Does cash dividend unsmoothing influence investors’ behavioral preference in China?
(2.School of Economics and Business Administration, Chongqing University)
【Abstract】Cash dividend unsmoothing is a prominent phenomenon in the Chinese capital market, but so far little empirical evidence has shown that investors have a preference for dividend smoothing and are willing to pay a premium to hold shares in China. In this paper, we addressed this gap by asking whether investors like dividend unsmoothing. In particular, we examined two related questions. First, we asked which types of investors have “driven out” stocks that pay unsmoothing dividends. Second, we explored whether any such investor preference has implications for firms’ cost of equity capital. The first question helps us understand the implications of dividend unsmoothing for the composition of a firm’s equity holders. We found that institutional investors, especially non-independent investors (securities firms, insurance companies, social security funds, enterprise annuities, trust companies and financial companies), are significantly more likely to sell dividend unsmoothing stocks, while individual investors are less likely to do so. This relation was more pronounced before the completion of the Split Share Structure Reform. Our findings have provided evidence that the Split Share Structure Reform was helpful in improving the independence of non-independent institutional investors in the capital markets. These findings are consistent with the findings of recent research by Larkin et al. (2016), suggesting that institutional investors are particularly effective monitors. They are also consistent with the findings of Leary ＆ Michaely (2011) that firms with dividend smoothing are more often those that appear to be most exposed to agency conflicts. Our evidence suggested that dividend unsmoothing “drives out” institutions, but institutional investors do not seem to influence the smoothness of firms’ dividends. To explore the causal effect of dividend unsmoothing on institutional investor composition, we used propensity score matching methods to alleviate the concerns. We found a set of counterfactual control groups to reduce the problem of endogeneity that may lead to a selection bias or a confounding bias in the sample. We examined the consistency of two stock groups and showed the net effect of dividend unsmoothing on investor holdings. Our results supported the observation that dividend unsmoothing influences institutions’ investor holdings. The second question centers on whether the preference for dividend smoothing on independent institutional investors has implications for firms’ cost of equity capital. First, we examined the cumulative abnormal returns around the announcement of a dividend. We found that investors prefer cash dividend unsmoothing stock portfolios to market portfolios containing “miser” and “no rules” stocks, but the level of cash dividend unsmoothing does not significantly affect investors’ short-term wealth. Furthermore, investors holding stock portfolios with low rather than high levels of dividend unsmoothing must pay an additional 4.2% dividend smoothing premium. In addition, we found that cash dividend unsmoothing has a significant influence on investors’ expected returns. Perhaps surprisingly, Larkin et al. (2016) found no discernable relation between a firm’s smoothing dividend policy and its valuation or cost of equity capital. Yet, our findings suggested that dividend smoothing premium exists in the Chinese capital market. To summarize, we found that institutional investors, especially independent investors, show a preference for dividend smoothing stocks. We consistently found evidence that firms can reduce their cost of equity capital by smoothing their dividend streams. In this case, firms that do not value the institutional investor clientele pay unsmoothing dividend to “drive them out,” but this may increase their cost of capital. Our findings also showed that the Split Share Structure Reform in China was helpful in improving the independence of participants in the capital markets. These findings have also provided an important reference for the construction of capital market systems in developing countries.
【Keywords】 dividend unsmoothing; institutional investor; stock portfolio; Split Share Structure Reform; dividend smoothing premium;
. ① Due to space limitations, the report is omitted here, which is available upon request.
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