Corporate payout-form: investors’ preference and catering theory

Abstract

Purpose The purpose of this paper is to develop and validate new robust measures of investors’ preference for the form of regular corporate payout. Then, the paper adds to the empirical evidence on catering theory by examining managers’ catering to such preference. Design/methodology/approach The authors use the matching method to control for firm characteristics. The authors apply two robustness tests to validate the measures. The authors use the rigorous multivariate analysis. Findings US investors’ preference for regular dividends vs regular stock repurchases, being different forms of corporate payout, varies over time. Managers cater to investors’ preference for payout form. The findings are consistent with the catering theory of Baker and Wurgler (2004a). The number of firms that pay cash dividends regularly continue to outnumber the ones that purchase their shares regularly. Research limitations/implications The study only uses US data. It does not cover other countries. Practical implications The measures can be used in several future research endeavors, such as examining investors’ payout-form preferences in other countries (see Booth and Zhou, 2017) and exploring their determinants, the corporate governance characteristics of firms that cater to investors’ preference vs firms that do not, etc. Social implications The study contributes to understanding investors’ preferences and corporate payout behavior which is prerequisite to efficient policy formulation. Originality/value The proxies for investors’ payout-form preference control for firm characteristics and are unrelated to investors’ time-varying risk preferences. Also, they are robust to measurement issues. Moreover, the study covers a period of 40 years.

Rational catering of irrational emotions: Investor sentiment and executive tone

“…Third, our findings differ from Baker and Wurgler ( 2004b ), Chazi et al ( 2018 ), and Kong ( 2018 ), all of whom verify the Catering Theory from the perspectives of either market-wide investor sentiment or firm-level investor behavior. By contrast, we investigate how executive tone is affected by investor sentiment at the market level and how investor behavior at the firm level affects the relationship between these two factors; we thereby complement the findings of previous studies.…”

“…The third is the catering route, where executives make financial decisions to meet the investors' expectations (Kong, 2018 ; Elbannan, 2020 ). Some studies show that managers change their dividends (Chazi et al, 2018 ), corporate names (Cooper et al, 2005 ), and investment choices (Polk and Sapienza, 2009 ) to cater to irrational investors. Meanwhile, other researchers argue that managers adopt information disclosures, such as earnings management, to respond to investor sentiment (Simpson, 2013 ; Kong, 2018 ).…”

“…On the other hand, the equity market comprises many irrational investors, whose sentiments significantly influence stock transactions and prices (Hong and Stein, 2003 ). Therefore, rational executives are intensely incentivized to respond to rising investor sentiment to avoid firm earnings and performance that disappoint investors and, by extension, result in negative consequences, such as stock trading and price declines (Chazi et al, 2018 ).…”

Are investors' desires for dividend increases stronger than dividend initiation

“…This study finds that IAP can significantly complement the dividend increases decisions and substitute dividend premium for dividend initiation. The results of the study support Li and Lie (2006) and Chazi et al (2018), who fleshed out Baker and Wurgler (2004b). The findings of this study show that the investor's desire towards dividend increases reflects investor sentiment on dividends, explained through the level of information asymmetry between dividend payers and non-payers.…”

“…Based on this criticism, Li and Lie (2006), supported by Ali and Urcan (2012), Tangjitprom (2013), and Kuo et al (2013) includes the manager's decision to increase the dividend, where the results significantly support the dividend catering theory in terms of the decision or the magnitude of the increased dividend. On the other hand, the results of the study of Cooper and Lambertides (2018), Chazi et al (2018) and Neves (2018) support that investor's sentiment towards dividend initiation is a sign that the company has a good prospect in the future. The dividend initiation and dividend increases are two dividend policies that will be used by companies to increase share prices.…”