Amy Dittmar and Robert Dittmar
Stock Repurchases Are Replacing Dividends
Firms are using stock repurchases more than dividends as a means to pay out permanent corporate earnings.
ANN ARBOR, Mich. Stock repurchases are replacing dividends as the dominant form of corporate earnings distribution, say University of Michigan business researchers.
A new study by Amy Dittmar and Robert Dittmar of the Stephen M. Ross School of Business at the University of Michigan shows that the fraction of earnings paid out in dividends decreased steadily over the course of the 1990s, declining from its peak of 55.6 percent in 1991 to a low of 26.3 percent in 1999.
During that same time period, the share of public firms paying dividends reached an all-time low of 24 percent. In 1997, the dollar value of stock repurchases surpassed that of dividends paid for the first time.
Traditionally, dividends are thought to be the mechanism firms use to distribute permanent earnings. The findings show, however, that repurchases are now an alternative mechanism that firms may use to distribute earnings more traditionally thought to be the source of dividend payments.
In their study of domestic firms, the researchers examined the source of earnings that drives the two types of distribution. They found that the primary driver of dividends and repurchases is the same: changes in permanent earnings.
"Both dividends and repurchases are used by firms as a means to distribute permanent earnings, and, therefore, these are potential substitutes," said Amy Dittmar, assistant professor of finance. "Although firms also use repurchases to distribute temporary earnings, dividends are not used for temporary earnings distribution. This redefines the way we think about corporate payouts."
Using a timeline, the researchers show that the sensitivity of the change in dividend payments to a change in permanent earnings decreased significantly with the onset of stock repurchases. They examined the period before and after 1977, which was the first year in which a firm engaged in a major stock repurchase program.
They report that the pre-1977 sensitivity of dividend growth to permanent-earnings growth was more than four times higher than the implied post-1977 sensitivity, indicating this point marked a significant shift in the payout policy of permanent earnings. This implies that if a firm has $1 of additional earnings to pay out, it will only increase dividends by $0.25.
The researchers say the slack in dividend payments after the 1977 payout policy shift was taken up by repurchases. They determine this by analyzing the difference between the dividends that firms would have paid, based on the pre-1977 estimates, and the dividends that companies actually paid.
Their findings suggest that the difference between predicted and paid dividends is accounted for by the portion of repurchases used to pay permanent earnings. These results further confirm that repurchases are replacing dividends as the predominant form of corporate payouts, the researchers say.
"This evidence documents a dramatic change in aggregate payout policy and requires us to rethink our definition of future expected firm distributions," Robert Dittmar said.
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