Managerial Finance

Dividend policy and corporate valuation

Richard Hauser, John H. Thornton Jr,
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Dividend
Dividend policy and policy and
corporate valuation corporate
valuation
Richard Hauser
Department of Finance, Gannon University, Erie, Pennsylvania, USA, and
663
John H. Thornton Jr
College of Business, Kent State University, Kent, Ohio, USA Received 27 May 2015
Revised 15 February 2017
Accepted 6 March 2017
Abstract
Purpose – The purpose of this paper is to investigate an empirical solution to dividend policy relevance.
Design/methodology/approach – The paper combines measures of firm maturity in a logit regression to
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define a comprehensive life-cycle model of the likelihood of dividend payment. The valuation of firms that
conform to the model is compared to the valuation of firms that do not fit the model. Valuation is measured by
the market to book (M/B) ratio.
Findings – The analysis indicates that dividend policy is related to firm value. Dividend-paying firms that fit
the life-cycle model have a higher median valuation than dividend-paying firms that do not fit the life-cycle
model. Similarly, non-paying firms that fit the life-cycle model have a higher median valuation than
non-paying firms that do not fit the life-cycle model. The results also provide evidence that the disappearing
dividend phenomenon is related to shifts in valuation.
Research limitations/implications – This paper focuses on the payment of dividends. Stock repurchases
are not considered.
Practical implications – The results indicate that dividend policy is related to firm value. Approximately
15 percent of sample observations have a dividend policy counter to the life-cycle model.
Originality/value – This paper shows that the relation between a firm’s M/B ratio and dividend policy
changes over the firm’s life-cycle. It also shows that the catering motive for dividends is strongest among
firms that are outliers in the life-cycle model and firms of intermediate maturity.
Keywords Dividends, Valuations
Paper type Research paper

1. Introduction
Miller and Modigliani (1961) show that in a perfect world dividend policy has no effect on
firm value. Their study is important for establishing a base for further analysis, but we do
not live in a perfect world. Somewhat closer to the real world, Black (1976) argues that since
dividends are tax disadvantaged when compared to stock repurchases dividends should
have a negative effect on firm value. To Black, the prevalence of dividend-paying firms is a
“puzzle.” Although the percentage of public firms that pay dividends has declined since
Black’s time a substantial number of firms continue to pay dividends (Fama and
French, 2001). Why? Although several theories, based on various real world imperfections
such as agency problems or information asymmetry, have been advanced to explain Black’s
puzzle, the puzzle has not been fully solved.
In this paper we approach the problem from a different angle. We ask the question: does
dividend policy matter to firm value? Surprisingly, we find little research into the economic
significance of dividend policy[1]. We fill the gap by investigating the relation between
dividend payment and firm value as the firm matures over its life-cycle.
That a firm’s life-cycle stage should be related to dividend policy was proposed by Grullon
et al. (2002). Their argument is that the initiation of dividends signals to the market a firm’s
transition from a high growth phase to a lower growth phase. DeAngelo et al. (2006) further
this idea by asserting that the life-cycle explanation for dividends relies on the trade-off Managerial Finance
between the costs and benefits of earnings retention. This implies that firms should select a Vol. 43 No. 6, 2017
pp. 663-678
dividend policy that maximizes the value of the firm, and that the nature of the trade-off © Emerald Publishing Limited
0307-4358
should change as firms mature. DOI 10.1108/MF-05-2015-0157
 MF We test this idea by developing an empirical model of the likelihood of a firm paying a
43,6 dividend. We include in the model variables that prior studies have proposed to measure a
firm’s maturity. We refer to this model as the “life-cycle model.” Our premise is that firms
that fit the life-cycle model are correctly balancing the costs of earnings retention and the
costs of earnings distribution while firms that do not fit the life-cycle model fail to correctly
trade-off these costs. We consider firms with dividend policies contrary to the life-cycle
664 model predictions to be “outliers.” By examining the relative valuation of firms that do and
do not fit the life-cycle model we are able to study of the fundamental question: does
dividend policy matter?
Similar to Baker and Wurgler (2004a, b), we use the market to book (M/B) ratio as
defined by Fama and French (2001) as our measure of firm value. The M/B ratio is a proxy
for Tobin’s Q. We note, however, that there are other interpretations of the M/B ratio.
Most notably it is often used as a proxy for investment opportunities (Baker and
Wurgler, 2004b). Moreover, Dybvig and Warachka (2015) show that maximizing Tobin’s Q
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does not maximize firm value. The reader should keep these caveats in mind while
interpreting our results.
Our results show that relation between dividend policy and firm valuation, measured by
M/B, is connected to firm maturity. The valuation of firms that follow the life-cycle model is
higher than the valuation of firms that do not follow the model. Firms that pay dividends,
but are not mature enough to be consistent dividend payers, have lower valuations than
dividend payers that fit the life-cycle model. Meanwhile, non-paying firms that are mature
enough to be consistent dividend payers have lower valuations than non-payers that fit the
life-cycle model. We conclude that dividend policy does matter to firm valuation.
We also provide insight in the “disappearing dividends” phenomena (Fama and French,
2001) by analyzing the valuation of firms that do not follow the life-cycle model’s prediction
for dividend policy. Consistent with prior studies, we identify a dramatic increase in
non-payers that should pay dividends in the latter part of our sample period. This increase
in non-payers that should pay coincides with a decrease in the M/B discounts suffered by
these non-paying outliers.
In pooled logit regressions in the outlier sample and in a sample of firms with
intermediate maturity, we find that the propensity to pay dividends is positively related to a
time-varying M/B premium. Our M/B premium variable is similar to the “dividend
premium” variable of Baker and Wurgler (2004a, b). Interestingly the dividend premium
relation in the outlier and intermediate maturity samples is robust to the inclusion a risk
measure. This is in contrast to the findings in Hoberg and Prabhala (2009) who find that the
Baker and Wurgler (2004a, b) catering variable loses significance when a risk measure is
included in the specification. We conclude that the Baker and Wurgler (2004a, b) catering
incentives are strongest among firms that are outliers in the life-cycle model and among
firms of intermediate maturity.

2. Literature review and hypotheses

2.1 Life-cycle hypothesis
One of the most comprehensive explanations for corporate dividend policy is the maturity or
life-cycle hypothesis. In their empirical investigation defining the characteristics of dividend
payers, Fama and French (2001) discuss the impact of new listings on the population of
firms. Although they imply a firm life-cycle with the discussion of new listings not having
the characteristics of dividend payers, Fama and French (2001) do not discuss or test
life-cycle variables. Grullon et al. (2002) formalize the discussion of the maturity hypothesis
and dividend policy. Grullon et al. (2002) suggest that dividends convey information about
changes in a firm’s life-cycle[2]. They postulate that changes in dividends indicate a firm’s
transition from a high growth phase to a mature phase.
 DeAngelo and DeAngelo (2007) and DeAngelo et al. (2009) summarize the life-cycle model Dividend
as a foundation for dividend payout policy. In the life-cycle model, an optimum dividend policy and
policy is achieved when firms trade-off flotation costs and other retention costs against the corporate
agency costs of free cash flow. They point out that the trade-off evolves over a firm’s
life-cycle. In the early stages, firms have ample growth projects and relatively less ability to valuation
generate sufficient funds internally, so they avoid dividend payouts. In their mature phase,
firms pay cash dividends since they generate sufficient internal funds as the investment 665
opportunities decline. Distributions in the form of dividends and stock repurchases are
important in the mature phase of the life-cycle because firms would face substantial agency
costs of free cash flow if cash accumulated internally.
Empirical studies find support for the life-cycle model using several proxies for firm
maturity. Julio and Ikenberry (2004) and Bulan et al. (2007) use firm age as a maturity proxy.
DeAngelo et al. (2006) argue that the earned capital ratio is a good proxy for firm maturity,
and report that a firm’s propensity to pay dividends is significantly related to the earned
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capital ratio. Despite the significance of the earned capital ratio to the probability of paying
dividends, DeAngelo et al. (2006) are unable to define a specific earned capital ratio or
life-cycle stage where a firm should pay a dividend. Hoberg and Prabhala (2009) regard risk
as a proxy for firm maturity and show that the firm’s probability of paying a dividend is
greater when the risk is lower. Thus, the prior literature contains several measures for firm
maturity-age, earned capital ratio, and risk.
Studies also find support for the life-cycle in international samples. In a cross-section of
international markets Denis and Osobov (2008) find that the propensity to pay dividends is
positively related to the ratio of retained earnings to total shareholders’ equity, a measure of
firm maturity. Wang et al. (2011) essentially duplicate the DeAngelo et al. (2006) results for firms
listed on the Taiwan Stock Exchange and find that more-mature firms have a higher
propensity to pay cash dividends. Two other studies of international dividend policy actually
test the propensity to pay dividends using the earned capital ratio and risk as determinants, but
the focus of their research lies outside the maturity hypothesis and valuation. Ferris et al. (2009)
investigate the propensity to pay across common law and civil law countries and find that the
global decline in the propensity to pay dividends is more pronounced in firms incorporated in
common law jurisdictions. Likewise, Twu (2010) investigates the probability of paying
dividends with firms in 34 countries and reports that prior dividend payers are more sensitive
to the earned capital ratio while non-payers are more sensitive to risk.

2.2 Dividends and valuation

Baker and Wurgler (2004a, b) develop a catering theory and utilize the M/B ratio for the
valuation of firms. Although Julio and Ikenberry (2004) and Hoberg and Prabhala (2009)
question the catering theory, Baker and Wurgler (2004a, b) present empirical data that
indicate that non-paying firms have higher equal weighted and value-weighted M/B ratios
than dividend-paying firms. DeAngelo et al. (2006) also report that non-paying firms have a
higher median M/B than dividend-paying firms. We closely follow Baker and Wurgler’s
(2004a, b) approach to analyze the valuation of firms.
Most of the literature relating dividend payout policy to firm value comes from asset pricing
research. Black and Scholes (1974) add a dividend yield term to an empirical version of the
CAPM and report that the dividend yield has no impact on the required return. Litzenberger
and Ramaswamy (1982) report that stocks with higher dividend yields have higher required
returns. Similarly, Naranjo et al. (1998) investigate returns as a function of the Fama and French
(1992) factors and a dividend yield term and also find that higher dividend yields have higher
required returns (and consequently lower firm value). These prior studies tend to either support
the proposition that dividends are irrelevant to firm value or that investors should not want
dividends, but these studies do not explicitly examine dividend policy.
 MF 2.3 Hypotheses
43,6 The overall theme of our study is that, consistent with previous studies, dividend policy
is related to firm value (Baker and Wurgler, 2004a, b; DeAngelo et al., 2006). Stated formally
the hypothesis is:
H1. Dividend policy is related to firm value.

666 The main contribution of our study is to examine how dividend policy is related to firm
value at different stages of the firm’s life-cycle. Previous studies find that mature firms have
a higher propensity to pay dividends (e.g. Julio and Ikenberry, 2004; DeAngelo et al., 2006;
Bulan et al., 2007). The life-cycle model sketched in DeAngelo and DeAngelo (2007) and
DeAngelo et al. (2009) points out the optimum dividend policy should evolve over the
life-cycle. Immature firms retain cash to fund growth projects. Mature firms generate more
cash than is needed for investment opportunities and should optimally distribute cash to
shareholders. This reasoning lead to:
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H1a. Mature firms that pay a dividend have higher valuation than mature firms that do
not pay a dividend.
H1b. Immature firms that do not pay a dividend have higher valuation than immature
firms that do pay a dividend.
Fama and French (2001) identify a disappearing dividend phenomenon. The propensity to pay
dividends has declined over time. Baker and Wurgler (2004a, b) identify a time-varying
premium that investors award to dividend-paying firms. In our study we investigate whether
the disappearing dividend phenomenon is related to the time-varying premium. We conjecture
that the decline in the propensity to pay dividends is mostly likely concentrated in firms that
follow a dividend policy that is not consistent with their life-cycle stage. This leads to:
H2. The disappearing dividend phenomenon is related to changes in the premium or
discount incurred by firms that follow a dividend policy that is inappropriate for the
firms’ life-cycle stage.

3. Sample and variables

Our sample comes from the merged CRSP and Compustat file during the period 1982-2010[3].
Similar to prior dividend studies we exclude financial firms and utilities (SIC codes in the
intervals of 4900-4949 and 6000-6999). We also eliminate ADRs, closed-end funds, ETFs, and
real estate investment trusts. To be included in the sample, a firm must have non-missing
annual data values for dividends and financials from Compustat, as well as return data from
CRSP. Following DeAngelo et al. (2006), we delete firms with negative total equity.
Our empirical strategy is to develop a “life-cycle” model of dividend payment. We then
compare the valuation of firms with a dividend policy that is consistent with the model to
the valuation of outliers, firms with inconsistent dividend policies.

3.1 The life-cycle model

The life-cycle model is a logit model predicting the likelihood of a firm paying a dividend.
We base our model on the “propensity to pay a dividend” academic literature. In the model,
the dependent variable in year t is a dummy variable that is assigned a value of 1 if the firm
paid a dividend in the year and 0 otherwise.
For the model we need to measure firm maturity. We select three maturity measures
from prior literature – the natural logarithm of firm age ( Julio and Ikenberry, 2004),
the retained earnings to total equity (RE/TE) ratio (DeAngelo et al., 2006), and risk,
measured by the standard deviation of monthly stock returns (Hoberg and Prabhala, 2009;
 Ferris et al., 2009). Details about the construction of these and other variables are in Table I. Dividend
Although these three variables have been used in prior studies as proxies for maturity, policy and
we believe they capture different aspects of firm maturity. In Table II, we provide support for corporate
this belief by showing that the correlations between the maturity variables are rather low.
In addition to the proxies for maturity we include a comprehensive set of control variables valuation
drawn from the dividend literature (Fama and French, 2001; DeAngelo et al., 2006; Hoberg and
Prabhala, 2009). The variables are profitability, measured by ROA; growth opportunities, 667
proxied by the sales growth rate; size, measured by the NYSE market capitalization percentile;
leverage, measured by the total equity to total assets ratio; and the cash to total assets ratio.
A firm’s economic sector should affect dividend policy as the firm’s growth potential is related
to the overall industry. To control for the economic sector, we assign each observation with a
dummy variable representing the S&P economic sectors listed in Compustat.
For most of our reported results we follow the dividend life-cycle literature and estimate
our model using the Fama and MacBeth (1973) statistical methodology. We run separate
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Variable Definition

Age Time in years that the firm entity (Permno) has had price data available in the CRSP
database
SD of returns The standard deviation of monthly returns for the year
RE/TE Ratio of retained earnings to total shareholders’ equity
RE/TA Ratio of retained earnings to total assets
NYSE percentile The percentile ranking of firm’s market equity. NYSE market equity capitalization
percentile breakpoints provided at Dr Kenneth R. French’s website, http://mba.tuck.
dartmouth.edu/pages/faculty/ken.french/data_library.html
Sales growth rate Sales growth rate, which equals (sales t/(sales t−1))−1
ROA Return on assets in current year t
ROE Return on equity in current year t
CA/TA Cash to total asset ratio
TE/TA Total equity to total asset ratio
M/B Book value of assets minus book value of equity plus market equity all divided by
book assets. Where, market equity ¼ year closing price times shares outstanding
and book equity ¼ stockholders equity minus preferred stock plus balance sheet
deferred taxes and investment tax credit minus post retirement asset. If
stockholder’s equity is not available, it is replaced by either common equity plus
preferred stock par value or assets minus liabilities. Preferred stock is preferred
stock liquidating value or preferred stock redemption
Meaningful share A firm observation that effected a net reduction in shares outstanding by 1% or
repurchases more in year t compared to the previous year t−1
Materials Dummy variable assigned a value of 1 if the firm is included in the materials
economic sector as defined by Standard and Poor’s, and 0 otherwise
Consumer Dummy variable assigned a value of 1 if the firm is included in the consumer
discretionary discretionary economic sector as defined by Standard and Poor’s, and 0 otherwise
Consumer staple Dummy variable assigned a value of 1 if the firm is included in the consumer staples
economic sector as defined by Standard and Poor’s, and 0 otherwise
Healthcare Dummy variable assigned a value of 1 if the firm is included in the healthcare
economic sector as defined by Standard and Poor’s, and 0 otherwise
Energy Dummy variable assigned a value of 1 if the firm is included in the energy economic
sector as defined by Standard and Poor’s, and 0 otherwise
Technology Dummy variable assigned a value of 1 if the firm is included in the industrials
economic sector as defined by Standard and Poor’s, and 0 otherwise
Telecom Dummy variable assigned a value of i if the firm is included in the
telecommunication services economic sector as defined by Standard and Poor’s, and
0 otherwise Table I.
Valuation premium Difference in median M/B ratios Variable definitions
 MF logit regressions for each of the 29 sample years (1982-2010) to obtain a time series of
43,6 coefficients. The coefficients that we report are the mean value from the 29 regressions.
The t-statistics for the coefficients are based on the hypothesis that the expected coefficient
is 0. We also estimated the model using a random effects panel logistic regression with
year fixed effects. Results using this model are qualitatively similar to the reported results.
To conserve space we do not report those results.
668
4. Results
In Table III, we report the results of the logit analysis. Models 1-3 include a single maturity
variable, while Model 4 includes all of the maturity variables. Each maturity variable is
statistically significant at the 1 percent level. Consistent with prior studies RE/TE and
Ln (age) are positively related to the probability of paying a dividend and the standard
deviation of monthly returns is negatively related to the probability of paying a dividend.
Also consistent with the prior literature, size and profitability are positively related to the
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probability that a firm pays a dividend, while growth potential (as measured by sales
growth rate) is negatively related to the probability that a firm pays a dividend.
In Model 4, with all three measures of maturity incorporated in the model, we note that
each measure of maturity is still statistically significant at the 1 percent level, which is
consistent with the low correlations between the maturity variables reported in Table II.
In terms of model fit statistics, Model 4 has a higher pseudo R2 value. We classify a
prediction from the model as correct if the predicted probability is greater than or equal to
0.5 and the firm actually pays a dividend, or if the predicted probability is less than 0.5 and
the firm does not pay a dividend. Based on this definition of a correct prediction, Model 4
correctly predicts the dividend policy of about 84 percent of the observations, which is better
than Models 1-3.
In summary, the logit analysis of the probability of paying dividends indicates that each
individual definition of maturity reported in the prior literature captures a statistically
significant dimension of maturity with the consistent control variables. However, the
combination of all maturity variables in Model 4 provides the best statistical model.
Since Model 4 provides the best statistical fit, we proceed with the analysis of the outliers
from Model 4[4].

4.1 Outlier valuation analysis

We now turn to the fundamental question: does dividend policy matter? To examine this
question we examine the valuation of firms that do and do not fit the life-cycle model.
We follow common practice in the dividend literature and use the M/B ratio as a proxy for
firm value[5].
We start by sorting the observations into dividend payers and non-payers. Next, we sort
each subsample into firms that fit the life-cycle model and firms that do not fit the model – the
outliers. Finally, we compare the median M/B ratio of dividend payers that fit the life-cycle

Variable RE/TE Firm age SD returns Market to book

RE/TE 1.0000
Age 0.0124 (0.00) 1.0000
SD returns −0.0233 (0.00) −0.2608 (0.00) 1.0000
Table II.
Correlation of M/B −0.0118 (0.00) −0.0978 (0.00) 0.1449 (0.00) 1.0000
maturity proxies Notes: This table shows the Pearson correlation coefficients among three proxies for firm maturity
and the market to and valuation, measured by the market to book ratio. Variable definitions are given in Table I. p-values
book ratio are in parentheses
 Variable Model 1 Model 2 Model 3 Model 4
Dividend
policy and
Intercept −1.4107 (−17.16)*** −3.6506 (−29.83)*** 0.7750 (9.48)*** −2.0696 (−20.31)*** corporate
Earned capital,
RE/TE 1.4131 (10.72)*** 0.9007 (8.89)*** valuation
Ln(age) 1.0006 (42.66)*** 0.8134 (29.97)***
Risk, SD returns −13.3187 (−20.36)*** −9.8519 (−20.17)***
Size, NYSE 669
percentile 3.5592 (20.50)*** 3.3579 (20.56)*** 3.3956 (18.48)*** 2.4877 (16.83)***
Sales growth rate,
SGR −1.0889 (−11.12)*** −0.8779 (−9.66)*** −1.1273 (−10.83)*** −0.6976 (−7.50)***
Profitability, ROA 0.0424 (12.68)*** 0.0727 (19.21)*** 0.0630 (17.53)*** 0.0424 (12.18)***
Market to book
ratio, M/B −0.2820 (−10.14)*** −0.2537 (−8.32)*** −0.2959 (−10.08)*** −0.1233 (−5.25)***
Cash to asset ratio,
CA/TA −1.1618 (−14.22)*** −1.4512 (−17.71)*** −1.3418 (−16.12)*** −1.0343 (−11.83)***
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Equity to asset
ratio, TE/TA 0.2422 (2.30)** 0.7580 (6.49)*** 0.3692 (3.68)*** 0.1134 (0.96)
Economic sector
Materials 0.5208 (8.80)*** 0.4829 (7.22)*** 0.4808 (8.82)*** 0.5609 (7.60)***
Consumer
discretionary −0.3986 (−14.75)*** −0.2676 (−9.48)*** −0.3436 (−11.04)*** −0.2291 (−8.59)***
Consumer staples 0.3045 (9.94)*** 0.3767 (13.05)*** 0.2308 (7.17)*** 0.3150 (9.53)***
Healthcare −0.8838 (−18.32)*** −0.9746 (−23.48)*** −1.0129 (−19.14)*** −0.7848 (−14.96)***
Energy −0.5142 (−8.31)*** −0.6590 (−15.32)*** −0.6723 (−12.35)*** −0.3534 (−7.38)***
Technology −1.2627 (−42.13)*** −1.3282 (−53.86)*** −1.1543 (−29.42)*** −1.0310 (−36.84)***
Telecom −0.1319 (−1.99)* −0.0813 (−0.81) −0.5060 (−6.33)*** 0.0788 (0.78)
% correct 82.00 81.51 81.24 83.59
Psuedo R2 0.3708 0.3786 0.3651 0.4146
Notes: This table shows the results of logit regressions of the determinants of the whether a firm pays
a dividend during the period 1982-2010. Coefficients and standard errors are calculated using the Table III.
Fama-Macbeth procedure. The dependent variable equals 1 if a firm pays a dividend during the year and Logit analysis of
0 otherwise. Variable definitions are given in Table I. *,**,***Statistically significant at the 10, 5, and the decision to pay
1 percent levels, respectively dividends

model to the dividend payer outliers. Similarly, we compare the non-payers that fit the model
to non-payer outliers. We use a non-parametric Wilcoxon test to determine if the difference in
the median M/B ratios is statistically significant.
Tables IV and V compare the characteristics of the firms that fit the model and outliers
for dividend payers and non-payers, respectively. First, Table IV reveals that the median
M/B ratio of dividend payers that fit the life-cycle model is greater than the M/B ratio of
dividend payers that do not fit the model; the difference is significant at the 1 percent level.
Likewise, Table V reveals that the median M/B ratio of non-payers that fit the model is
greater than the M/B ratio of non-payers that do not fit the model; and again the difference
is significant at the 1 percent level. The M/B ratio of firms that “follow” the life-cycle model
is higher than the valuation of firms that do not “follow” the model.
Further analysis of Tables IV and V provides some explanation to the valuation premium
for firms that correctly follow the life-cycle model. The maturity (measured by any maturity
variable) is lowest for non-payers that fit the model. The highest median maturity is for
dividend payers that fit the model. The results are somewhat surprising for the categories that
are outliers from the model, or in other words, firms that have a dividend policy contradictory
to the life-cycle model. The non-paying firms that do not fit the model actually have a
higher maturity than the dividend-paying firms that do not fit the model. This implies that
 MF Variable Outliers Fit Model Z
43,6
Median CRSP age (years) 10.0 25.0 −80.1***
Median SD of returns (%) 12.13 8.03 62.7***
Median RE/TE 0.5320 0.8328 −59.6***
Median NYSE percentile (%) 15.0 55.0 −78.9***
Median sales growth rate (%) 8.77 6.81 8.3***
670 Median earnings growth rate (%) 3.38 9.48 −7.4***
Median ROA (%) 4.37 6.04 −20.7***
Median ROE (%) 9.34 13.22 −28.3***
Median CA/TA 0.0736 0.0503 13.8***
Median RE/TA 0.2440 0.3838 −36.7***
Median TE/TA 0.5106 0.4725 10.9***
Median M/B 1.25 1.41 −7.9***
Median dividend growth rate (%) 3.26 5.83 −7.9***
Median dividend payout (%) 17.18 29.65 −31.5***
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Median dividend yield (%) 1.60 2.10 −18.7***

% meaningful share repurchases 15.20 24.69 −18.7***
% dividend cutters 13.26 6.72
Median predicted probability (%) 30.67 80.14
n 9,170 21,808
Notes: This table compares the characteristics of firm-year observations that are consistent with the life-cycle
Table IV. Model 4 in Table III (fit model) with observations that are not consistent with the model (outliers). The sample
Residual analysis of consists of firm-year observations in which the firm paid a dividend during the period 1982-2010. Variable
dividend-paying firms definitions are given in Table I. *,**,***Statistically significant at the 10, 5, and 1 percent levels, respectively

Variable Outliers Fit model Z

Median CRSP Age (years) 18.0 7.0 72.9***

Median SD of returns (%) 9.15 16.13 −72.5***
Median RE/TE 0.6935 −0.0069 75.1***
Median NYSE percentile (%) 35.0 10.0 52.0***
Median sales growth rate (%) 8.30 12.27 −17.0***
Median earnings growth rate (%) 14.75 1.08 15.7***
Median ROA (%) 5.25 0.85 52.4***
Median ROE (%) 11.45 1.83 54.6***
Median CA/TA 0.0588 0.1213 −27.4***
Median RE/TA 0.3190 −0.0031 73.9***
Median TE/TA 0.4903 0.5536 −17.9***
Median M/B 1.34 1.39 −4.6***
% meaningful share repurchases 25.10 9.44 38.2***
Median predicted probability (%) 63.40 6.45
n 6,486 58,532
Notes: This table compares the characteristics of firm-year observations that are consistent with the
life-cycle model 4 in Table III (fit model) with observations that are not consistent with the model (outliers).
Table V. The sample consists of firm-year observations in which the firm did not pay a dividend during the period
Residual analysis of 1982-2010. Variable definitions are given in Table I. *,**,***Statistically significant at the 10, 5, and 1 percent
non-paying firms levels, respectively

the valuation of dividend-paying firms increases as dividend-paying firms mature.

However, the valuation of non-payers decreases as non-payers mature.
Examination of Table IV reveals that the dividend-paying outliers have lower median
profitability, smaller median size, and higher sales growth rates in addition to lower maturity.
 The dividend-paying outliers do not have the usual firm characteristics of dividend payers. Dividend
Among the dividend-paying outliers, the percentage of firms cutting the dividend is more than policy and
twice the percentage of dividend cutters that fit the model. Furthermore, the dividend-paying corporate
outliers have a lower dividend growth rate. It seems that the dividend-paying outliers do not
have the financial characteristics to be consistent dividend payers. We believe that the valuation
significantly lower valuation of the dividend-paying outliers is because investors view these
immature dividend-paying outliers as riskier. 671
Examination of Table V reveals that the non-paying outliers have higher median
profitability, larger median size, and lower median sales growth rates in addition to the
higher median maturity. The non-paying outliers have the firm characteristics of dividend
payers, but do not pay. It seems that investors discount these mature non-payers as firms
with low growth potential. The lower valuation of the non-paying outliers is consistent with
the higher agency costs of excess free cash flow for mature firms.
To address firms that may have substituted repurchases for dividends (Grullon and
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Michaely, 2002; Hsieh and Wang, 2009), we track repurchasing firms that had “meaningful
share repurchases,” which we define as firms that reduce their shares outstanding by greater
than 1 percent in year t. In the total sample, about 14.5 percent of the firm observations had
significant repurchases such that those observations are classified as having meaningful
share repurchases. The life-cycle model for dividends seems to work well for significant
repurchases since about 80 percent of the meaningful share repurchase observations fit the
life-cycle model. Table V shows that about 25 percent of the dividend-paying firm
observations that fit the life-cycle model are also meaningful share repurchases. Our results
indicate that mature and profitable dividend-paying firms that fit the model are more likely to
conduct significant share repurchases than less-mature and less-profitable dividend payers
that do not fit the life-cycle model. For mature and profitable dividend payers, our analysis
indicates that significant repurchases compliment cash dividends. Table V shows that about
25 percent of the non-paying firm observations that are outliers of the life-cycle model are
meaningful share repurchases. The results in Table V indicate that the more-mature and
more-profitable non-paying firms that are model outliers are more likely to conduct significant
share repurchases. Consequently, we find that there may be a “substitution effect” where the
firm repurchases outstanding shares in lieu of cash dividends for some of the non-paying
outliers. While some of the non-paying outliers may substitute repurchases for cash dividends,
it remains that the median valuation of the non-paying outliers is lower than the valuation of
the non-paying firms that fit the life-cycle model.
In summary, the outlier analysis shows the valuation of firms that follow the life-cycle
model is significantly higher than the valuation of firms that do not follow the life-cycle model.
We conclude that indeed dividend policy does matter to firm valuation.

4.2 Outliers, outlier valuation premiums, and “disappearing dividends”

We classify the outliers into two categories: “over-zealous payers” and “non-payers that
should pay.” Over-zealous payers are dividend-paying firms where the life-cycle model
predicts that the firms should not pay a dividend. These firms have low median maturity,
lower median profitability, and smaller median size; consequently, the over-zealous payers
lack the typical characteristics of mature dividend-paying firms. On the other hand,
non-payers that should pay are non-paying firms where the life-cycle model predicts that the
firms should pay a dividend. These firms have a higher median maturity and a higher
median profitability that are the typical characteristics of dividend-paying firms.
With this outlier classification, we now begin to explore the relation between the
life-cycle model outliers and disappearing dividends. First, we sort firms into deciles based on
the RE/TE ratio measure of firm maturity. Figure 1 shows the time trend in the percentage of
dividend payers in RE/TE Decile 1 (least mature), Decile 10 (most mature), and Decile 5
 MF 100%
RE/TE Decile 1 RE/TE Decile 5 RE/TE Decile 10
43,6 90%

80%

Percentage of Dividend Payers

70%

672 60%

50%

40%

30%

Figure 1. 20%
Percentage of
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dividend payers 10%

in RE/TE deciles,
1982-2010 0%
1980 1985 1990 1995 2000 2005 2010

(middle of the maturity range). The figure confirms the prior observations of DeAngelo et al.
(2006). Over the 1982-2010 sample period, the percentage of dividend payers in Decile 1 is
consistently less than 5 percent while the percentage dividend payers in Decile 10 hovers
around 80 percent. The interesting information is in Decile 5. The intermediate maturity firms
show a significantly reduced propensity to pay dividends over the sample period. We concur
with DeAngelo et al. (2006) that the propensity to pay dividends is relatively unchanged with
the most mature and least mature firms. Furthermore, it is the most mature and least mature
firms that best fit the life-cycle model. The outliers of the life-cycle model are firms with
intermediate maturity. These firms show a significantly reduced propensity to pay dividends
and drive the disappearing dividends phenomena.
Next we now focus on the changes in outliers over time. In Figure 2, we show that,
consistent with the prior literature, there has been a dramatic increase in non-payers that
should pay dividends. It then follows that the increase in the non-payers that should pay
drives the disappearing dividends phenomena. However, what explains the increase in
non-payers that should pay (non-paying outliers) over the 1982-2010 sample period?
To answer this question, we return to the valuation analysis, but now we focus only on
valuation of the outliers. For the entire sample, Tables IV and V show that over-zealous

70.00%
% of Outliers that do not pay a dividend

60.00%

50.00%

40.00%

30.00%

20.00%

Figure 2. 10.00%
Increase of non-payers
that should pay 0.00%
1980 1985 1990 1995 2000 2005 2010 2015
 payers have a valuation of 89 percent of dividend payers that fit the model while non-payers Dividend
that should pay have a valuation of 96 percent of non-payers that fit the model. policy and
However, this valuation shifts over the sample time period. In Figure 3, we plot the time corporate
trend of the difference of the median M/B ratio of the outlier dividend payers and the outlier
non-payers (the outlier valuation premium). The valuation of outlier dividend payers was valuation
greater than outlier non-payers throughout the 1982-1990 time period. During that
period, the market rewarded dividend payers with a high median M/B ratio even if they are 673
over-zealous. However, the valuation advantage of dividend-paying outliers disappeared
after the mid-1990s.
In Table VI, we compare the outlier valuation premium in 1982 vs 2000. The 1982
over-zealous outliers were less mature, less profitable, and much smaller than the 1982
dividend payers that fit the model. However, the 1982 over-zealous dividend-paying outliers
had a median M/B ratio that was statistically insignificant from the 1982 dividend payers that
fit the maturity model. The 1982 non-paying outliers were more mature, more profitable, and
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larger than the 1982 non-payers that fit the model. However, the 1982 non-paying outliers had a
statistically significant lower median M/B ratio than the 1982 non-payers that fit the model.
Clearly in 1982, there was a valuation incentive for a firm with an intermediate maturity to pay
a dividend. Not surprising then, most outliers in 1982 paid a dividend.
By 2000, the valuation premium reversed. In 2000, over-zealous outliers were still less
mature, less profitable, and much smaller than 2,000 dividend payers that fit the maturity
model. In 2000, the over-zealous payers had a statistically significant lower median M/B
than the dividend payers that fit the model. In total, 2,000 non-paying outliers were still
more mature, more profitable, and larger than the 2,000 non-payers that fit the model.
However, 2,000 non-paying outliers had a median M/B ratio that was statistically
insignificant from 2,000 non-payers that fit the life-cycle model. Clearly in 2000, there was a
valuation incentive for a firm with an intermediate maturity to not pay. Not surprising then,
most outliers in 2000 did not pay a dividend.
This implies that the increase in non-payers that should pay is linked to the relative
market valuation of these outliers. In the early 1980s, the market seemed to value immature
dividend payers equal to mature dividend payers. On the other hand, in 1982 the non-paying
outliers faced a severe discount compared to non-payers that fit the model. As the market

0.4
Model 4 Linear (Model 4)
M/B of outlier payers minus outlier nonpayers

0.3

0.2

0.1

–0.1

–0.2

–0.3
Figure 3.
Disappearing M/B
–0.4 ratio “Valuation
Premium” for model
–0.5 outliers
1980 1985 1990 1995 2000 2005 2010
 MF 1982 2000
43,6 Variable Outliers Fit model Z Outliers Fit model Z

Panel A: residual analysis of dividend-paying firms (Model 4), 1982 vs 2000

Median CRSP age (years) 11.0 18.0 −17.5*** 11.0 29.0 −14.6***
Median SD of returns (%) 0.1326 0.0910 15.8*** 0.1629 0.1125 9.0***
Median RE/TE 0.6805 0.8245 −11.3*** 0.4727 0.8908 −11.5***
674 Median NYSE percentile (%) 10.0 45.0 −20.9*** 20.0 55.0 −8.7***
Median M/B 1.09 1.11 −0.5 1.11 1.36 −3.0**
n 566 1,040 274 614
Panel B: residual analysis of non-paying firms (Model 4), 1982 vs 2000
Median CRSP age (years) 17.0 5.0 9.9*** 18.0 7.0 14.9***
Median SD of returns (%) 9.88 16.08 −8.7*** 11.37 23.15 −16.2***
Median RE/TE 0.7413 0.2511 8.7*** 0.7416 −0.0796 15.8***
Median NYSE percentile (%) 10.0 5.0 5.2*** 35.0 10.0 8.3***
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Median M/B 0.94 1.25 −6.8*** 1.20 1.16 0.4

n 102 1,177 256 2,724
Table VI. Notes: This table compares the characteristics of observations that fit the life-cycle model in Table III Model 4
Disappearing outlier (fit model) to observations that do not fit the model (outliers) in two years 1982 and 2000. In Panel A the
dividend premium, observations are of firms that paid a dividend. Observations in Panel B did not pay a dividend. Variable
1982 vs 2000 definitions are in Table I. *,**,***Staistically significant at the 10, 5, and 1 percent levels, respectively

valuations became less favorable to over-zealous dividend payers over the sample period,
fewer firms became over-zealous in paying dividends. By 2000, the severe M/B discount on
non-paying outliers disappeared. Given the more favorable valuation in 2000, it follows that
the non-paying outliers increased.
The M/B premium that we use is a simpler version of the “dividend premium” variable of
Baker and Wurgler (2004a, b). Thus our results are consistent with their catering theory of
dividends. However, our results imply that the catering incentives are strongest among
firms that are outliers in the life-cycle model.
To more formally test these ideas, in Table VII we report the results of logit models of the
likelihood of paying a dividend using only the outlier sample. The variable of interest is the
outlier dividend premium. Since the premium varies only in the time series and not in the cross-
section, we estimate pooled logit models instead of the Fama-Macbeth procedure
or panel logits. In the sample of life-cycle model outliers, there is a positive and statistically
significant relation between the likelihood of paying a dividend and the outlier dividend
premium. Moreover, the relation persists after including a risk measure, the standard deviation
of returns. Hoberg and Prabhala (2009) show that the catering incentive variable of Baker and
Wurgler (2004a, b) loses significance when risk variables are included in the models.
In contrast, our results in the outlier sample are robust to the inclusion of a risk measure.
As a final test we examine catering and the likelihood of paying a dividend in firms with
intermediate maturity. Recall that Figure 1 shows that the decline in the propensity to pay a
dividend is very strong among firms in Decile 5 (intermediate maturity) using the RE/TE
measure of maturity. In Table VIII, we report the results of a pooled logit regression using
only the firms in Decile 5. The likelihood of paying a dividend among these intermediate
maturity firms is positively related to the dividend premium; and the result is robust to
inclusion of a risk measure.
In summary, the phenomena that Fama and French (2001) describe as “disappearing
dividends” can be attributed to the increase of non-paying outliers that should pay.
Our explanation for the increase of non-payers that should pay (and the corresponding
decline in over-zealous payers) is a decline in favorable M/B valuations placed on the
over-zealous payers. Similarly, the rise in non-payers that should pay is a result of the
 Variable
Dividend
policy and
Intercept 0.6041*** (33.06) −1.5564*** (−29.40) 22.5481*** (37.03) corporate
Outlier dividend premium 3.3362*** (29.97) 4.3757*** (34.71) 2.4688*** (7.90)
RE/TE −8.8441*** (−34.41) valuation
Ln (age) −8.7226*** (−39.56)
SD returns 20.0725*** (41.65) 104.267*** (37.70)
Size, NYSE percentile −25.2565*** (−38.6) 675
Sales growth rate, SGR 7.0899*** (24.99)
Profitability, ROA −0.4439*** (−30.93)
Market to book ratio, M/B 1.3747*** (22.31)
Cash to asset ratio, CA/TA 10.6945*** (23.52)
Equity to Asset ratio, TE/TA −0.3337 (−1.20)
Economic sector
Materials −7.4141*** (−29.24)
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Consumer. discretionary 1.0221*** (9.06)

Consumer staples −4.7629*** (−23.48)
Healthcare 2.4106*** (11.53)
Technology 9.0989*** (33.34)
Telecom −2.0213 (−4.79)
Psuedo R2 0.0456 0.1598 0.8381
Table VII.
Notes: For each year over 1982-2010, the sample consists of US incorporated, NYSE, NASDAQ, and AMEX-listed Logit analysis of the
industrial firms with CRSP sharecodes 10 or 11 and non-missing data on dividends, financial, and return data. We outlier dividend
include only firms with positive total equity. The sample for this regression is restricted to observations that were premium on the
outliers of the life-cycle model (Model 4). The coefficients are estimated from a pooled logit regression and decision to pay
t-statistics are in parentheses below the estimated coefficient. Variable definitions appear in Table I. dividends for life-cycle
***Statistically significant at 1 percent level model outliers

disappearance of the severe M/B discounts placed on these non-paying outliers. Moreover,
the catering theory of Baker and Wurgler (2004a, b) holds among firms that are outliers in
the life-cycle model and among firms of intermediate maturity.
Analysis of the shift in market valuation is outside the scope of this paper, although we
offer an explanation that is consistent with the maturity hypothesis. The early 1980s period
was near the end of a long secular bear market. It is likely that corporate managers as well
as investors saw fewer growth opportunities in such circumstances. In that secular bear
market the cost of retaining earnings seemed higher and firms shifted to paying dividends.
Likewise, investors would have expected lower capital appreciation based on the limited
growth opportunities and demanded return in the form of dividends. Then in the 1990s
when this shift reversed, the USA was in the middle of a great bull market. Corporate
managers and investors saw abundant growth opportunities. In this great bull market the
cost of distributing earnings seemed higher and firms shifted firms to retaining earnings.
Likewise, investors expected large capital appreciation based on the abundant growth
opportunities and demanded fewer dividends.

5. Summary and conclusions

The main theme of this research is that firm maturity affects dividend policy, and in turn,
dividend policy affects firm value throughout the firm’s life-cycle. Our life-cycle model
correctly classifies about 84 percent of the observations as dividend payers or non-payers.
The valuation of firms that follow the model is higher than the valuation of firms that do not
follow the model. Dividend-paying outliers do not have the financial characteristics to be
consistent dividend payers. Our conjecture for the significantly lower valuation of the
 MF Variable
43,6
Intercept −1.8409*** (−8.37)
Outlier dividend premium 1.8712*** (8.39)
RE/TE 1.2818** (2.16)
Ln (age) 0.5913*** (16.37)
SD returns −7.2803*** (−12.31)
676 Size, NYSE percentile 2.412*** (18.44)
Sales growth rate, SGR −0.53225*** (−5.71)
Profitability, ROA 0.0407*** (7.22)
Market to book ratio, M/B −0.0703** (−2.49)
Cash to asset ratio, CA/TA −0.6388** (−2.70)
Equity to asset ratio, TE/TA −0.4074** (−2.25)
Economic sector
Materials 0.5024*** (4.27)
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Consumer discretionary −0.3871*** (−4.78)

Healthcare −0.7789*** (−6.95)
Energy −0.5075*** (−4.16)
Technology −1.354*** (−12.65)
Telecom 0.5646** (2.54)
Psuedo R2 0.2252
Table VIII.
Logit analysis of the Notes: For each year over 1982-2010, the sample consists of US incorporated, NYSE, NASDAQ, and
outlier dividend AMEX-listed industrial firms with CRSP sharecodes 10 or 11 and non-missing data on dividends, financial,
premium on the and return data. We include only firms with positive total equity. The sample for this regression is restricted
decision to pay to observations that are within the RE/TE Decile 5 (middle decile). The coefficients are estimated from a
dividends for RE/TE pooled logit regression and t-statistics are in parentheses below the estimated coefficient. Variable definitions
Decile 5 appear in Table I. **,***Statistically significant at the 5 and 1 percent levels, respectively

dividend-paying outliers is that investors view these immature dividend payers as risky and
discount their valuations. The non-paying outliers have the firm characteristics of dividend
payers, but do not pay. The lower valuation of the non-paying outliers is consistent with the
higher agency costs of excess free cash flow for mature firms.
Analysis of the firms that do not follow the life-cycle model’s prediction for dividend
policy provides further insight in the disappearing dividends phenomena. We concur with
the prior literature that the propensity to pay dividends is relatively unchanged for the most
mature and least mature firms. The outliers of the life-cycle model are firms with
intermediate maturity. These firms show a significantly reduced propensity to pay
dividends; therefore, outliers of the life-cycle model drive the disappearing dividends
phenomena. Moreover, the composition of the outliers changes over the sample period.
Consistent with the prior literature, we show a dramatic increase in non-payers that should
pay dividends. This implies that the increase in non-payers that should pay is linked to the
relative market valuation of these outliers. In the early 1980s, the market seemed to value
immature dividend payers equal to mature dividend payers. On the other hand, in 1982
the non-paying outliers faced a severe median M/B discount compared to non-payers that fit
the model. As the market valuations became less favorable to over-zealous dividend payers
over the sample period, fewer firms became over-zealous in paying dividends. By 2000, the
severe M/B discount on non-paying outliers disappeared. Given the more favorable
valuation in 2000, it follows that the non-paying outliers increase.
Formal tests using pooled logit regressions show that the propensity to pay a dividend
is positively related to the dividend premium in the sample of outliers from the life-cycle
model and in a sample of firms of intermediate maturity. Moreover, in contrast to Hoberg
and Prabhala (2009), these relations are robust to the inclusion of a risk measure, the
 standard deviation of returns. We conclude that the catering phenomena of Baker and Dividend
Wurgler (2004a, b) occur, but only in firms that are outliers in the life-cycle model or that policy and
are of intermediate maturity. corporate
valuation
Notes
1. See Bhattacharyya (2007) and Baker and Weigand (2015) for recent reviews of the dividend literature.
677
2. The concept of a firm life-cycle with growth stages is generally attributed to Mueller (1972).
3. Since the models require prior growth rates, the data series actually begins in 1981.
4. In robustness tests, we obtain similar results from the outliers of Models 1-3.
5. See Shin and Stulz (2000), Fama and French (2001), and Baker and Wurgler (2004a, b) for other
studies that used M/B as a valuation measure.
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Corresponding author
John H. Thornton Jr can be contacted at: jthornt5@kent.edu

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