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Essay: Is the Lintner model applicable in defining the speed of adjustment of Dutch listed companies?

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Every enterprise will sooner or later be faced with the spending decision regarding their payout policy. The implementation of this decision can be executed in roughly two ways. First of all, through payment of dividend to the shareholder. Until approximately 1990 this method prevailed. However, the last 20 something years another method is gaining popularity, namely the purchase of own shares. Despite the fact both methods pursue a similar goal, freeing up cash for the shareholder, there are large differences in the arguments for the use of both payout options.
For example, buyback of shares gives a tax advantage for the existing shareholder. The added value of the repurchases will not be taxed. With dividend payments this advantage disappears, making this method less attractive for investors. Thereby, repurchases can also be used for the execution of a defensive strategy. In this way, you raise the internal control within the corporation. A hostile take-over will be more difficult (Bozanic 2010). In line with the rise of dividends paid, the announcement of a possible buyback of shares will give a positive signal, implying the shares outstanding are considered to be undervalued (Dobbs & Rehm 2005).
In the Netherlands, there are multiple companies using buyback of shares on a frequent level. For example Philips NV, they bought in 22 million shares over the past period from October 2013 until October 2014 with a total value of EUR 533 million. The purchase is part of a program worth EUR 1.5 billion for a total period of two or three years (FD.nl).
On the other hand, dividend policy drives on some advantages as well. First of all, dividend policy can control agency costs. Dividend payouts often subject an enterprise to the market, reflecting increasingly control. In this way, dividend payments are a ‘free’ way of supervision for the corporation. As mentioned above, dividend payments follow the signaling theory. The basic concept of the idea implies the manager has excess to nonpublic information according the future earnings or losses of the company. In this way, the amount of dividend reflects a signal regarding possible profits. (De Haan 1995).
The dividend policy of an enterprise can be divided into two different dimensions. First of all, the decision on the amount of the dividend, the desired pay-out ratio and second of all the speed at which dividends may be adjusted if this desired pay-out ratio changes.
An important dimension of dividend policy contains the adaptive behavior of dividend paid. Previous research showed Dutch companies handle a stable dividend policy. This reflects in the fact that the actual dividend is only gradually adjusted as the desired pay-out level changes. In this type of study, several theories are relevant. For instance the signaling theory and the pecking order theory.
1.1 Research question
The question arises whether Dutch companies use the same velocity for both the increase as well as the reduction of their dividend paid. In addition, it becomes clear which theory Dutch companies follow. Therefore, the main research question becomes:
Is the Lintner model applicable in defining the speed of adjustment of Dutch listed companies? (actualization of the article De Haan, equivalent results)
Which of the two theories, Signaling theory and Pecking order theory, are supported by the actual dividend adjustment behavior of Dutch companies?
Is there any influence of stock repurchases on the speed of adjustment?
To answer this main question, a specific sample of listed Dutch companies, excluding financial institutions, is used, consistent with the study of De Haan (1995). This sample contains data from the period 1983 until 1997. The adaptive behavior of dividend will be examined with the aid of the Lintner model. To explore the applicability of the Lintner model nowadays, a new dataset with the period 1980 until 2013 will be build. In this dataset stock repurchases will be factored in. Furthermore the underlying concepts of dividend adjustment policy are explained thoroughly. More information considering the followed data processing and methodology is given in section (X).
1.2 Structure of the paper
In the following section an overview of prior empirical literature is shown. Followed by the expected hypotheses. In chapter (X) a description of the data selection is given. This is followed by chapter (X), where the methodology of the empirical research is explained. In chapter (X) the results are discussed. And finally, in chapter (X) the conclusion with a comparison of the results obtained.
2. Literature study
The payout policy can be divided into the payment of dividends and the purchase of own shares. This chapter is used to explore the motives behind both views.
Uitkeerbare winst afhankelijk van wettelijke bepaling ex Titel 9 Boek 2 BW.
2.1 Dividend payments
2.1.1. Agency Costs
The desired payout ratio differs per company. These differences are a result of market imperfections such as agency problems, asymmetric information, transaction costs and tax effects (De Haan 1995).
Agency problems often arise due to a difference between the interests of managers and shareholders. The manager is interested in the highest possible growth on the short term while the shareholder would like to chase a long-term vision. The company is forced to reconcile these different interests. Such conflicts of interest can be avoided if the managers is controlled, regulated and corrected if necessary.
A company with a relative high percentage of internal shareholders will have lower agency costs as this implies the group of shareholders is more involved in the company. For this group, growth is more important than maintaining a high dividend. The capital interest of the insiders, the Supervisory board and the Management board play an important role in this form of costs. The higher the capital interest of the insider, reflecting the same level of interest of the shareholder, the lower the agency cots (Holder, Langrehr, Hexter, 1998). However, in the case of a majority of external shareholders, a high diversity of interests and preferences is reached. In this case, a higher dividend payment can reduce the agency costs. A company that chooses to pay dividend is subject to the market and therefore under increasing control. In this way, dividend payment can be seen as a free form of supervision. Companies with a large number of shareholders and logically a great diversity in the preferences and interests should therefore pursue regular dividend payments to decrease their agency costs (De Haan 1995).
The relation between the enterprise value and the internal shareholder is established (Jensen and Meckling, 1976). They found a relationship between the amount of shares in the hands of the board and management the difference in interest between the internal and external shareholders is balanced better.
The shareholding value of the major shareholders also has an outstanding influence on the level of agency costs. If this group is relatively small, little agency costs will occur due to small differences in interests. However, an enterprise with a large spread in the outstanding shares will logically make higher costs because there is a higher dispersion of ownership.
Interest expenses also play a major role in the development of the agency costs. The board of an enterprise with high interest charges is less likely to waste the cash flows belonging to the shareholders. In this case, payment of dividend is no longer a requirement for controlling the board. The high interest expenses compel the board to conduct an efficient policy. Following this theory, an enterprise with high interest expenses will prefer low dividend payments.
2.1.2. Asymmetric information
The phenomenon asymmetric information occurs when the shareholder has an incomplete picture of the organization. In this case, occurrence of problems becomes more problematic. Insiders, the board and the directors, have more information than external investors. Within this skewed distribution, an enterprise can react according the signaling theory or the theory of corporate finance. (pikordefinanciering). Both theories will be explained in more detail below.
2.1.2.1. Signaling theory
The signaling theory is based on attracting investors. It assumes the amount of dividend includes information related to future earnings. The basis principle of the theory implies the manager owns non-public information regarding potential profits and losses. The amount of dividend paid reflects the future vision of the enterprise (De Haan, 1995). The way of changing the current dividend policy provides information to outsiders. A dividend increase logically suggests positive future company conditions, releasing a flourishing signal to the market. So in this way, an enterprise with a stable and high dividend policy is seen as a good investment opportunity.
Miller and Modigliani (1961) argue the conduct of dividend policy is irrelevant regarding the market value of the company. Adjustment in the policy do not affect the value of a company under the condition there are no market imperfections. The enterprise pays dividends to the shareholder. In order to finance future projects, the enterprise will issue an equal amount of new shares. This implicates the enterprise value will remain the same. The value of the dividends paid are erased by the decline in value the shares outstanding. Black and Scholes (1974) substantiate the theory of Miller and Modigliani. They find no empirical evidence the level of dividend effects future earnings. Black and Scholes examined the relationship between dividend proceeds and equity profits. No significant relationship is observed. Brennan (1970) showed higher dividends paid resulted in a lower share price. Two explanations can be followed. First of all, capital gains are often lower taxed than dividends paid. Secondly, mostly you should pay tax on profits made on shares if these are sold. So, these two tax benefits make it more attractive for the investor to increase the enterprise value. This advantage is not applicable anymore in the Netherlands as a new tax system, introduced in 2001, equally taxes dividends and capital gains.
Bhattacharya (1979) examines the information signaling theory for the first time. Miller and Rock (1985), John (1985) and John and Lang (1991) enhanced this philosophy. An increase in the dividend will result in a signal the company will have a bright future. Obviously a reduction of the dividend will give rise to a signal of bad news. A high dividend payment will reduce the uncertainty. You would rather obtain a high benefit today than a uncertain capital gain in the future.
Li en Lie (2005) introduce the size effect. The large and more profitable companies are more likely to increase their dividends. The dividend yield, debt ratio, cash ratio and the market to book value of the previous years were of influence as well. This raise in dividends can be explained by the fact that board members anticipate to the needs of their shareholders and investors, in other words, dividend catering. They found remarkable evidence a lower shares price could be the result of ignoring such requests. However, the findings of Li en Lie must be nuanced. Balanchandran a.o. (2012) established not only profitability determines the raise of dividend policy. Enterprises give priority to other needs before they choose to pay dividend. In principle, companies prefer to maintain their current level of dividends paid. A rise in this policy will only be considered after all investments and liquidity needs are met.
A dividend reduction implies a strong negative signal to the market. Logically, Brav a.o. (2005) find evidence managers are not eager to decline their dividend policy. Over more than 80% of the respondent directors were convinced changes in dividend policy will reveal information to external parties. Thereby, the information force of a decreasing signal is stronger than the upward variant. As the reduction becomes greater, the negative signal becomes stronger. The timing of the reduction also has great impact. A sudden degradation during the book year is often seen as a last resort rather than an informed decision. So, the overall conclusion the higher and more unexpected the decision, the stronger the market reaction, can be made. The same movements were seen by Allen en Michaely (2003). They found asymmetric reactions to dividend movements as decreases release more information to the market. This asymmetric release is explained because reductions are unusual and more rare. Therefore, their impact is greater.
2.1.2.2. Finance theory
In this theory, an enterprise is more keen on using internal finance. External finance is seen as a last resort to minimize dependence on external capital providers. Internal financing can include retained earnings or the use of reserves. The reason to chose internal financing might be related to the prevailing tax system. So, it may be the case profits taxed on capital are more beneficial. However, in the Netherlands, were dividends and tax are equally taxed this does not apply (HR 2002).
The larger companies often apply a high pay-out rate of dividend. They have easy access to the capital markets and are therefore barely assigned to internal financing (Holder, Langrehr, Hexter 1998). A bigger size enterprise is often is possession of a strong liquidity position, partly due to the easy access to the capital markets and the overall credit position. This conclusion was enhanced by Farma & Franch (2001) and Adjaoud & Ben-Amar (2010). Banks have a higher willingness to issue loans at a large and well-known company. So, a better liquidity position allows a payment of dividend. The availability of the possible sources of capital is dependent on the characteristics of the Dutch market. (Glen and Karmokolias, et al, 1997).
The effect of the finance theory can be observed through the realized and expected revenue growth. Research by Rozeff (1982) showed relatively high growth companies have a substantial need for financing. They will therefore mainly apply internal financing in order to realize their growth. So, the desired pay-out ratio are relatively low in order to realize a sustainable growth.
The theory applies exclusively to the higher developed countries, including the Netherlands. Developing countries show a considerable lower dividend payment, about only two third of the amount of a developed country. Implying internal financing is of great importance. Developing countries are unable to cover the payment of dividend with purely internal financing. So, such countries have a great demand for external financing.
2.1.3. Transaction costs
There are additional costs at external financing, the so-called emission costs. For example, transaction and issuance costs arising at the share emission. To meet this extra expense, the enterprise needs to attract more external funding. Several studies show mainly risky enterprises, like a relatively small company with price sensitive stocks, is facing high emission costs (Holder, Langrehr, Hexter 1998).
2.1.4. Taxes and institutional constraints
Evert country uses a different tax system. If there is a difference between the taxation of dividend income and the taxation of capital gains on shares. In the prior Dutch tax system dividends were heavier taxed which led to a tax-clientele effect (Haan 1995). Investors in a low tax rate will invest primarily in companies with high dividend payments. Conversely, investors in high tax rates are automatically more interested in companies wit low dividends. However, since the new tax system in 2001, dividend payments are taxed in a similar way. The tax effect is no longer relevant at this day.
The chosen accounting method is of importance as well. The applied system determines the level of profit (Glen and Karmokolias, et al, 1997). The method of accounting can influence this level tremendously. Thereby, the debt policy may pose restrictions as well.
2.1.5. Industry effect
The industry an enterprise operates can also affect the amount of dividend paid, revealed by Lintner (1956). In addition to company-specific factors, such as investment earnings and volatility of profits, industry factors play a role as well. Lintner saw this industry effect as a so-called dividend leadership. Companies often tend to follow those leading companies. This competitive aspect of the chosen dividend strategy leads to different policies among the industries. Dempsey, Laber and Rozeff (1993) elaborate on Lintner’s study as they try to examine the impact of the industry effect on the desired pay-out ratio. They argue the main company specific characters influence the dividend policy. No specific evidence is founded for Lintner’s research.
Glen, Karmokolias et al. (1997) found a similar conclusion on the industry effect of the dividend policy. A difference between the need for capital and future earnings came to the light. Both factors are of great importance for the determination of the dividend. Besides, a significant difference was found between the dividend pay-out ratios among various industries. The automotive sector shows the strongest differ. Another conclusion of their study covered the consensus of the chosen policy. It showed, enterprises do not always follow a similar strategy. But quite often an enterprise, prior to the determination of their own dividend policy, observed the policy of competing firms. Thereby, to a large extent the need of capital was decisive for the dividend policy. A general conclusion however was difficult to make.
There is a small link discovered between the stability of the market and the level of benefits. Companies that are in a stable fixed market are more willing to pay a higher dividend. Companies tend to hold in their dividend payments in a volatile market.
2.2 Repurchases
The last decade, the purchase of own shares has increased in popularity at the expense of dividend payments (Fama & French 2001 and Skinner 2008). Such a share buyback program often indicates the inside management believes the outstanding shares are undervalued.

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