The Marginal Value of Dividends in the United States of America
Name: Li Fan
Study Program: MSc Finance Student number: s2861674 Supervisor: Henk von Eije
Keywords: Dividend, Marginal value, Agency Costs, Firm value
Abstract
1. Introduction
How much is one dollar of dividend actually valued by shareholders? And how is the value changing in different financial conditions? Many researchers study the relationship between dividend payment and firm value, but the marginal value of dividends have not received much attention. Different from other dividends related studies, this study applies a marginal value analysis method to exhibit how one dollar of dividend is actually valued by shareholders in firms under different corporate financial situations.
Early research conducted by Miller and Modigliani (1961) demonstrated that dividend payment is irrelevant for firm value. But the irrelevancy theory of Miller and Modigliani (1961) is based on perfect market assumptions. In the real world, perfect market assumptions do not hold, so many different elements influence the value of the dividend payment. Bhattacharya (1979) indicated that tax would decrease the marginal value of dividend payment when the capital gains tax rate is lower than the dividend tax rate. Besides, due to the agency problem between managers and shareholders, the agency costs also influences the value of dividend payment (Zhang et al. 2015). Moreover, when good investment opportunities exist in the future, firms need to refinance from the capital market after they are paying dividends out (Jensen, 1986). Thus, the refinancing costs will reduce the value of dividend payment. Additionally, dividend payment can signal to the shareholders that firm will have high profitability in the future (Miller and Rock, 1985; Ambarish et al., 1987), so the signaling mechanisms can add value to the dividend payment.
A considerable number of empirical studies are also conducted to analyze the relationship between dividend payment and firm value. Some researchers found that dividend payment does not add firm value (Watts,1973; Penman,1983; Benartzi et, al, 1997; Pascareno and Siringoringo, 2016). However, other researchers find that dividend payment has a positive impact on future market return. (Petit, 1972; Kalay and Loewenstein, 1985; Eades et al., 1985; Nissim and Ziv, 2001; DeAngelo and Stulz, 2006; Howatt et al., 2009; Onyinlola and Ajeigbe, 2014).
3 America from 2000 to 2016. Meanwhile, we want to examine whether different financial situations have an impact on the marginal value of dividend, so the second research question is to test how the value of one dollar of dividend payment is differentiated between financial constrained firms and financial unconstrained firms.
For the data collection part, we firstly acquire the ISIN numbers from Oribis and detailed company information from Datastream. Then we get 80650 firm-year observations after some basic screening. To test the value of one dollar dividend payment, we make sure that the firm has dividend payment during last fiscal year or this fiscal year, and this leaves us with 11144 firm year observations. Recall that the purpose of this study is to evaluate the marginal value on one dollar of dividend payment. So we use the change of firm's market value of equity as our dependent variable and the change of dividend payment in the proportion of the market value of equity as our main independent variable. Other variables such as firm size, leverage and market to book ratio are controls and used to test how different financial policies influence the value of one dollar of dividend payment.
2.Literature Review
2.1 Theory background
Based on the perfect capital market assumptions, Modigliani and Miller (1961) pointed out that firm value is unrelated to dividend payment. In the real word, the perfect capital market assumption does not hold. The dividend payments will be influenced by taxes, agency costs and the refinancing costs (Opler et al. 1999). Besides, the signaling theory also indicates that dividend payment can influence firm value by signaling future profitability to shareholders (Miller and Rock, 1985; Ambarish et al., 1987).
2.1.1 The marginal value of dividend and the taxes
Bhattacharya (1979) indicated that tax would decrease the marginal value of dividend payment when the capital gains tax rate is lower than the dividend tax rate. Due to the dividend tax cut in 2003, however, the actual dividend tax is around 17.38%1, and the actual capital gains tax is around 16.09%2 during the 2000 to 2016 period. We can see that the difference between dividend tax and the capital gains tax is not remarkable anymore, so the taxes will not significantly influence the value of dividend payments during our sample period.
2.1.2 Agency costs
As we mentioned before, agency problem may seriously decrease firm value. Normally, managers should act on behalf of the shareholders, but this happens only when the benefits of managers are connected with those of the shareholders (Pinkowitz et al. 2006; Zhang et al. 2015). However, agency cost arises when there is a conflict of interest between managers and the shareholders. Thus, self-interested managers prefer to use retained earnings for their private
1
Source:http://www.dividend.com/taxes/a-brief-history-of-dividend-tax-rates. Dividend tax from 2000-2002 is assumed to be 34%=((18%+50%)/2). Dividend tax after dividend tax cut period is 15%. We weight average the dividend tax before dividend tax cut period(from 2000-2002) and after the dividend tax cut period(from 2003-2016), and we get the weighted average dividend tax is 17.38%=((2*34%+14*15%)/16).
2
5 benefits. So the agency cost emerges when the shareholders hire the agent to monitor self-interest managers (Jensen, 1986; Zhang et al. 2015). The dividend payments can mitigate the agency problem because managers will not be able to spend the dividend payments for negative net present value projects, so the reduction of agency costs positively impact the value of dividend payment.
2.2.3 Dividend payment and the refinancing costs
However, the free cash flow theory implies that managers need to raise external financing for new investment opportunities after cash is distributed to the shareholders (Jensen, 1986). Thus, the refinancing costs emerge, and they also decrease the firm value. So the value of one dollar of dividend payment decreases because of the rise in refinancing costs. However, the refinancing costs are different across different firms depending on their financial constraints. According to Faulkender and Wang (2006), when the corporate cash holdings cannot satisfy the future investment plan, firms may give up the good investment opportunities due to high refinancing costs. For financial constrained firms, the need and the costs of accessing capital markets are high, so financial constrained firms normally pay fewer dividends because the benefits from dividend payment may not offset the refinancing costs. On the other hand, financial unconstrained firms can benefit more from dividend payment because of low refinancing costs. Thus, when we consider the refinancing costs, the dividend payment will bring relative more benefits to financial unconstrained firms than financial constrained firms.
2.1.4 Dividend signaling theory
rating level. Due to the information asymmetry between financial institutions and managers, firms can signal to financial institutions that they have plenty of cash flows after they are paying dividends to the shareholders, which finally may increase the credit rating level. Hence paying out not only avoids agency problems but may also decrease the cost of external finance (Easterbrook, 1984). Accordingly, the positive signals will increase the value of dividend payment.
In conclusion, the marginal value of dividend is expected to be positive, and significantly larger than one due to the reduction in agency costs and the positive signals. But the marginal value of dividend is expected to decrease due to the refinancing cost. Since the refinancing costs for financial constrained firms is higher than financial unconstrained firms, we can assume that one dollar of dividend payment is valued by shareholders in financial constrained firms lower than in financial unconstrained firms.
2.2 Empirical Findings
2.2.1 The marginal value of dividend
7 However, many studies do indicate that dividend payment positively influences future market return. Initially, Petit (1972) used a statistical method to prove that dividend changes have positive impacts on short-term abnormal return. Later, to test whether the announcement of dividends has an impact on firm value, Kalay and Loewenstein (1985) also found that the stock return is positively affected by dividend increases. Based on the test of Kalay and Loewestein (1985), Eades et al. (1985) also find that dividend payments have a significant and positive effect on the market returns. To test whether dividend payments affect future profitability, Nissim and Ziv (2001) found that other researchers have measurement error and omitted correlated variables. After fixing the model, Nissim and Ziv (2001) found that the dividend payment is significantly positively related to future profitability. Besides, they use consensus analysis's’ earnings to do the robustness check, and that also strongly supports their findings. Many recent researches also show that dividend payment increases the market return. After applying the multivariate logit tests to test 1348 dividend payers and 3015 non-dividend payers within the United States of America, DeAngelo and Stulz (2006) found that firms with high retained earnings are more likely to pay dividends because high retained earnings are implying higher agency costs. And the outcome is in line with their life-cycle theory of dividends policy. Later, Howatt et al. (2009) pointed out a positive correlation between dividend payment and future real earnings per share. And a more recent study from Onyinlola and Ajeigbe (2014) also demonstrates that dividend per share during last fiscal year t-1 positively impacts the earnings per share during this fiscal year t.
According to empirical findings, we can summarize that most researchers indicate that dividend payments convey positive information to shareholders and that the increase in dividends positively impacts the firm value. So we can conclude that the benefits from dividend payment dominate the costs incurred from refinancing. However, different from the dominant methods that other researchers use, we use the marginal value of dividend to explore how one dollar of dividend is actually valued by shareholders. Combined with the theoretical background and empirical findings; we assume that one dollar of dividend payment is positively valued by the shareholders.
2.2.2 Financial constrained firms and financial unconstrained firms
As we mentioned in the theoretical background, due to the difference on refinancing costs, one dollar of dividend payment brings more value to financial unconstrained firms than financial constrained firms. Some studies documented that one dollar of corporate cash holding increase contributes more to financial constrained firms than to financial unconstrained firms (Faulkeder and Wang, 2006; Zhang et al. 2015). Holding all others the same, the increase of dividend payment means the decrease of corporate cash holdings. When shareholders assign more value to cash holdings (especially for constrained firms), the dividend payment will decrease the marginal value of cash holdings in these firms more. Thus, the marginal value studies on corporate cash holdings indirectly indicate that shareholders in financial unconstrained do not bother to payout same cash as shareholders of constrained firms. Thus constrained firms assign more value on one dollar of dividend payment than shareholders in financial constrained firms.
There are also some empirical findings directly demonstrate that dividend payment contributes more to the financial unconstrained firms than to financial constrained firms. Chen and Wang (2012) applied 4710 repurchase announcements within the United States of America to evaluate the relation between stock repurchase and the abnormal return, and they found that the financial constrained firms show worse operating performance than financial unconstrained firms. Later, Pathan et al. (2014) applied 7866 firm-year observations within the United States of American from 1989 to 2012 to analyze the announcement of dividend increases between financial constrained firms and financial unconstrained firms. They find that both financial constrained firms and financial unconstrained firms experienced market value increases during the short term, but financial unconstrained firms performed better than financial constrained firms. For the long run, Panthan et al. (2014) also found that the financial constrained firms experienced lower abnormal returns than financial unconstrained firms. Combined with the theoretical background and the empirical findings, we therefore assume that one dollar of dividend is expected to be valued higher by shareholders in financial unconstrained firms than in financial constrained firms.
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3.Methodology and Data
3.1 Methodology
In this research, we primarily study how one dollar of dividend payment influences the firm value, and how different type of financial conditions influence the value of one dollar of dividend payment. A marginal value model will be considered to test the research question, so we apply the model that Faulkender and Wang (2006) used to analyze the marginal value corporate cash holdings. Moreover, we combine the methodology that Zhang et al. (2015) used to adjust the impact of the specific firm characteristics, so we add both market to book ratio (𝑀𝑀𝑀𝑀𝑖𝑖,𝑡𝑡−1) and firm size (𝑆𝑆𝑖𝑖,𝑡𝑡−1) as our control variables. The final model we use is stated below:
𝑀𝑀𝑖𝑖,𝑡𝑡−𝑀𝑀𝑖𝑖,𝑡𝑡−1 𝑀𝑀𝑖𝑖,𝑡𝑡−1 = 𝛾𝛾0+ 𝛾𝛾1 ∆𝐷𝐷𝑖𝑖,𝑡𝑡 𝑀𝑀𝑖𝑖,𝑡𝑡−1+ 𝛾𝛾2 ∆𝐸𝐸𝑖𝑖,𝑡𝑡 𝑀𝑀𝑖𝑖,𝑡𝑡−1+ 𝛾𝛾3 ∆𝑁𝑁𝑁𝑁𝑖𝑖,𝑡𝑡 𝑀𝑀𝑖𝑖,𝑡𝑡−1+ 𝛾𝛾4 ∆𝐼𝐼𝑖𝑖,𝑡𝑡 𝑀𝑀𝑖𝑖,𝑡𝑡−1+ 𝛾𝛾5 ∆𝐶𝐶𝑖𝑖,𝑡𝑡 𝑀𝑀𝑖𝑖,𝑡𝑡−1+ 𝛾𝛾6 𝐶𝐶𝑖𝑖,𝑡𝑡−1 𝑀𝑀𝑖𝑖,𝑡𝑡−1+ 𝛾𝛾7𝐿𝐿𝑖𝑖,𝑡𝑡+ 𝛾𝛾8𝑀𝑀𝑀𝑀𝑖𝑖,𝑡𝑡−1+ 𝛾𝛾9𝑆𝑆𝑖𝑖,𝑡𝑡−1+ 𝛾𝛾10𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 ∗𝑀𝑀∆𝐷𝐷𝑖𝑖,𝑡𝑡 𝑖𝑖,𝑡𝑡−1+ 𝜀𝜀𝑖𝑖,𝑡𝑡 (1)
Where: Firm market return is the dependent variable. As we mentioned before, we use the return on the market value of equity during fiscal year t to measure the increase in firm value. Similar to Faulkender and Wang (2006), ∆Xi,t means the change of independent variables for firm i during fiscal year t. We applied the common cash dividend payment paid to shareholders as dividend payment, so the first independent variable ∆𝐷𝐷𝑖𝑖,𝑡𝑡 means the change of common cash dividend payment. The second independent variable ∆𝐸𝐸𝑖𝑖,𝑡𝑡 means the change in the sum of earnings before extraordinary items and interest expenses. The third independent variable ∆𝑁𝑁𝑁𝑁𝑖𝑖,𝑡𝑡 means the change of net assets. The fourth independent variable ∆𝐼𝐼𝑖𝑖,𝑡𝑡 and fifth independent variable ∆𝐶𝐶𝑖𝑖,𝑡𝑡 are the change of interest expense and the change of corporate cash holdings separately. Moreover, the sixth independent variable 𝐶𝐶𝑖𝑖,𝑡𝑡−1 represents the amount of corporate cash holdings for firm i at the end of last fiscal year t-1. And the seventh variable ∆𝐿𝐿𝑖𝑖,𝑡𝑡 means the level of leverage ratio.
variable (𝑑𝑑𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 ∗ ∆𝐷𝐷𝑖𝑖,𝑡𝑡
𝑀𝑀𝑖𝑖,𝑡𝑡−1) . The dummy variable means financial constrained firms or not, in
which 1 means financial constrained. Besides, 𝛾𝛾0 is the intercept; 𝛾𝛾1 𝑡𝑡𝑡𝑡 𝛾𝛾10 are the coefficients of independent variables, and 𝜀𝜀𝑖𝑖,𝑡𝑡 is the error item for firm i in year t.
As a robustness test and in line with Faulkender and Wang (2006), we add two control variables 𝐶𝐶𝑖𝑖,𝑡𝑡−1
𝑀𝑀𝑖𝑖,𝑡𝑡−1∗
∆𝐷𝐷𝑖𝑖,𝑡𝑡
𝑀𝑀𝑖𝑖,𝑡𝑡−1 𝑎𝑎𝑎𝑎𝑑𝑑 𝐿𝐿𝑖𝑖,𝑡𝑡∗
∆𝐷𝐷𝑖𝑖,𝑡𝑡
𝑀𝑀𝑖𝑖,𝑡𝑡−1 to test whether the level of corporate cash holdings and the
leverage ratio influence the value of one dollar of dividend payment. And the model for the robustness check is stated below:
𝑀𝑀𝑖𝑖,𝑡𝑡−𝑀𝑀𝑖𝑖,𝑡𝑡−1 𝑀𝑀𝑖𝑖,𝑡𝑡−1 = 𝛾𝛾0+ 𝛾𝛾1 ∆𝐷𝐷𝑖𝑖,𝑡𝑡 𝑀𝑀𝑖𝑖,𝑡𝑡−1+ 𝛾𝛾2 ∆𝐸𝐸𝑖𝑖,𝑡𝑡 𝑀𝑀𝑖𝑖,𝑡𝑡−1+ 𝛾𝛾3 ∆𝑁𝑁𝑁𝑁𝑖𝑖,𝑡𝑡 𝑀𝑀𝑖𝑖,𝑡𝑡−1+ 𝛾𝛾4 ∆𝐼𝐼𝑖𝑖,𝑡𝑡 𝑀𝑀𝑖𝑖,𝑡𝑡−1+ 𝛾𝛾5 ∆𝐶𝐶𝑖𝑖,𝑡𝑡 𝑀𝑀𝑖𝑖,𝑡𝑡−1+ 𝛾𝛾6 𝐶𝐶𝑖𝑖,𝑡𝑡−1 𝑀𝑀𝑖𝑖,𝑡𝑡−1+ 𝛾𝛾7𝐿𝐿𝑖𝑖,𝑡𝑡+ 𝛾𝛾8𝑀𝑀𝑀𝑀𝑖𝑖,𝑡𝑡−1+ 𝛾𝛾9𝑆𝑆𝑖𝑖,𝑡𝑡−1+ 𝛾𝛾10𝑀𝑀𝐶𝐶𝑖𝑖,𝑡𝑡−1 𝑖𝑖,𝑡𝑡−1∗ ∆𝐷𝐷𝑖𝑖,𝑡𝑡 𝑀𝑀𝑖𝑖,𝑡𝑡−1+ 𝛾𝛾11𝐿𝐿𝑖𝑖,𝑡𝑡∗ ∆𝐷𝐷𝑖𝑖,𝑡𝑡 𝑀𝑀𝑖𝑖,𝑡𝑡−1+ 𝛾𝛾12𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 ∗ ∆𝐷𝐷𝑖𝑖,𝑡𝑡 𝑀𝑀𝑖𝑖,𝑡𝑡−1+ 𝜀𝜀𝑖𝑖,𝑡𝑡 (2)
Accordingly, the hoarding of cash may cause frequent acquisitions or the investment in negative-NPV projects, and therefore reduce firm value ( Harford et al. 2008; Zhang et al. 2015). Findings from Ammann et al. (2011) also demonstrate that when firm is paying dividend out rather than retain corporate cash, the possibility to invest in negative-NPV project decreases. Moreover, more cash holdings mean more serious agency problem. Thus, the marginal value of dividend is expected to increase followed by the level of cash holdings because dividend payment can solve the agency problem more efficiency, and therefore the benefits from dividend payment should be higher. So 𝛾𝛾10 is expected to be positive.
11 3.2. Sample and Data Collection
In this research, the data are acquired from both Oribis and DataStream; the sample concludes listed firms within the United States of America over the 2000 to 2016 period. Firstly we get the ISIN number and SIC codes of sample firms from Orbis. We exclude all financial firms (SIC codes from 6000 to 6999) and utilities(SIC codes from 4900 to 4999) because those two type of firms are regulated firms. Meanwhile, we delete all firms without ISIN code from our data sheet, and finally we get 6158 firms.
Secondly, we apply the ISIN number to download financial data from DataStream. The market return, in this case, is the return on market value of equity (𝑀𝑀𝑀𝑀). Dividend payment in this research is defined as common cash dividend paid to shareholders. We use the net income plus the interest expense to acquire Earnings (𝐸𝐸). Then we use the total assets minus the amount of cash holdings (𝐶𝐶) to get net assets (𝑁𝑁𝑁𝑁). For the calculation on leverage ratio (𝐿𝐿), we use the amount of total debt divided by the sum of total debt and the market value of equity. And we download all related variables directly from DataStream. Related explanations on variables and World scope are stated in the table1 below:
Table1. Data source and explanations
Explanation DataStream code
MV Market value of equity MV
Dividend Common cash dividend paid to shareholders wc05376 Net Income Net Income before extraordinary items wc01751
Total Assets Total assets wc02999
Interest expense Interest expense on total debt wc01251 Cash holdings Cash and cash equivalent wc02005
MB Market to book value MTBV
Total debt Total debt wc03255
Thirdly, observations with negative market value of equity and negative total assets are removed from our sample. Consider the quality of our data, the observations within the bottom 15% deciles total asset value are removed from our sample because those firms almost have no data available3. We winsorized all variables at 1% and 99% tails to eliminate the impact of extreme values. Since we want to analyze the marginal value of dividend payment, we should make sure
3
that there is dividend payment for firms either during this fiscal year t or last fiscal year t-1. Therefore, Our final sample contains 11144 firm-year observations. And the summary statistics stated in Table 2 below:
Table2.Summary Statistics for the 2000-2016 sample
Mean Median Std. Dev. N
𝑟𝑟𝑖𝑖,𝑡𝑡 0.203 0.076 1.339 11707 ∆𝐷𝐷𝑖𝑖,𝑡𝑡 0.003 0.001 0.020 11571 ∆𝐸𝐸𝑖𝑖,𝑡𝑡 0.009 0.005 0.272 11265 ∆𝑁𝑁𝑁𝑁𝑖𝑖,𝑡𝑡 0.099 0.022 0.613 11608 ∆𝐼𝐼𝑖𝑖,𝑡𝑡 0.002 0.000 0.033 11285 ∆𝐶𝐶𝑖𝑖,𝑡𝑡 0.013 0.003 0.179 11612 𝐶𝐶𝑖𝑖,𝑡𝑡−1 0.165 0.082 0.325 11673 𝐿𝐿𝑖𝑖,𝑡𝑡 0.202 0.155 0.198 11816 𝑀𝑀𝑀𝑀𝑖𝑖,𝑡𝑡−1 2.873 2.090 8.693 11665 𝑆𝑆𝑖𝑖,𝑡𝑡−1 13.892 14.005 2.110 12421
Notes: This table displays the descriptive statistics for the whole sample over 2000 to 2016 period. We winsorized all the variables in 1% and 99% tails. Std.Dev means the standard deviation and N means the number of observations. i means firm i
and t means year t. The dependent variable market return (𝑟𝑟𝑖𝑖,𝑡𝑡) means the return on market value of equity. All Independent
variables except for Leverage (𝐿𝐿𝑖𝑖,𝑡𝑡); logarithm firm total assets (𝑆𝑆𝑖𝑖,𝑡𝑡−1) and Market to book ratio(𝑀𝑀𝑀𝑀𝑖𝑖,𝑡𝑡−1) are divided by the
market value of equity at time t-1. ∆𝐷𝐷𝑖𝑖,𝑡𝑡 means the change on dividend payment. ∆𝐸𝐸𝑖𝑖,𝑡𝑡 means the change on sum of earnings
(before extraordinary items) and interest expense. ∆𝑁𝑁𝑁𝑁𝑖𝑖,𝑡𝑡 means the change on net assets. ∆𝐼𝐼𝑖𝑖,𝑡𝑡 means the change on interest expense. ∆𝐶𝐶𝑖𝑖,𝑡𝑡 means the change on corporate cash holdings and 𝐶𝐶𝑖𝑖,𝑡𝑡−1 is the corporate cash holdings level at time t-1.
According to the descriptive data, we can see that all variables except for the firm size are right-skewed because the mean of each variable is higher than the median. And we can see that the average change of dividend in this study is much higher than the average change of dividend payment of Faulkender and Wang (2006) because we only focus on firms that have dividends paid during this fiscal year or last fiscal year. Meanwhile, we can see that the average cash holdings level and the average leverage ratio are similar to Faulkender and Wang (2006), indicating that the average cash holding level and leverage ratio do not change a lot between 1972 to 2001 period of the study in Faulkender and Wang (2006) and the 2000 to 2016 period here in our study.
13 In line with Faulkender and Wang (2006), we also divide our sample using the interest coverage ratio and market to book ratio to further test the value on one dollar of dividend payment regarding different corporate financial situations. For the calculations of interest coverage ratio, we add up corporate cash holdings at time t-1 and the earnings at the end of time t, and then divide it by the interest expense during time t. Accordingly, a high interest coverage ratio means more cash in hand and less debt remaining to be serviced. And Faulkender and Wang (2006) indicated that high interest coverage ratio firms have a high level of case reserves, and the dividend payment in this case is relative low. The situation happens when the refinancing costs dominate the benefits from dividend payment. Moreover, it is more costly for a financial constrained firm to reach the same debt level as financial unconstrained firms. So the refinancing cost for firms with high interest coverage ratio is high. Thus we assume that high (above median) interest coverage ratio firms are more financial constrained.
4. Empirical Results
We have four parts for the empirical results section. In the first part, we test the first hypothesis that whether one dollar of dividend is positively valued by shareholders. Later, we apply three methods to test whether financial constraint has an impact on the marginal value of dividend. As we mentioned before, we assume small size firms are more financial constrained, so we apply firm size to do the test in our second part. Afterwards, we assume high interest coverage ratio firms are more constrained, so we apply the interest coverage ratio to test the impacts of financial constrained type in the third part. Finally, we assume high growth opportunity firms are more financial constrained. So we applied the growth opportunity to further examine the impacts of financial constrained type in the fourth part.
4.1 Test for dividend payment
15 Table3. Whole sample test for the marginal value of dividend
Variables 1 2 ∆𝐷𝐷𝑖𝑖,𝑡𝑡 2.464*** 1.322** (0.376) (0.516) ∆𝐸𝐸𝑖𝑖,𝑡𝑡 -0.222*** -0.243*** (0.036) (0.036) ∆𝑁𝑁𝑁𝑁𝑖𝑖,𝑡𝑡 0.158*** 0.159*** (0.016) (0.016) ∆𝐼𝐼𝑖𝑖,𝑡𝑡 -1.502*** -1.747*** (0.291) (0.293) ∆𝐶𝐶𝑖𝑖,𝑡𝑡 0.816*** 0.799*** (0.05) (0.05) 𝐶𝐶𝑖𝑖,𝑡𝑡−1 1.549*** 1.478*** (0.041) (0.041) 𝐿𝐿𝑖𝑖,𝑡𝑡 -1.599*** -1.608*** (0.078) (0.077) 𝑀𝑀𝑀𝑀𝑖𝑖,𝑡𝑡−1 -0.002* -0.002** (0.001) (0.001) 𝑆𝑆𝑖𝑖,𝑡𝑡−1 0.093*** 0.092*** (0.023) (0.022) 𝐶𝐶𝑖𝑖,𝑡𝑡−1∗ ∆𝐷𝐷𝑖𝑖,𝑡𝑡 5.703*** (0.578) 𝐿𝐿𝑖𝑖,𝑡𝑡∗ ∆𝐷𝐷𝑖𝑖,𝑡𝑡 -4.516*** (1.408) Intercept -1.062*** -1.037*** (0.314) (0.313) 𝐶𝐶𝑖𝑖,𝑡𝑡−1(Mean) 0.165 𝐿𝐿𝑖𝑖,𝑡𝑡(Mean) 0.202
The marginal value of 1 dividend 2.464*** 1.352b
Cross-section Fixed Fixed
Period Fixed Fixed
Observations 11144 11144
AdjR2 0.543 0.547
Notes: This table displays the outcome of the marginal value of dividend payment from 2000 to 2016 regarding the whole sample. Column 1 means the test on the value of one dollar of dividend for the whole sample. Column 2 means the robustness check after we apply the impact of the corporate cash holdings level and the leverage ratio. We want to make sure our outcome is not biased, so we applied both the fixed cross-section effect and fixed period effect. We winsorized all the variables in 1% and 99% tails. i means firm i and t means year t. The dependent variable is the market return on equity. All Independent variables except for Leverage (𝐿𝐿𝑖𝑖,𝑡𝑡); logarithm firm total assets (𝑆𝑆𝑖𝑖,𝑡𝑡−1) and Market to book ratio(𝑀𝑀𝑀𝑀𝑖𝑖,𝑡𝑡−1) are divided by the market value
of equity at time t-1. ∆𝐷𝐷𝑖𝑖,𝑡𝑡 means the change on dividend payment. ∆𝐸𝐸𝑖𝑖,𝑡𝑡 means the change on the sum of earnings (before
extraordinary items) and interest expense. ∆𝑁𝑁𝑁𝑁𝑖𝑖,𝑡𝑡 means the change on net assets. ∆𝐼𝐼𝑖𝑖,𝑡𝑡 means the change on interest expense. ∆𝐶𝐶𝑖𝑖,𝑡𝑡 means the change on corporate cash holdings and 𝐶𝐶𝑖𝑖,𝑡𝑡−1 is the corporate cash holdings level at time t-1. (b) means standard
error is not calculated. *, **, and *** means significance at 10% , 5% and 1% confidence level.
dividend payment dominates the refinancing costs incurred from the same amount of dividend payment.
The result changes significantly after we add the impacts from the level of corporate cash holdings and leverage ratio. According to the robustness check, when a firm has no cash holdings and no leverage, the pointed estimated marginal value of dividend is 1.322. Moreover, In line with our expectation, the coefficient of the interaction of dividend changes with the level of corporate cash holdings is significantly positive. So the marginal value of dividend is increasing in the level of corporate cash holdings. Consistently, the agency cost is high when a firm holds a lot of cash in hand, so one unit dividend payment will more efficiently solve the agency problem and thereby create more benefits for firms with high level of corporate cash holdings.
Furthermore, the same as our expectation, the coefficient for the interaction of dividend changes with the leverage ratio is significantly negative (-4.516), which economically indicates that increasing 10% leverage ratio will decrease the marginal value of dividend by -$0.45 (=-$0.4516*0.1). When the firm has high leverage, more dividend paid to shareholders means less cash in hand. Supporting our hypothesis, the increases in refinancing costs that result from the rise in bankruptcy costs dominate the impact from the benefits on dividend payment. Therefore, the marginal value of dividend is decreasing in the leverage ratio.
17 4.2 Test for financial constrained according to firm size
Table4. Small size firms and Large size firms
Variables
Robustness Check
Small size Large size Small size Large size
∆𝐷𝐷𝑖𝑖,𝑡𝑡 1.423** 3.465*** 2.111*** 5.370*** (0.573) (0.470) (0.767) (0.810) ∆𝐸𝐸𝑖𝑖,𝑡𝑡 -0.480*** 0.066*** -0.487*** 0.021 (0.060) (0.039) (0.060) (0.038) ∆𝑁𝑁𝑁𝑁𝑖𝑖,𝑡𝑡 0.158*** 0.148*** 0.168*** 0.156*** (0.028) (0.017) (0.029) (0.017) ∆𝐼𝐼𝑖𝑖,𝑡𝑡 -5.046*** 5.722*** -4.983*** 5.414*** (0.463) (0.342) (0.471) (0.336) ∆𝐶𝐶𝑖𝑖,𝑡𝑡 0.714*** 1.285*** 0.719*** 1.296*** (0.078) (0.063) (0.078) (0.061) 𝐶𝐶𝑖𝑖,𝑡𝑡−1 1.747*** 1.315*** 1.722*** 1.292*** (0.064) (0.056) (0.066) (0.055) 𝐿𝐿𝑖𝑖,𝑡𝑡 -1.836*** -1.494*** -1.854*** -1.539*** (0.144) (0.078) (0.144) (0.076) 𝑀𝑀𝑀𝑀𝑖𝑖,𝑡𝑡−1 0.000 -0.002*** 0.000 -0.002*** (0.002) (0.001) (0.002) (0.001) 𝑆𝑆𝑖𝑖,𝑡𝑡−1 0.182*** 0.031*** 0.179*** 0.042* (0.046) (0.024) (0.046) (0.023) 𝐶𝐶𝑖𝑖,𝑡𝑡−1∗ ∆𝐷𝐷𝑖𝑖,𝑡𝑡 0.846 10.190*** (1.013) (0.603) 𝐿𝐿𝑖𝑖,𝑡𝑡∗ ∆𝐷𝐷𝑖𝑖,𝑡𝑡 -6.778*** -14.298*** (2.474) (1.817) Intercept -2.094*** -0.189*** -2.054*** -0.341 (0.564) (0.368) (0.564) (0.359) p(S-L) 0.022 𝐶𝐶𝑖𝑖,𝑡𝑡−1(Mean) 0.211 0.124 0.211 0.124 𝐿𝐿𝑖𝑖,𝑡𝑡(Mean) 0.152 0.246 0.152 0.246
The marginal value of dividend 1.423** 3.465*** 1.257(a)(b) 3.109(b)
Cross-section Fixed Fixed Fixed Fixed
Period Fixed Fixed Fixed Fixed
Observations 5137 6007 5137 6007
AdjR2 0.600 0.423 0.600 0.453
Notes: This table displays the outcome of the marginal value of dividend payment from 2000 to 2016 regarding different firm size sample. We assume small size firms are more financially constrained and large size firms are more financially unconstrained. We want to make sure our outcome is not biased, so we applied both the fixed cross-section effect and fixed period effect. We winsorized all the variables in 1% and 99% tails. i means firm i and t means year t. The dependent variable is the market return on equity. All Independent variables except for Leverage (𝐿𝐿𝑖𝑖,𝑡𝑡); logarithm firm total assets (𝑆𝑆𝑖𝑖,𝑡𝑡−1) and Market to book ratio(𝑀𝑀𝑀𝑀𝑖𝑖,𝑡𝑡−1) are divided by the market value of equity at time t-1. ∆𝐷𝐷𝑖𝑖,𝑡𝑡 means the change on dividend payment. ∆𝐸𝐸𝑖𝑖,𝑡𝑡
means the change on the sum of earnings (before extraordinary items) and interest expense. ∆𝑁𝑁𝑁𝑁𝑖𝑖,𝑡𝑡 means the change on net
assets. ∆𝐼𝐼𝑖𝑖,𝑡𝑡 means the change on interest expense. ∆𝐶𝐶𝑖𝑖,𝑡𝑡 means the change on corporate cash holdings and 𝐶𝐶𝑖𝑖,𝑡𝑡−1 is the corporate
cash holdings level at time t-1. p(S-L) means the p-value when add variable (small size firm dummy*∆𝐷𝐷𝑖𝑖,𝑡𝑡 ) to evaluate whether
the marginal value of dividend is significant different between financial constrained firms and financial unconstrained firms. (a)
means the marginal value of dividend is calculated using insignificant coefficient. (b) means standard error is not calculated. *, **,
As we discussed before, we expect that one dollar of dividend is valued by shareholders in financial constrained firms lower than in financial unconstrained firms. In this part, we distinguish our sample based on being above or below median firm size to test how financial constraints impact the marginal value of dividend. We do the overall sample test in the first and the second column of Table 4. Then we apply robustness checks in the third and the fourth column by adding the impacts from both the level of corporate cash holdings and leverage ratio.
We can see from Table 4 that the average cash holding in the proportion of the market value of equity is more than twice in small size firms than in large size firms. Small firms need to hold relative more cash in hand because the refinancing costs in small firms are higher than large firms. Meanwhile, the average leverage ratio in small firms is lower than large firms, which further indicates that it is more costly for small firms to finance from capital markets. And it is more costly for small firms to reach the same leverage ratio as large firms.
On the other hand, the p(S-L) value that evaluates the difference between financial constrained (small) firm and the financial unconstrained (large) firm is significant at 1% confidence level, indicating that financial constraints have a significant impact on the value of one dollar of dividend. Consequently, we can see that the point estimation on one dollar dividend is valued by shareholders in financial constrained firms (1.423) significantly lower than in financial unconstrained firms (3.465), which support our second hypothesis that the marginal value of dividend in financial constrained firms is lower than financial unconstrained firms. As we discussed before, the increase in dividend payments further exacerbates the cash shortage for the financial constrained group, so high costs incurred from refinancing will dominate the benefits from dividend payment. Moreover, financial unconstrained firms bear relatively low refinancing costs, and that is why the point estimated marginal value of dividend for financial unconstrained firms (3.465) is significantly higher than one. Additionally, we can see that value on one dollar of dividend is always positively estimated by shareholders no matter whether the firm is in financial constrained or not, so we can conclude that the average benefits from dividend payment for both financial constrained and unconstrained firms dominate the average refinancing costs.
19 So the point estimated robustness check also demonstrates that one dollar of dividend is valued by shareholders in financial constrained firms significantly lower than financial unconstrained firms. What is also worth mentioning, is that the coefficient for 𝐶𝐶𝑖𝑖,𝑡𝑡−1
𝑀𝑀𝑖𝑖,𝑡𝑡−1∗
∆𝐷𝐷𝑖𝑖,𝑡𝑡
𝑀𝑀𝑖𝑖,𝑡𝑡−1 is significantly
higher in financial unconstrained firms (10.190) than in financial constrained firms (0.846), which means the level of corporate cash holdings in financial unconstrained firms influences the marginal value of dividend more. Thus, the higher level of cash that financial unconstrained (large) firms have in hand during last fiscal year, the more benefits the dividend payment will bring to the firm. Moreover, the coefficient for 𝐿𝐿𝑖𝑖,𝑡𝑡 ∗ ∆𝐷𝐷𝑖𝑖,𝑡𝑡
𝑀𝑀𝑖𝑖,𝑡𝑡−1 is significantly lower in financial
unconstrained firms (-14.298) than in financial constrained firms (-6.778). So the higher the leverage ratio in a financial unconstrained (large) firm during last fiscal year, the less benefits dividend payment will bring to the firm. Meanwhile, after adjusting the impact from corporate cash holdings level and leverage ratio, we also find that one dollar of dividend in estimation is always positively valued by shareholders no matter whether the firm is financial constrained or not.
4.3 Interest coverage ratio
Table5. High interest coverage ratio and Low interest coverage ratio
Robustness Check
Variables High Low High Low
∆𝐷𝐷𝑖𝑖,𝑡𝑡 2.773*** 3.145*** 1.521*** 9.293*** (0.405) (0.639) (0.496) (1.517) ∆𝐸𝐸𝑖𝑖,𝑡𝑡 0.078 0.034 0.019 0.034 (0.065) (0.045) (0.065) (0.044) ∆𝑁𝑁𝑁𝑁𝑖𝑖,𝑡𝑡 0.364*** 0.077*** 0.353*** 0.063*** (0.029) (0.019) (0.029) (0.019) ∆𝐼𝐼𝑖𝑖,𝑡𝑡 -2.770*** -1.035*** -3.180*** -0.886*** (0.629) (0.324) (0.659) (0.322) ∆𝐶𝐶𝑖𝑖,𝑡𝑡 0.696*** 0.705*** 0.752*** 0.528*** (0.065) (0.078) (0.065) (0.080) 𝐶𝐶𝑖𝑖,𝑡𝑡−1 1.158*** 2.357*** 1.066*** 2.337*** (0.046) (0.085) (0.048) (0.084) 𝐿𝐿𝑖𝑖,𝑡𝑡 -2.062*** -1.930*** -1.966*** -1.950*** (0.137) (0.110) (0.138) (0.109) 𝑀𝑀𝑀𝑀𝑖𝑖,𝑡𝑡−1 -0.003** -0.002* -0.004*** -0.002* (0.001) (0.001) (0.001) (0.001) 𝑆𝑆𝑖𝑖,𝑡𝑡−1 0.071** 0.079** 0.064** 0.084** (0.028) (0.034) (0.028) (0.034) 𝐶𝐶𝑖𝑖,𝑡𝑡−1∗ ∆𝐷𝐷𝑖𝑖,𝑡𝑡 5.333*** 8.998*** (0.757) (1.028) 𝐿𝐿𝑖𝑖,𝑡𝑡∗ ∆𝐷𝐷𝑖𝑖,𝑡𝑡 -12.920*** -16.977*** (3.168) (2.924) Intercept -0.857** -0.565 -0.750** -0.625 (0.380) (0.488) (0.378) (0.484) p(H-L) 0.002 𝐶𝐶𝑖𝑖,𝑡𝑡−1(Mean) 0.214 0.099 0.214 0.099 𝐿𝐿𝑖𝑖,𝑡𝑡(Mean) 0.091 0.349 0.091 0.349
The marginal value of dividend 2.773*** 3.145*** 1.485(b) 4.258(b)
Cross-section Fixed Fixed Fixed Fixed
Period Fixed Fixed Fixed Fixed
Observations 6224 4920 6224 4920
AdjR2 0.600 0.660 0.603 0.667
Notes: This table displays the outcome of the marginal value of dividend payment from 2000 to 2016 regarding different interest coverage ratio sample. High means interest coverage ratio and Low means low interest coverage ratio. We assume high interest coverage ratio firms are more financially constrained and we assume low interest coverage ratio firms are more financially unconstrained. We want to make sure our outcome is not biased, so we applied both the fixed cross-section effect and fixed period effect. High means high interest coverage ratio and low means low interest coverage ratio. We winsorized all the variables in 1% and 99% tails. i means firm i and t means year t. The dependent variable is the market return on equity. All Independent variables except for Leverage (𝐿𝐿𝑖𝑖,𝑡𝑡); logarithm firm total assets (𝑆𝑆𝑖𝑖,𝑡𝑡−1) and Market to book ratio(𝑀𝑀𝑀𝑀𝑖𝑖,𝑡𝑡−1) are divided by the
market value of equity at time t-1. ∆𝐷𝐷𝑖𝑖,𝑡𝑡 means the change on dividend payment. ∆𝐸𝐸𝑖𝑖,𝑡𝑡 means the change on the sum of earnings
(before extraordinary items) and interest expense. ∆𝑁𝑁𝑁𝑁𝑖𝑖,𝑡𝑡 means the change on net assets. ∆𝐼𝐼𝑖𝑖,𝑡𝑡 means the change on interest
expense. ∆𝐶𝐶𝑖𝑖,𝑡𝑡 means the change on corporate cash holdings and 𝐶𝐶𝑖𝑖,𝑡𝑡−1 is the corporate cash holdings level at time t-1. p(H-L)
means the p-value when add variable (High interest coverage ratio dummy*∆𝐷𝐷𝑖𝑖,𝑡𝑡 ) to evaluate whether interest coverage ratio
influence the value of one dollar of dividend. (b) means standard error is not calculated. *, **, and *** means significant at 10%,
5% and 1% confidence level.
21 interest coverage ratio firms than low interest coverage ratio firms. Similarly, we can see that the average leverage ratio in high interest coverage firms is significantly lower than in low interest coverage ratio firms.
Table 5 shows that the p(H-L) value is significant at 1% confidence level, which indicates that interest coverage ratio has a significant impact on the value of one dollar of dividend. Meanwhile, we can see that the point estimated marginal value of dividend for high interest coverage ratio firms (2.773) is lower than low interest coverage ratio firms (3.145). So the outcome indicates that the marginal value of dividend in high interest coverage ratio firms is significantly lower than low interest coverage ratio firms. The result is in line with our expectation. High interest coverage ratio firms have a higher level of corporate cash holdings and a lower debt level, meaning the refinancing costs for high interest coverage ratio firms are higher than low interest coverage firms. Moreover, although interest coverage ratio has an impact on the value of one dollar of dividend, we can see that the estimated marginal value of divided for both high interest coverage ratio firms and low interest coverage ratio firms are always positive.
After we adjust the impact of corporate cash holdings and leverage ratio, the pointed estimated marginal value of dividend for high interest coverage firms and low interest coverage firms are 1.485 and 4.258 separately. We can see that the gap is even higher than without the cash holding level and leverage adjustments. So the robustness check further confirms our hypothesis.
4.4. Growth Opportunities
Table6. High gworth opportunitiesand Low growth opportunities
Robustness Check
Variables High Low High Low
∆𝐷𝐷𝑖𝑖,𝑡𝑡 1.522*** 1.313** 2.728*** 2.526*** (0.293) (0.563) (0.402) (0.809) ∆𝐸𝐸𝑖𝑖,𝑡𝑡 -0.054 0.014 -0.097 0.007 (0.059) (0.046) (0.060) (0.046) ∆𝑁𝑁𝑁𝑁𝑖𝑖,𝑡𝑡 0.289*** 0.083*** 0.308*** 0.088*** (0.023) (0.020) (0.023) (0.020) ∆𝐼𝐼𝑖𝑖,𝑡𝑡 -1.488*** -3.399*** -1.610*** -3.338*** (0.538) (0.372) (0.538) (0.375) ∆𝐶𝐶𝑖𝑖,𝑡𝑡 0.765*** 0.594*** 0.784*** 0.595*** (0.079) (0.062) (0.079) (0.062) 𝐶𝐶𝑖𝑖,𝑡𝑡−1 0.726*** 1.354*** 0.744*** 1.325*** (0.049) (0.055) (0.049) (0.056) 𝐿𝐿𝑖𝑖,𝑡𝑡 -1.377*** -1.964*** -1.402*** -1.966* (0.063) (0.119) (0.063) (0.119) 𝑀𝑀𝑀𝑀𝑖𝑖,𝑡𝑡−1 -0.004*** 0.005*** -0.004*** 0.005*** (0.001) (0.003) (0.001) (0.003) 𝑆𝑆𝑖𝑖,𝑡𝑡−1 0.024 0.234* 0.023 0.229*** (0.016) (0.040) (0.016) (0.040) 𝐶𝐶𝑖𝑖,𝑡𝑡−1∗ ∆𝐷𝐷𝑖𝑖,𝑡𝑡 -1.362 0.855 (1.077) (0.757) 𝐿𝐿𝑖𝑖,𝑡𝑡∗ ∆𝐷𝐷𝑖𝑖,𝑡𝑡 -6.696*** -6.290*** (1.436) (2.004) Intercept -0.139 -2.708*** -0.115 -2.636*** (0.224) (0.533) (0.224) (0.533) p(H-L) 0.009 𝐶𝐶𝑖𝑖,𝑡𝑡−1(Mean) 0.098 0.234 0.098 0.234 𝐿𝐿𝑖𝑖,𝑡𝑡(Mean) 0.170 0.236 0.170 0.236
The marginal value of dividend 1.522 1.313 1.458(a)(b) 1.242(a)(b)
Cross-section Fixed Fixed Fixed Fixed
Period Fixed Fixed Fixed Fixed
Observations 5588 5556 5588 5556
AdjR2 0.487 0.673 0.490 0.674
Notes: This table displays the outcome of the marginal value of dividend payment from 2000 to 2016 regarding different growth opportunity sample. We assume high market to book ratio firms are more financially constrained and we assume low market to book ratio firms are more financially unconstrained. We want to make sure our outcome is not biased, so we applied both the fixed cross-section effect and fixed period effect. High means high market to book ratio and Low means low market to book ratio. We winsorized all the variables in 1% and 99% tails. i means firm i and t means year t. The dependent variable is the
market return on equity. All Independent variables except for Leverage (𝐿𝐿𝑖𝑖,𝑡𝑡); logarithm firm total assets (𝑆𝑆𝑖𝑖,𝑡𝑡−1) and Market to
book ratio(𝑀𝑀𝑀𝑀𝑖𝑖,𝑡𝑡−1) are divided by the market value of equity at time t-1. ∆𝐷𝐷𝑖𝑖,𝑡𝑡 means the change on dividend payment. ∆𝐸𝐸𝑖𝑖,𝑡𝑡
means the change on the sum of earnings (before extraordinary items) and interest expense. ∆𝑁𝑁𝑁𝑁𝑖𝑖,𝑡𝑡 means the change on net
assets. ∆𝐼𝐼𝑖𝑖,𝑡𝑡 means the change on interest expense. ∆𝐶𝐶𝑖𝑖,𝑡𝑡 means the change on corporate cash holdings and 𝐶𝐶𝑖𝑖,𝑡𝑡−1 is the corporate
cash holdings level at time t-1. p(H-L) means the p-value when add variable (High market to book ratio dummy*∆𝐷𝐷𝑖𝑖,𝑡𝑡 ) to
examine whether growth opportunities have impact on the value of one dollar of dividend payment. a means the marginal value
of dividend is calculated using insignificant coefficient. (b) means standard error is not calculated. *, **, and *** means
23 Different as the outcome of firm size and interest coverage ratio evaluation, we can see from Table 6 that the average cash holding in the proportion of market value of equity for high growth firms is significantly lower than low growth firms. And the average leverage ratio for high growth films is lower than for low growth firms.
5. Conclusion
This paper studies how one dollar of dividend change is valued by shareholders. Firstly, we find that on average one dollar of extra dividend is valued by shareholders at 2.464. Then we find that the dividend increases are more valuable when the level of corporate cash holdings is high and when the leverage ratio is low. After the adjustment for the impacts of corporate cash holdings level and the leverage ratio, we find the marginal value of dividend for the average firm in the total sample decreases to 1.352, which is still positive. In average, the benefits from agency costs reduction and the benefits from positive signaling dominate the refinancing costs.
Then we test whether financial constraints have a significant impact on the value of one dollar dividend by using the firm size to measure financial constraints. In line with our expectation, one dollar of dividend is valued by shareholders in small firms significantly lower than shareholders in financial unconstrained large firms. After we adjust for the impact of corporate cash holdings level and leverage ratio, the gap between the marginal value of dividend for small and large firms is even larger. Our reasoning suggests that due to high refinancing costs, the benefits from dividend payment for financial constrained (small) firms are fewer than financial unconstrained (large) firms.
Later, in line with our expectation, we find that one dollar of dividend contributes more to high interest coverage ratio firms because corporate cash reserves in high interest coverage ratio firms are high. However, different to our expectation, we find that one dollar of dividend contributes more to high growth opportunities firms. Although firms with low growth opportunities bear less refinancing costs, high growth opportunities firms benefit more from the dividend signals. Thus, managers in firms with a large size, a low interest coverage ratio and high growth opportunities may benefit shareholders more with dividend payments.
25
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