Dividend Policy of German Firms

Abstract

German firms pay out a lower proportion of their cash flows, but a higher proportion of their published profits than UK and US firms. We estimate partial adjustment models and report two major findings. First, German firms base their dividend decisions on cash flows rather than published earnings as (i) published earnings do not correctly reflect performance because German firms retain parts of their earnings to build up legal reserves, (ii) German accounting is conservative, (iii) published earnings are subject to more smoothing than cash flows. Second, to the opposite of UK and US firms, German firms have more flexible dividend policies as they are willing to cut the dividend when profitability is only temporarily down. Acknowledgements:We are indebted to Peter Alamire, Steve Bond, Julian Franks, Jens Köke, Colin Mayer, Joe McCahery, Christian Schlag, Reinhardt Schmidt, Mark Wahrenburg, and seminar participants at the Goethe University of Frankfurt for valuable comments and suggestions. We are grateful to Luis Correia da Silva for providing us with part of the data. Dividend policy of German firmsA panel data analysis of partial adjustment models ABSTRACTGerman firms pay out a lower proportion of their cash flows, but a higher proportion of their published profits than UK and US firms. We estimate partial adjustment models and report two major findings. First, German firms base their dividend decisions on cash flows rather than published earnings as (i) published earnings do not correctly reflect performance because German firms retain parts of their earnings to build up legal reserves, (ii) German accounting is conservative, (iii) published earnings are subject to more smoothing than cash flows. Second, to the opposite of UK and US firms, German firms have more flexible dividend policies as they are willing to cut the dividend when profitability is only temporarily down.

Revisiting the Dividend and Investment Puzzle: An International Review using US Corporate Governance Data

“…German firms issue dividends based on cash flow, unlike UK and USA firms (Goergen, Renneboog, & Correia da Silva, (2004) which are based on actual earnings projected onto long term payout ratios. For German firms, in cases of diminishing profitability, dividends are cut, as opposed to the "smoothness" dividend policy of UK and USA firms.…”

“…Many studies (Bank, Cheffina, & Goergen, 2009;Corina, Mirela & Mihaela, 2009;Dann, 1981;Gugler, 2003;Goergen, Renneboog, & Correia da Silva, 2004;Skinner, 2008) have also analyzed the relationship between dividends, stock price, cash flow, debt structure, as well as repurchasing of stock. For example, Dann (1981) examined the response of repurchasing common stock on the value of the repurchasing company's common stock, debt and preferred stock.…”

“…In stark contrast to UK and USA firms, German firms base their dividend on cash flow (Goergen, Renneboog, & Correia da Silva, 2004) rather than on long run target payout ratios. In the German corporate scenario cash flow dictate dividend policy; published earnings do not form the basis of the dividend policy.…”

“…In general, the findings support agency cost-based lifecycle theories, while questioning signaling, clientele, and catering explanations of dividend. Goergen, Renneboog, and Correia da Silva (2004) compared dividend pay-out ratio of German firms (based on cash flow) to UK and USA firms. Liljeblom and Pasternack (2006) studied the variables that determine share repurchases and dividend in Finland.…”