.04
50.
021
Pay
outra
tio
(prior)
!0.
179
0.10
8!
0.18
50.
123
!0.
189
0.09
7
380 M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384
Std
.dev
iation
ope
rating
inco
me
!1.
109
0.06
526
.347
0.00
024
.314
0.00
0O
per
atin
gin
com
e(p
ost
)2.
495
0.00
0!
2.79
30.
063
!2.
411
0.01
0N
on-
ope
rating
inco
me
(post
)5.
594
0.00
73.
351
0.65
20.
274
0.94
3In
stitutiona
low
ner
ship
0.02
10.
000
!0.
016
0.00
2!
0.00
50.
121
Prior
year
stoc
kre
turn
!0.
697
0.00
0!
0.17
90.
441
!0.
722
0.00
0C
urr
entye
arst
ock
retu
rn0.
185
0.10
4!
0.70
40.
001
!0.
441
0.00
4
Firm
-yea
rsw
ith
repu
rchas
ean
noun
cem
ents
and
divi
dend
incr
ease
s
Inte
rcep
t!
5.32
60.
000
!1.
684
0.00
0!
1.93
70.
000
Firm
size
16.7
080.
015
33.3
970.
056
0.94
00.
891
Oper
atin
gin
com
e(p
rior)
6.91
50.
000
4.90
40.
000
0.31
60.
816
Non-
ope
rating
inco
me
(prior)
1.39
10.
817
!1.
451
0.81
97.
594
0.23
8Pay
out
ratio
(prior)
0.05
20.
909
0.18
50.
123
!0.
004
0.94
0Std
.dev
iation
ope
rating
inco
me
!27
.457
0.00
0!
26.3
470.
000
!2.
033
0.53
9O
per
atin
gin
com
e(p
ost
)5.
288
0.00
02.
793
0.06
30.
381
0.78
9N
on-
ope
rating
inco
me
(post
)2.
243
0.75
6!
3.35
10.
652
!3.
076
0.68
4In
stitutiona
low
ners
hip
0.03
60.
000
0.01
60.
002
0.01
10.
022
Prior
year
stoc
kre
turn
!0.
518
0.01
10.
179
0.44
1!
0.54
20.
009
Curr
entye
arst
ock
retu
rn0.
889
0.00
00.
704
0.00
10.
262
0.20
8
Firm
-yea
rsw
ith
div
iden
din
crea
ses
Inte
rcep
t!
3.38
90.
000
0.25
30.
217
1.93
70.
000
Firm
size
15.7
680.
000
32.4
570.
052
!0.
940
0.89
1O
per
atin
gin
com
e(p
rior)
6.59
90.
000
4.58
80.
000
!0.
316
0.81
6N
on-
ope
rating
inco
me
(prior)
!6.
203
0.05
9!
9.04
50.
021
!7.
594
0.23
8Pay
out
ratio
(prior)
0.00
80.
719
0.18
90.
097
0.00
40.
940
Std
.dev
iation
ope
rating
inco
me
!25
.423
0.00
0!
24.3
140.
000
2.03
30.
539
Oper
atin
gin
com
e(p
ost
)4.
906
0.00
02.
411
0.01
0!
0.38
10.
789
Non-
ope
rating
inco
me
(post
)5.
319
0.12
1!
0.27
40.
943
3.07
60.
684
Inst
itutiona
low
ners
hip
0.02
60.
000
0.00
50.
121
!0.
011
0.02
2Prior
year
stoc
kre
turn
0.02
40.
706
0.72
20.
000
0.54
20.
009
Curr
entye
arst
ock
retu
rn0.
627
0.00
00.
441
0.00
4!
0.26
20.
208
Obse
rvat
ions
5,12
4Log-
like
lihoo
d!
2,85
1
M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384 381
between 1985 and 1996. The data indicate that repurchases have grown over thisperiod. In 1996, actual repurchases amounted to between $44.3 and $63.3billion, suggesting that they are an economically important source of payouts.However, repurchases are still considerably smaller than the $141.7 billion individends paid that year.
Repurchases are noticeably more volatile than dividends. They appear to varyprocyclically, they were high during the rising markets of the late 1980s, droppedin the recession of the early 1990s and increased during the boom of themid-1990s. Repurchases are responsible for a disproportionately large fractionof the variation in total payouts. The smoothness of the dividend series com-bined with the volatility and procyclicality of the repurchase series are consis-tent with the view that dividends are paid out of sustainable cash #ows whilerepurchases are paid out of temporary cash #ows. Repurchases do not appear tobe replacing dividends; rather they seem to serve the complementary role ofpaying out short-term cash #ows.
A cross-sectional analysis of "rms' decisions to increase dividends or repur-chases is consistent with this view. Firms with higher operating cash #ows aremore likely to increase dividends, while "rms with higher non-operating cash#ows are more likely to increase repurchases. Firms with a higher standarddeviation of cash #ows are more likely to use repurchases. Subsequent to thepayout increase, cash #ows of repurchasing "rms continue to be lower thanthose of dividend-increasing "rms.
Textbook discussion of payout policy generally suggests that dividends andstock repurchases are more or less equivalent ways of paying out cash #ows (seeBrealey and Myers, 1996 or Grinblatt and Titman, 1988). Generally, the dis-cussion of the choice between the two revolves around Black's (1976) focuson repurchases' tax advantage relative to dividends. Our empirical work sug-gests that much more than taxes are necessary to explain di!erences in howdividends and repurchases are used in practice. Dividends and repurchases areused at di!erent places in the business cycle by di!erent types of "rms. Ourinterpretation of these results emphasizes the "nancial #exibility inherent inrepurchases. While this is likely to be part of the explanation, the completeanswer is undoubtedly more involved. For example, the striking di!erence instock market performance prior to dividend increases and repurchase programssuggests that valuation is also an important factor in determining payoutmethods.
Even though repurchases have not replaced dividends, they have become animportant source of payouts. Many branches of "nance research have focusedon dividends, and their yields in many di!erent contexts. For example, muchresearch has examined the extent to which expected returns can be predictedusing dividend yields (see Campbell and Shiller, 1988; Fama and French, 1988;Kandel and Stambaugh, 1996; Kothari and Shanken, 1997; or Ponti! andSchall, 1998). Another related literature has focused on excess volatility and the
382 M. Jagannathan et al. / Journal of Financial Economics 57 (2000) 355}384
issue of whether the variation in stock prices can be explained by movements individends (see Shiller, 1981; Leroy and Porter, 1981; Marsh and Merton, 1986;Kothari and Shanken, 1992). These two strands of the literature could beextended productively by considering total payouts rather than only dividendsin their econometric work.
References
Allen, F., Bernardo, A., Welch, I., 1998. A theory of dividends based on tax clienteles. Unpublishedworking paper, UCLA.
Bernartzi, S., Michaely, R., Thaler, R., 1997. Do changes in dividends signal the future or the past?The Journal of Finance 52, 1007}1034.
Black, F., 1976. The dividend puzzle. Journal of Portfolio Management 2, 5}8.Brealey, R., Myers, S., 1996. Principles of Corporate Finance., 5th Edition. McGraw-Hill,
New York.Campbell, J., Shiller, R., 1988. The dividend-price ratio and expectations of future dividends and
discount rates. Review of Financial Studies 1, 195}228.Comment, R., Jarrell, G., 1991. The relative signaling power of Dutch-auction and "xed-price
self-tender o!ers and open market share repurchases. Journal of Finance 46, 1243}1271.Cook, D., Krigman, L., Leach, J., 1997a. Safe harbor or smoke screen? compliance and disclosure
under SEC rule 10b-18. Unpublished working paper, University of Colorado.Cook, D., Krigman, L., Leach, J., 1997b. Corporate repurchase programs: execution strategy and the
competing market-maker e!ect. Unpublished working paper, University of Colorado.Dann, L., 1981. The e!ects of common stock repurchase on security holder's returns. Journal of
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