1. Non-Dividend Paying Stocks and the Negative Value Premium George W. Blazenko and Yufen Fu Faculty of Business Administration Simon Fraser University Vancouver, BC, CANADA 2010 NTU Conference on Finance, December, 2010, Taipei, Taiwan. 1

2. Purpose Theoretically and Empirically Investigate the Value Premium for Non-Dividend Paying Firms 2

3. The Value Premium The Value-Premium is a Commonly Reported Negative Relation Between Equity Returns and Market/Book. High Market/Book “Growth” Firms: Low Returns Low Market/Book “Value” Firms: High Returns 3

4. In this Paper Theoretically, we have reason to believe that there is a Negative Value Premium for Non- Dividend Paying Stocks Empirically, we find a Negative Value Premium for Non-Dividend Paying Stocks. 4

5. The Theoretical Model Based on the primary presumption that non- dividend and dividend paying companies are different. 5

6. Primary Theoretical Assumptions 1. Dividend Payment is evidence of: Limits to Growth  Organizational Inertia  Costs of Development and Planning Arrow (1974), Tobin (1969) 2. Non-Dividend Payment is evidence of: Less Restrictive Limits on Growth, but, financing Constraints, e.g., Froot, Scharfstein, and Stein (1993) 6

7. Three State Dynamic Equity Valuation Model 1.Manager suspends growth when profitability (ROE) is below a value maximizing threshold 2.At intermediate profitability (ROE) the manager grows at the maximum rate that profitability will allow, g=ROE, because of financing constraints. 3.At high profitability, limits on organization restrict corporate growth to a maximum rate and only then does the manager pay dividends. 7

8. Expected Return Versus Profitability 8

9. Data COMPUSTAT: Book equity (BVE), reported earnings. BVE=Total Assets – Total Liabilities – Preferred Stock + Deferred Taxes and Investment Tax Credits CRSP: Dividends, Split Factors, Shares Outstanding, Daily Share Prices, Daily Returns. Thomson I/B/E/S: Consensus Analysts’ annual EPS Forecasts. Ken French’s Website: Daily Portfolio Returns and Riskless Rates 9

10. Sample Selection Sample Selection Criteria Firms must have Data available from COMPUSTAT, CRSP, and Thomson I/B/E/S Positive book value of equity (BVE) in the latest reported quarterly financial statements Positive trailing twelve month earnings at the time of portfolio inclusion Zero trailing twelve month dividends at the time of portfolio inclusion. 10

11. FORWARD ROE Calculate Forward ROE on I/B/E/S Statistical Period dates. I/B/E/S reports consensus earnings forecasts on Statistical Period dates (the Thursdays proceeding the third Friday of the month). 11 Median I/B/E/S analysts’ EPS forecasts: EPS1: forecasts for the first unreported fiscal year-end annual EPS EPS2: forecasts for the second unreported fiscal year-end annual EPS EPS3: forecasts for the third unreported fiscal year-end annual EPS ROE calculated with EPS1, EPS2, and EPS3. Test Period ROE1, ROE2: 1/15/1976 to 9/17/2009, 404 months, ROE3: 9/20/1984 to 9/17/2009, 301 months.

12. Portfolio Sorting Portfolio Sorting: 25 portfolios Sort Key: Forward ROE Portfolio Rebalance at each I/B/E/S Statistical Period date 12

13. Realized Portfolio Returns Versus Profitability 13

14. 14

15. Do Investors/Asset Pricing Models Recognize the Negative Value Premium for Non-Dividend Paying Stocks? 15

16. Conditional Fama-French-Carhart Four Factor Model We risk adjust the 25 ROE and Volatility sorted portfolios in the conditional four-factor model Conditional Fama-French-Carhart Four Factor Asset Pricing Model (Fama and French 1992, Carhart 1997, Ferson and Harvey 1999)  Factors: HML, SMB, MOM, Market Premium  Information Variables: Aggregate Dividend Yield, Risk Free Rate k=1,2,...,5, v=1,2,...,5, t =1,2,…. TP 16

17. Conditional Fama-French-Carhart Four Factor Model 17

18. Abnormal Returns Evidence of Non-zero alphas  Under-Pricing of High Risk Stocks (Positive alphas for High Profitability Non-Dividend Paying Growth Stocks)  Over-Pricing of Low Risk Stocks (Negative alphas for Low Profitability Non-Dividend Paying Value Stocks) 18

19. Conclusion Theoretically, we expect a negative Value Premium for Non- Dividend Paying Stocks Empirically, we find a negative Value Premium for Non- Dividend Paying Stocks We Find Evidence of Abnormal Returns: Investors/Asset Pricing Models do not Fully Recognize the Negative Value Premium for Non-Dividend Paying Stocks 19