Payout Policy through the Financial Crisis

Why managers pay dividends remains a puzzle. In our paper, Payout Policy through the Financial Crisis: The Growth of Repurchases and the Resilience of Dividends, which was recently made publicly available on SSRN, we report evidence on the payout policy of US financial and industrial firms over the past 30 years, including through the financial crisis, to shed new light on the why managers pay dividends. There are two specific goals. First, we investigate whether, as would be expected if share repurchases now dominate dividends as a means of paying cash to shareholders, managers used the financial crisis as a convenient excuse to stop paying dividends. Second, we use these data to provide new evidence on whether taxes, and in particular the Tax Relief Act of 2003 (which effectively eliminated the tax disadvantage of dividends) had a first order effect on payout policy.

We find that industrials and financials both increased payouts in the years prior to the crisis, at a pace that was impressive both in absolute terms and relative to earnings. Dividends reach a low point in 2002 but rebound thereafter. Although there is an increase in the fraction of dividend-payers immediately after the Tax Relief Act, we show that this is part of a broader increase in cash payouts that also includes a strong increase in repurchases. In the years after the Tax Relief Act there is no evidence of a shift in the mix of dividends and repurchases towards dividends—if anything, the reverse is true. Nor is there evidence of an increase in dividend payout ratios.

For industrials, dividends have increased steadily over time with payout ratios that are remarkably stable over the last 15 years. Industrials, and especially dividend payers, have increasingly used repurchases to supplement dividends, so that overall payouts (relative to earnings) have increased to levels that are very high by historical standards. This trend fueled the explosive growth of payouts through 2007, when industrials paid out 90% of aggregate earnings. During the crisis industrials cut back repurchases sharply but continued to pay dividends, with payout ratios largely unaffected by the crisis. Dividends and repurchases rebound strongly in 2010. We interpret this as evidence of the resilience of dividends as a payout mechanism.

Findings are similar for financials, although these firms generally exhibit a greater propensity to pay and increase dividends than industrials. Financials also exhibit growth in payouts over the last 15 years that is fueled by increased repurchases, culminating in explosive growth in payouts in the years prior to the crisis. Financials cut back dividends aggressively as the crisis takes hold, although they too evidence a reluctance to cut dividends at the beginning of the crisis, including for the TARP banks.

Overall, our evidence clearly demonstrates the staying power of dividends as well as the strong growth of repurchases. We argue that the resilience of dividends is unlikely to be driven by taxes; we interpret our evidence on payout policy over the last ten years as inconsistent with taxes having a first order effect on payout policy. Instead, it seems more likely that agency or behavioral explanations account for the strong persistence of dividends as a form of payout, and perhaps also for the massive increase in overall payouts.

The full paper is available for download here.