Disappearing Dividends, Catering, and Risk Research Paper

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The article under consideration for this paper is titled “Disappearing Dividends, Catering, and Risk” co-authored by Gerard Hoberg and Nagpurnanand R. Prabhala of Robert H. Smith School of Business, University of Maryland. At the onset, the article refers to the findings of the study carried out by Fama and French (2001a) which suggests that the figures relating to the tendency of paying dividends recorded a radical fall from the year 1978 to 1998. It was observed that 66.5 percent of the listed companies paid their dividends in 1978, whereas just 20.8 percent of them did so in 1999. This phenomenon was termed as the “disappearing dividends” puzzle by them.

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The authors of the study under consideration examined this conundrum through the perspective of risk and noticed that considering the risk factor is significant in accounting for the dividend-paying standings of companies. They ascertain that the risk variable affects the economic status quo in a manner, which is comparable to some other elements used to explicate the dividend-paying positions. Their substantiations advocate that risk account for almost one-third to one-half of the Fama-French disappearing dividends problem.

In their study, the authors find little evidence, which generates support for the outlook, that tendency to pay dividends rises and falls since companies “cater” to dividend fads. Further investigations prove that in cases where there is no control for risk, dividend premiums, the principal proxy for dividend fads, can be used to explicate the varying tendencies in paying dividends. However, if control for risk exists, this association disappears. Identical results are produced when other fad proxies are used and in different subsamples. They highlight that the relationship instituted by Baker-Wurgler amongst the dividend premium and the variations in the Fama-French tendency to pay dividends is not pragmatically incorrect. However, the paper puts forward a dissimilar understanding of their findings.

Baker and Wurgler (2004a) present their results in favor of the fads-driven dividend strategy. Facts and Data gathered by the authors propose that the dividend premium carries weight in the analysis carried out by Baker and Wurgler, not for the reason that it implicates behavioral fads but somewhat since it assumes the role of a proxy for risk. The strength of the paper’s findings is tested outside the Fama-French framework by probing into catering theory’s postulation concerning long-run return reversals and retail ownership after dividend events. However, the findings of this paper do not align with the anticipations of the catering theory.

Nevertheless, the analysis of the paper reveals a significant obstacle in establishing clean proxies for behavioral issues not “contaminated” by neoclassical thoughts, for instance, risk and cash flows. The dividend premium exploited by Baker and Wurgler is derived from M/B ratios and can be considered a price variable. Neoclassical asset pricing theory emphasizes that prices vary at the time when cash flows are likely to grow and when assets are vulnerable subject to altering intensities of systematic risk. The paper also reflects that the dividend premium is associated quite consistently with both the neoclassical causes of variation. Finally, it concludes that behavioral issues could be significant, but straightening out their effect with dependable proxies or other trials carries on being a fascinating challenge.

References

Hoberg, Gerard & Nagpurnanand R. Prabhala. “Disappearing Dividends, Catering, and Risk. Robert H. Smith School of Business” (University of Maryland: 2007). Web.

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IvyPanda. 2022. "Disappearing Dividends, Catering, and Risk." March 5, 2022. https://ivypanda.com/essays/disappearing-dividends-catering-and-risk/.

1. IvyPanda. "Disappearing Dividends, Catering, and Risk." March 5, 2022. https://ivypanda.com/essays/disappearing-dividends-catering-and-risk/.


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IvyPanda. "Disappearing Dividends, Catering, and Risk." March 5, 2022. https://ivypanda.com/essays/disappearing-dividends-catering-and-risk/.

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