1. REAL-WORLD FACTORS FAVORING A HIGH-DIVIDEND POLICY
THE CLIENTELE EFFECT: A RESOLUTION OF REAL-WORLD FACTORS?

2. REAL-WORLD FACTORS FAVORING A HIGH-DIVIDEND POLICY
AN INTRODUCTION
Dividend: - Distribution of firm’s income to shareholders.
Dividend Policy: - Determine the value of the firms as dividend
increases or decreases.
- Trade-off between retained earning and distributing
cash to shareholders.
Dividend Structure: - Communicate to market participants
- Send signals about the prospect of the firm

3. REAL-WORLD FACTORS FAVORING A HIGH-DIVIDEND POLICY
Firms pay high-dividend
even in the presence of personal taxes on these dividends
WHY?
Consider 4 factors favoring a high-dividend policy

4. 1st factor DESIRE FOR CURRENT INCOME
Who: Retired people and individual living on fixed income.
They would bid up the stock price if dividend increase and bid down the stock price should dividends decline.
This argument does not hold in M & M theoretical model that dividend irrelevancy rest on the following assumption.
No Tax
No Transaction Cost
No Issuance Cost
Existence on Fixed Investment Policy
Real-world: Current income argument is relevant and stock sales involve
Brokerage fees
Other transaction cost
Time consuming

5. 2nd factor BEHAVIORAL FINANCE
Behaviorism in psychology theory – human behavior is learnt by adapting outside condition
“The self is not something ready-made but something in continuous formation through choices of action” – John Dewey.
Basic idea is ‘Self-Control’ – Investor must deal with it and decide on.
Better return
Or other investment instruments
Always set personal rules like, never “dipping into principle”
Behaviorists do not think that everyone has the same concept or idea
This explain why firm pay dividend even in the presence of taxes.

6. 3rd factor AGENCY COST Involves 3 parties: Bondholders Stockholders
Management
They form mutually beneficial reason and gain at the other’s expense.
Potential conflict – bondholders and stockholders
Bondholders want higher cash retained so it could be available to pay them during financial distress
Make loan agreement to protect themselves on dividend payout
DeAngelo and DeAngelo – firms in financial distress are reluctant to cut dividends.
Potential conflict – Managers and stockholders
Managers with selfish goal at the expense of stockholders
Take on projects with negative NPVs or not work hard

7. 3rd factor (continued)
Several Scholars: Dividend to reduce agency cost
Dividend payout equal to the amount of ‘surplus’ cash flow can reduce management ability to squander firm’s resources
This factor is not an argument to for dividends over repurchases .
Agency cost imply firms may increase dividend or share repurchases over hoarding large sum of cash.

8. 4rd factor INFORMATION CONTENT AND DIVIDEND SIGNALING
Information Content Effects
Stock price rise when dividend increase
The rise of stock prices following dividend increase is called ‘Information Content Effects
Stockholders increases their expectation on future earning and cash flow
Genting Malaysia Berhad (GENM) – Stock price rise 16% after dividend announcement with total dividend of 7% as compare to 6.48% in previous year. Stock price rises gradually from RM2.50 to RM2.90.
Tradewinds (M) Bhd (TWS) – Stock price fall 4.6% when the total dividend decline from 23% in previous year to 20% this year. The stock price fall gradually from RM3.02 to RM2.88.

9. 4rd factor (Continued) INFORMATION CONTENT AND DIVIDEND SIGNALING
Dividend increases send good news and vice versa
Signal about the financial state of the firms
Management could increase dividend to show high cash flow even they know that the cash flow remain the same.
This would hurt the stock prices if the market participant knew about it.
Equation: Cash Flow = Capital Expenditure + Dividends

10. 4rd factor (Continued) INFORMATION CONTENT AND DIVIDEND SIGNALING
Suppose firm announces current dividend will be 30 million and market believes that capital expenditures are 70 million, the market would then determine cash flow to be 100 million.
Cash Flow =
Capital Expenditure +
Dividends
100 70 30

11. 4rd factor (Continued) INFORMATION CONTENT AND DIVIDEND SIGNALING 100
Assume the firm makes changes where dividend will be 40 million and the cash flow remain the same thus implying capital expenditures of 60 million.
Cash Flow =
Capital Expenditure +
Dividends
100 70 30
Cash Flow =
Capital Expenditure +
Dividends
100 60 40

12. 4rd factor (Continued) INFORMATION CONTENT AND DIVIDEND SIGNALING 100
Assume the firm makes changes where dividend will be 40 million and the cash flow remain the same thus implying capital expenditures of 60 million. As a result, the increase of dividend would hurt stock price because the increase of dividend is obtained by a reduction in capital expenditures.
Cash Flow =
Capital Expenditure +
Dividends
100 70 30
Cash Flow =
Capital Expenditure +
Dividends
100 60 40

13. 4rd factor (Continued) INFORMATION CONTENT AND DIVIDEND SIGNALING 100
On the other hand, assume that the capital expenditures remain at 70 million as well as dividend at 40 million thus implying cash flow to be 110 million. As a result, market will learn that cash flow has increase and the stock price would likely rise. Stock prices usually increase with cash flow.
Cash Flow =
Capital Expenditure +
Dividends
100 60 40
Cash Flow =
Capital Expenditure +
Dividends
110 70 40

14. 4rd factor (Continued) INFORMATION CONTENT AND DIVIDEND SIGNALING
Most academic model implies that dividend and share repurchases are perfect substitutes.
In these models, managers will consider to reduce capital expenditure to increase either dividend or share repurchases.
In conclusion, firms pay higher dividends would send good signal about good financial prospect in the future and so vice versa.
This indicates that investors prefer dividends to capital gains.

15. THE CLIENTELE EFFECT: A RESOLUTION OF REAL-WORLD FACTOR
Personal taxes favors a low-dividend policy
whereas other factors favor high-dividend
HOW?
Consider group of tax brackets
favoring low and high-dividend policy

16. THE CLIENTELE EFFECT: A RESOLUTION OF REAL-WORLD FACTOR
Different group of people prefer different dividend payout policies
There are two categories of tax bracket individuals apart from tax-free institution and corporation
Low Tax Bracket
High Tax Bracket
Retired person, pension funds and university lecturers generally prefers cash income – much better-off if they receive higher payout from earning
Individual who do not need current income or individual in high tax bracket may prefer for capital gain for tax reason.
Individual who need current income might sell some or all shares to obtain cash and thus selling pressure may result drop of stock prices.

17. THE CLIENTELE EFFECT: A RESOLUTION OF REAL-WORLD FACTOR (continued)
A study made by John Graham and Alok Kumar disclose that
Relative to low-income investor, high-income investor put a greater percentage of their asset into low-dividend securities
Relative to low-income investor, high-income investor put a smaller percentage of their assets into high-dividend securities.
In conclusion
Clienteles are likely follow from the fact that tax bracket vary across investors.
Suggest that there is also clienteles effect on stock prices.
Further, clienteles effect on desire for current income.

18. THANK YOU