Article · November 011 citations reads 10,107 2

Life cycle theory: Propensity to pay dividends and catering theory of dividends

1. 
   Propensity to pay dividends
   

In a well-known article from 2001, Fama and French noted that only 21% of American companies (on the NYSE) paid dividends compared with 67% in 1978. For Fama and French, this evolution is the result of a change that has affected many companies. Indeed, because of the ‘new economy’ and the increase of IPOs (initial public offerings), US firms were, on average, smaller and had more growth opportunities than previously. These growth opportunities had a negative influence on dividends because firms have attempted to capture all these opportunities using cash. The other reason is the propensity to pay dividends, which can be explained by numerous factors¹⁸.

Finally, two main reasons remain to explain dividend decrease. The first is a firm’s profitability. Indeed, firms making IPO offerings are much younger than in the past. These ‘young firms’ are less profitable than ‘mature firms’, which explains why they are reluctant to pay dividends. The second is the decrease in the propensity to pay dividends. The authors note that, in 1978, 72% of firms paid dividends compared with only 30% in 1998.

In addition, several other reasons can also explain this situation. First, the development of stock options among managers makes these stock options less attractive for managers. Indeed, dividend payments reduce the share value and consequently the value of a stock option. This result is highlighted by DeJong et al. (2000) on the Canadian market. Second, corporate governance reduces the use of dividends as a means to exert pressure to the benefit of other techniques (expert committees, independent administrator in boards of directors or incentives such as stock options). Third, the decrease of transaction costs allows investors to frequently change their portfolios. Fourth, tax legislation leads investors to prefer to receive a capital gain rather than dividends.

2.