slide chương 15 tài chính hành vi lucy f ackert richard deaves

– If certain investor groups with particular dividend preferences e.g., those desiring high, low, or no payout exist, and if not enough firms currently satisfy the desires of these inves

Chapter 15: Rational Managers and

Irrational Investors

Powerpoint Slides to accompany Behavioral

Finance: Psychology, Decision-making and Markets

by Lucy F Ackert & Richard Deaves

Mispricing and goals of managers

• Three conflicting goals in presence of potential

mispricing:

1 Maximize rationally-calculated present value of

future cashflows

2 Maximize current share price relative to value.

– This goal can be pursued by undertaking various actions

which “cater” to a range of investor desires unrelated to (rational) value-enhancement

Mispricing and goals of managers cont.

• Examples of catering:

– Investors believe that certain kinds of investment (e.g., in

computer technology in late 90s) creates more value than should really be the case

– If certain investor groups with particular dividend

preferences (e.g., those desiring high, low, or no payout) exist, and if not enough firms currently satisfy the desires

of these investor groups, catering may operate as firms alter their dividend payout in response.

– Miscellaneous discrete actions:

• accounting changes

• earnings management

Mispricing and goals of

managers cont ii.

3 Take advantage of current mispricing so as to

benefit current and holding shareholders.

• Done by issuing stock when it is overvalued

• Doing so benefits current shareholders at expense of

new shareholders

• This can be done to “pay for” hard assets in a merger

• Or buying stock back when it is undervalued

• Doing so benefits holding shareholders at expense of

selling shareholders

Share issues and repurchases:

Evidence

• Evidence exists that firms time purchases and sales of stock.

• Around the world, high issuance activity leads

to low future returns in 12 out of 13 major

markets.

• Using U.S data from 1935-1972, five-year

returns that are below market returns by 21-35% have been documented.

Mergers and acquisitions:

Conventional theory

• It makes sense for even correctly priced firms to

combine when synergies exist, with both firms

sharing in the spoils

• Firm A: Value = $200 million

• Firm B: $100 million

• Firm A+B = $400 million

• A could acquire B paying $150 million

Stock acquisitions using overvalued stock

• Suppose a firm is overvalued by market.

• Further investors perceive that synergies can

be gained form a merger (though in reality

they do not truly exist)

• This can often explain stock acquisitions in

overheated markets.

• This can be true even if all managers (bidder

and firm to be acquired) understand this.

Why would managers of acquired

firms go along?

1 Target managers may have short horizons

– Since they plan to get out before the long run comes, their only

concern is the short run

– Managers who want to sell out (perhaps because they are nearing

retirement) would fit the bill

– Acquisition allows them to cash out overvalued equity

2 Target managers may expect to be paid for their

acquiescence

– In form of acceleration in the exercise of stock options, generous

severance pay, or retaining management positions.

– Same incentive does not exist with cash acquisitions of undervalued assets.

Catering by changing company’s name

• Some companies changed their names to “dotcom” names during internet craze of late 90s

• Sample: 147 firms that changed their names in this fashion from June 1998 to July 1998

• Share prices appreciated after announcement (and often dramatically so) – even when their underlying business had little or nothing to do with internet

• This dotcom effect on average led to average

cumulative excess returns of 74% during a 10-day

announcement window

Dividend policy and perfect markets

• In a world of perfect markets, dividend payout

should be irrelevant

– Required: no taxes, transaction costs and information

asymmetries; hold constant firm’s financing and

investment policy

• Suppose that a firm currently pays out all of its free cashflows in the form of a dividend, but it is now

considering eliminating its payout

• Say investor actually desires 10% cashflow yield that currently comes in form of dividend

Dividend policy and perfect markets cont.

• She could employ process known as “home-made” dividends

• Done by selling off shares in lieu of receiving a cash dividend and using the proceeds to “pay” herself an amount of cash equivalent to the former dividend

• Conversely, if an investor holds a dividend-paying

stock but does not desire cashflow, an automatic

dividend reinvestment program is answer

Dividend policy and perfect

markets cont ii.

• Bottom line: investor “sets” own dividend yield

• But real world is much more complicated than this

• Frictions such as taxes and transaction costs exist

• Because of these frictions managers accommodate the dividend stability that investors seem to desire, and only as a last resort cut dividends

Disappearing dividends

• Researchers, focusing on NYSE, AMEX, and NASDAQ firms from 1972 to 1999, have documented that for much of this period percentage of firms paying

dividends was on decline

– In 1973 52.8% of publicly-traded non-financial non-utility firms paid dividends

– Percentage rose until 1978 by which time it hit 66.5%, before falling to 20.8% by 1999

• Is it because characteristics of firms changed, tilting towards the characteristics that non-payers embody?

Disappearing dividends cont.

• Conclude was that this was about half of explanation for

declining propensity to pay dividends.

• Larger, more profitable firms with fewer investment

opportunities tend to be payers, and it turned out that many

of the newly listed firms were smaller and less profitable with

an array of investment opportunities.

• Many of new listers in 70s tended to quite profitable:

– earnings of new lists averaged 17.8% of book value (vs 13.7% for all firms)

– earnings of new lists during 1993-98 averaged 2.1% (vs 11.3% for all firms)

Is there a behavioral story?

• Catering motive may be best explanation

• Evidence is based on time-variation in so-called

dividend premium

• One way in which this premium can be proxied is by difference between average market-to-book ratio of dividend-payers and nonpayers

• Then investigate whether dividend initiations and

omissions are related to time-variation in this

premium

Dividend premium and initiations

• When dividend premium rises, reflecting

increased investor preference for dividends, initiations tend to subsequently rise.

• On the other hand, when dividend premium falls, reflecting decreased investor preference for dividends, initiations tend to subsequently fall.

Four distinct payout periods

• Going back in time there are four distinct trends:

1 Increasing trend in the mid 1960s

2 Decline falling into negative territory through 1969

3 Positive trend in 1970 staying in positive territory till 1977

4 Well-known “disappearing dividends” period after that

• Each of these trends lines up with a corresponding

fluctuation in dividend premium