Dividend multifactor process, long-run risk and payout ratios

Abstract

The purpose of this paper is to examine the theoretical relationship between the multidimensionality of risk and dividend policy, in an intertemporal context. After assuming that dividends are generated by a multifactor process, we use the fundamental framework of the consumption capital asset pricing model to explore the effect of longrun risk on dividend payout ratios (dividends divided by earnings). Our approach is similar to any multifactor model that, given the N factor process, derives useful equilibrium conditions. Our main result shows that the dividend payout ratio is negatively related to N sensitive coefficients, given by the long-run covariance between dividends and economic factors. This suggests that the multidimensionality of long-run consumption risk influences dividend policy. In brief, the model proposes that the target payout ratio can be determined with a simple and easy-to-apply formula that takes into account the long-run sensitivity of dividends to various economic factors.

Consumption, earnings risk, and payout ratios

“…The present paper can be viewed as a direct extension of Bergeron et al (2015) and Bergeron et al (2018). The first paper examines the theoretical relationship between the multidimensionality of risk and dividend policy, in an intertemporal context.…”

“…12 Similarly to Bergeron et al (2015, p. 187), this relationship could be illustrated by a curve that approaches the horizontal axis asymptotically. However, in Bergeron et al (2015) no link was shown to earnings risk. Furthermore, in Bergeron et al (2015) the illustrated relationship is based on a particular case, where the number of factors that are supposed to influence dividend growth are arbitrarily reduced to 1, and where the unique factor is arbitrarily made equivalent to the aggregate consumption growth.…”

“…1 Along this line, many models suggest that risk influences dividend payments. Examples include, Bajaj and Vijh (1990), Michaely et al (1995), Jagannathan et al (2000), Grullon et al (2002), Carter (2008), Hussainey et al (2011), Bergeron et al (2015), and Varela (2015). According to Abdoh and Varela (2017, p. 503), "Dividends are negatively related with risk because firms that operate under high uncertainty would prefer to accumulate retained earnings by reducing dividends.…”

Consumption, earnings risk, and payout ratios

“…1 Along this line, many models suggest that risk influences dividend payments. Examples include, Bajaj and Vijh (1990), Michaely et al (1995), Jagannathan et al (2000), Grullon et al (2002), Carter (2008), Hussainey et al (2011), Bergeron et al (2015), and Varela (2015). According to Abdoh and Varela (2017, p. 503), "Dividends are negatively related with risk because firms that operate under high uncertainty would prefer to accumulate retained earnings by reducing dividends.…”

“…Moreover, it supports the existence of an optimal dividend policy, in an intertemporal context. The present paper can be viewed as a direct extension of Bergeron et al (2015) and Bergeron et al (2018). The first paper examines the theoretical relationship between the multidimensionality of risk and dividend policy, in an intertemporal context.…”