Version: September 7, 2004 
Payout policy in the 21st century 
Alon Brava, John R. Grahama, Campbell R. Harveya,b, and Roni Michaelyc,d 
a Duke University, Durham, NC 27708, USA 
b National Bureau of Economic Research, Cambridge, MA 02138, USA 
c Cornell University, Ithaca, NY 14853 USA 
d The Inter-Disciplinary Center, Herzelia, Israel 

Abstract 
We survey 384 financial executives and conduct in depth interviews with an additional 23 to determine the factors that drive dividend and share repurchase decisions. Our findings indicate that maintaining the dividend level is on par with investment decisions, while repurchases are made out of the residual cash flow after investment spending. Perceived stability of future earnings still affects dividend policy as in Lintner (1956). However, fifty years later, we find that the link between dividends and earnings has weakened. Many managers now favor repurchases because they are viewed as being more flexible than dividends and can be used in an attempt to time the equity market or to increase EPS. Executives believe that institutions are indifferent between dividends and repurchases and that payout policies have little impact on their investor clientele. In general, management views provide little support for agency, signaling, and clientele hypotheses of payout policy. Tax considerations play a secondary role.  
1. Introduction 
In 1956, John Lintner laid the foundation for the modern understanding of dividend policy. Lintner (1956) interviewed managers from 28 companies and concluded that dividends are sticky, tied to long-term sustainable earnings, paid by mature companies, smoothed from year to year, and that managers target a long-term payout ratio when determining dividend policy. In this paper, we survey and interview financial executives at the start of the 21st century to learn how dividend and repurchase policies are currently determined. We shed light on managers’ motives as well as on payout theories. 
Using survey and field interviews, we are able to augment existing evidence on payout policy. We address issues such as the role of taxes, agency considerations, and signaling in the decision to pay; why young firms prefer not to pay dividends (Fama and French (2001)); why many firms prefer to pay out marginal cash flow through repurchases and not through dividends (Jagannathan, Stephens and Weisbach, (2001), Grullon and Michaely, (2002)); and at the same time why some companies still pay substantial dividends (Allen and Michaely (2003); DeAngelo, DeAngelo, and Skinner (2003)). A unique aspect of our survey is that we ask many identical questions about both dividends and repurchases, which allows us to compare and contrast the important factors that drive the selection of each form of payout. Overall, the surveys and field interviews provide a benchmark describing where academic research and real-world dividend policy are consistent and where they differ. 
Our analysis indicates that maintaining the dividend level is a priority on par with investment decisions. Managers express a strong desire to avoid dividend cuts, except in extraordinary circumstances. However, beyond maintaining the level of dividends per share, payout policy is a second-order concern – increases in dividends are considered only after investment and liquidity needs are met.  In contrast to Lintner’s era, we find that the target payout ratio is no longer the preeminent decision variable affecting payout decisions. In terms of when nonpayers might initiate dividend payments, two reasons dominate: a sustainable increase in earnings, and demand by institutional investors.  
Repurchases were virtually nonexistent when Lintner (1956) and Miller and Modigliani (1961) wrote their papers, so it is not surprising that these authors ignore repurchases. Because of their growing importance over the last two decades, we study repurchases in depth and identify key factors that influence repurchase policy. Consistent with a Miller and Modigliani irrelevance theorem, and in contrast to decisions about preserving the level of the dividend, managers make repurchase decisions after investment decisions. Many executives view share repurchases as being more flexible than dividends, and they use this flexibility in an attempt to time the market by accelerating repurchases when they believe their stock price is low. CFOs are also very conscious of how repurchases affect earnings per share, consistent with Bens, Nagar, Skinner, and Wong (2004). Companies are likely to repurchase when good investments are hard to find, when their stock's float is adequate, and to offset option dilution. 
Executives believe that dividend and repurchase decisions convey information to investors. However, this information conveyance does not appear to be consciously related to signaling in the academic sense. Managers reject the notion that they pay dividends as a costly signal to convey their firm’s true worth or to purposefully separate their firm from competitors. Overall, we find little support for both the assumptions and resulting predictions of academic signaling theories that are designed to predict payout policy decisions, at least not in terms of conscious decisions that executives make about payout. 
While there is some evidence that repurchases are used to reduce excess cash holdings (consistent with Jensen’s (1986) free cash flow hypothesis), we find no evidence that managers use payout policy to attract a particular investor clientele that may monitor their actions (as in Allen, Bernardo and Welch (2000)). Executives believe that dividends are attractive to individual investors but that dividends and repurchases are equally attractive to institutions. In general, most executives say that they do not use payout policy as a tool in an attempt to alter the proportion of institutions among their investors. 
Executives indicate that taxes are a second-order payout policy concern. Most say that tax considerations are not a dominant factor in their decision about whether to pay dividends, to increase dividends, or in their choice between payout in the form of repurchases or dividends. A follow-up survey conducted in June 2003, after tax legislation passed that reduced dividend taxation, reinforces the second-order importance of taxation. While a minority of executives in that survey say that reduced dividend taxation will lead to dividend increases at their firms, more than two-thirds say that the dividend tax reduction would definitely not or probably not affect their dividend decisions.1 
The rest of the paper proceeds as follows. Section 2 describes the sample and presents summary statistics. Section 3 investigates the interaction of dividend, share repurchase, and investment decisions. Section 4 compares the practice of payout policy at the beginning of the 21st century to one half century earlier when Lintner (1956) conducted his classic analysis. In addition to survey evidence, Section 4 uses regressions to estimate speed of adjustment and target payout parameters and concludes that the importance of the payout ratio target has declined in recent decades. Section 5 analyzes how modern executives’ views about payout policy match up with various theories that have been proposed to predict dividend and repurchase decisions. Section 6 discusses the factors that CFOs and Treasurers of non-payout firms say might eventually encourage their firms to initiate dividends or repurchases. Section 7 concludes and summarizes the “rules of the game” that affect the corporate decision-making process. 
1 Julio and Ikenberry (2004) argue that the recent tax rate decrease has not had a first-order effect on dividend policy because the recent increase in dividend payout began before the 2003 tax legislation was announced, and the recent dividend initiations primarily occur in stocks that appear to be predominantly held by institutions, where tax motivations are less obvious. 

7. Summary and discussion 
By asking managers about their opinions and the motives underlying their firms’ payout policies, this paper provides a unique perspective on corporate dividend and repurchase policies at the beginning of the 21st century. The evidence gathered through surveying and interviewing a large number of CFOs contributes to our understanding of payout policy along three dimensions. First, in line with Lintner (1956), we document stylized facts concerning dividend policy. In addition, we gather parallel information on repurchase policies that we compare and contrast to dividend decisions. We also study firms that do not pay dividends and do not repurchase shares. Second, given the wealth of payout theories, we explore some of the underpinnings of these theories. Our hope is that this exploration will enable researchers to derive theories that encompass a wider array of the motives for dividend and repurchase policies. Finally, we provide a synthesis of the “rules of the game” that determine the context within which management makes corporate decisions. Table 11 summarizes our key findings regarding dividends and repurchases. 26 When one of the CFOs we interviewed saw these results, he suggested that CFOs generally have a five-year horizon, and that answers longer than five years should not be interpreted literally, but rather as an indication that initiating payout is not in the CFO’s five-year plan.  
With respect to dividend policy, one of Lintner’s key findings still holds: dividend policy is very conservative. From management’s perspective, dividend conservatism emanates primarily from the market’s asymmetric reaction to dividend increases and decreases. Firms, therefore, are very reluctant to cut dividends, and the current level of dividend payments is taken as given (except in extreme cases). Dividend conservatism also affects non-payers, who are reluctant to initiate dividends because once they do, they must operate in the inflexible dividend-payers’ world.  
We also find that many of those firms that do pay dividends wish they did not, saying that if they could start all over again, they would not pay as much in dividends as they currently do. Firms with stable and sustainable increases in earnings are for the most part the only firms that consider increasing or initiating dividends. But even many of these firms would prefer to pay out in the form of repurchases. We identify two important differences relative to Lintner. First, our evidence indicates that firms target the dividend payout ratio less than they used to and they view the target as more flexible than they used to. Second, share repurchases are now a very important form of payout. The interviewed managers state that the flexibility of repurchases (relative to dividends) is one the main reasons that repurchases have increased. This flexibility allows managers to alter payout in response to the availability of good investment opportunities, to accommodate time-varying attempts to affect EPS or stock valuation, to offset stock option dilution, or simply to return capital to investors at the appropriate time.  
Beyond documenting stylized facts, the second dimension of this paper is that it allows us to shed light on dividend and repurchase theories that were developed over the last 40 years. Overall, we find that repurchase policy is better explained by the Miller and Modigliani (1961) framework than is dividend policy. That is, managers clearly indicate that operational and investment decisions are more important than share repurchases. In contrast, for dividends, the level of payout is viewed as being on par with incremental investment, and external funds would be raised before dividends would be cut. Dividend increases, however, are secondary to investment decisions. Though the recent reduction in dividend tax rates has led to initiation at some firms, our survey and interviews indicate that managers at most firms generally believe that taxes are not a dominant factor affecting payout choices. Moreover, we do not find that manager’s views are consistent with payout clientele explanations. Unlike the assumptions and implications from several theories, executives believe that repurchases are equally as attractive as dividends to most institutional investors. Even firms that want to attract institutional investors do not view payout policy as an important tool to persuade institutional investors to hold their stock. 
There is also no evidence that payout is being used to self-impose discipline, nor that payout is being used to separate a firm from its competitors (in the academic signaling sense). Not a single interviewed executive told us that their firm had ever thought of increasing payout as a costly means of separating themselves from competitors.  
Finally, surveying and interviewing hundreds of financial executives suggests that executives tend to employ decision rules that are fairly straightforward (rules of thumb) in response to a handful of widely held beliefs about how outsiders and stakeholders will react. We believe that these “rules of the game” determine the playing field for many corporate decisions. With respect to payout policy, the rules of the game include the following: there is a severe penalty for cutting dividends, do not deviate far from competitors, maintain a good credit rating, it is good to have a broad and diverse investor base, maintain flexibility, and given that an important portion of investors price stocks using earnings multiples, do not take actions that reduce EPS. These rules of the game are consistent with the informal rules that Graham and Harvey (2001) find most affect debt policy, such as the desire for flexibility and a good credit rating, and equity policy, such as focusing on earnings per share and stock price appreciation. We believe that future research that models the manner in which such rules are selected, and the resulting policies that they lead to, can contribute to our understanding of the interaction between corporations and investors. Such research could also shed light on how the decision-making process affects corporate decisions in general, and payout policy in particular. 

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