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HONOR PROJECT
Dividend Policy in Mainland China and USA
By
Zheng Baiyao
08050325
Finance
An Honours Degree Project Submitted to the
School of Business in Partial Fulfilment
of the Graduation Requirement for the Degree of
Bachelor of Business Administration (Honours)
4/27/2011
Hong Kong Baptist University
Hong Kong
April 2011
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Contents Abstract ..................................................................................................................................................... 1
Introduction ............................................................................................................................................... 1
Literature Review ...................................................................................................................................... 2
National environment & Hypotheses ........................................................................................................ 4
Methodology ............................................................................................................................................. 7
Data and Variables .................................................................................................................................... 8
Regression Analysis ................................................................................................................................. 11
Discussions ............................................................................................................................................. 18
Conclusions ............................................................................................................................................. 21
Limitation ................................................................................................................................................ 22
References: .............................................................................................................................................. 22
Abstract The purpose of his project is to examine and compare the level and stability of dividend policy in China
and the USA. The main intuition of my analysis is that the various national contexts may imply some
significant differences in dividend policy for firms from the two countries. This research is based on
earlier research on dividend puzzle, which has developed some interpretations including but not limited
to "bird in hand", signaling effect, and pecking order theory. By applying regression, I analyze a
sample of 11673 US firms from 1991 to 2007 and 1680 Chinese firms from 1998 to 2007. The most
interesting observation is that while dividend payouts are positively related to cash in US firms, the
relationship is reversed in China. Also noteworthy is the ambiguous relationship between retained
earnings and dividend payout for Chinese companies. In order to test the accuracy of the findings, I
split the sample into different years and industries. Similar results are drawn out from the two
regressions. Another part of this paper compares the smoothness of dividend policy in the two countries.
The sample space is pooled by 11673 US firms and 1680 Chinese firms for the same sample years as
the level analysis. The result suggests that the Chinese firms have less sticky dividend policy than the
USA firms, which implies a less significant role played by dividend policy in signaling and agency
models in China than it does in the USA.
Introduction
How firms determine their dividend policy is one of the core subjects in Corporate Finance. It is
interesting to note that while paying out dividend consistently is one of the most important signals of a
firm's future earnings in USA, this situation is not that common in China, especially in the mainland
market. What's the implication of this phenomenon? What's the average level of dividend payment in
the USA, and in Mainland China accordingly? How stable is it? Do the factors influencing the dividend
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policy of American corporations apply in China as well? In this essay, these questions will be discussed
deeper.
After years of academic research, empirical study and debate, a strong relationship is found between
dividend payments and corporate governance mechanisms. According to my research, however, lots of
academic study on dividend policy has been conducted in USA, while only limited researches are based
on China. Considering the considerable differences of these two countries in terms of culture, legal
environment and finical system, this paper will be written with the main target to compare the level and
stability of dividend payment in Mainland China and USA. It is reasonable to surmise that this topic is
in interest of professional persons and other involved individuals.
This paper will be organized as the following. Section 1 is the introduction of the background and
objectives. Followed is a brief literature review in this research area. Then institutional background of
these two countries will be discussed basing one several selected macro financial indicators. In the
same section, hypotheses will be proposed to be tested later. In section 4, the methodology applied in
this project will be introduced. In section 5, I will analyze data and variable in order to find out the
results of regression. One group of results indicates the level of dividend payment in relationship with
six variables in the two countries. Another group of results tests the the stability of dividend payment in
China in comparison with American firms. Lintner empirical model will be applied to conduct the test.
Finally a brief discussion basing on the results above will be given.
Literature Review
Why should companies compensate their shareholders by paying cash regularly? What factors affect
the dividend policies most? These questions have long been debated among financial economists.
Basically, there are four main theories being developed by far to explain the dividend puzzle.
Following is the brief introduction to them.
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The first one is called "Bird in hand", which suggests that high-dividend are paid out by companied to
satisfy shareholders' desire for current income. This theory can be understood by intuition, since
individuals naturally tend avoid risk in the future and current dividend provide them a sense of security.
Yet this argument was challenged by Miller and Modigliani in 1962. In their theoretical model, stocks
can be traded without any transaction fees, so that shareholders should in indifferent with dividend
payment. However, many people disagree by arguing that in the real world, stock-market is never
frictionless. Thus the dividend payment due serves as a compensation.
The second important theory is "Signaling effect theory". It is firstly raised by Lintner in 1956 and
stimulated a heated debate about dividend policy in academic circles afterwards. After observing
dividend decisions and policies of 28 US companies during the period of 1918 to 1941 and 1926 to
1954. Lintner drew out two significant conclusions:
(1) Real-world companies typically set long-term target ratios of dividends to earnings;
(2) Managers know that only part of any change in earning is likely to be permanent...dividend changes
appear to lag earnings changes by a number of periods.( Stephen , Randolph , Jefrey ,2010, p.599)
The basic idea is that a smooth dividend payout ratio serves as a significant signal of the corporate's
financial healthy to outsiders, and it and implicates manager's expectation of the firm's further growth
.Thus managers should try to avoid dividend reduction.
Although dividend signaling is well developed in theory, the limitation reveals when it is applied in
reality to predict companies' dividend policy. Thus the new trend theories in this area take more firm-
specific factors and macroeconomic variables influence into consideration. One of the representatives
is agency problem theory. The most distinctive difference between agency theory and previous ones is
that it points out interest conflicts between managers (agents) and shareholders (owners) in reality. If an
effective governance mechanism is absent, it would be likely that managers misuse the redundant cash
to pursue their own interests rather than maximum shareholders' benefits. By paying dividends,
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companies can share its earning with their stockholders and at the same time limit the availability of
free cash flows to managers. In this way, paying dividend achieves the same consequence as
repurchasing stocks, employing external monitors and so on. It is consistent with Easterbrook(1984)'s
explanation about the role of dividends in alleviate agency problems.
The last but not the least important one is pecking order theory. According to Myers(1984),
companies prioritize internal financing over external financing when there is a need of funding raising,
considering the higher cost of external capital. Hence, it is reasonable to expect a company in a country
with a less developed financial system to reserve dividends rather than pay them out. Since they can be
utilized as a source of internal capital in emergency time, the company reduces the risk of raising
expensive external capital in financial market.
National environment & Hypotheses
Although various theories mentioned above have been developed and tested in USA, they may not be
applied to explain the dividend policy in other parts of the world. It is known that significant
differences exist between mainland China and the USA. Among those, differences in macro-economy
environment, legal system and financial system development are by no means negligible.
With regard to macro-economy environment, these countries have different GDP growth rate,
inflation rate and so on. Group 1 data in Table 1 reveals the average data of these factors of USA and
China from 1998 to 2007. It is interesting to note that during the past period, while China had enjoyed a
high economic growth with GPD growing approximately 10% per year, it limited the inflation rate at
1.32% per year. Compared with China, USA had a lower average GPD growth yet a higher average
inflation rate. So I expect that firms in China have better investment opportunities.
Group 2 data in Table 1 provides information about the level and maturity of financial system
development in the two countries. It is evident that the USA owns a much more developed financial
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market than the one of China. Firstly, the USA's financial market size is around 18 times larger than
Chinese financial market. Then, the total value of shared traded is about 230% of GDP on average in
the period, which is 4 times larger than Chinese market capitalization ratio. Finally, stocks are more
frequently traded in the USA market than in China, as indicated by the turnover ratio.
Legal system also plays an important role in corporate government thus affects the decision of
dividend payment. It is expected that in a country with a highly transparent legal system, companies
face less severe information asymmetries. Gianni, Luc and Kenichi(2007) constructed a composite
corporate governance quality (CGQ) index to quantify the quality of legal system. The CGQ index,
calculated from three indicators: Accounting Standards, Earning Smoothing, and Stock Price, measures
outcomes of corporate governance in the dimensions of accounting disclosure and transparency. The
bigger the index, the more transparent and disclosed the legal system is. Group 3 data in Table 2
indicate that the USA's legal system is more transparent in terms of accounting standards that the one
of China.
Hypothesis
Basing on the suggestions provided by previous researchers that an adequate and smoothing dividend
payment is an important signal of a company's financial health, and the fact that China has a less
developed financial market and less transparent legal system than the USA, I would like to come up
with the following hypotheses:
Hypothesis 1: The level of dividend payment of firms in mainland China is less connected with its
actual situation such as profitability, growth and cash.
Hypothesis 2: Firms in mainland China have less sticky dividend payments than those in the
USA
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Table 1 National environment
Group 1: macro-economy environment
Average 98-07
USA China Sources 1GDP growth (annual %) 2.859 10.189 World Bank national accounts data, and OECD National Accounts data files. 2Inflation, consumer prices (annual %) 2.711 1.320 International Monetary Fund, International Financial Statistics and data files.
Group 2:financial system development
Average 98-07 Sources
USA China 3Stocks traded, total value (current US$) 2.63E+13 1.45768E+12 Standard & Poor's, Global Stock Markets Factbook and supplemental S&P data. 4Stocks traded, total value (% of GDP) 230.274 58.764 Standard & Poor's, Global Stock Markets Factbook and supplemental S&P data. 5Stocks traded, turnover ratio (%) 167.309 111.392 Standard & Poor's, Global Stock Markets Factbook and supplemental S&P data.
Group 3: legal system
Average 00-03 Sources 6CGO USA China
0.77 0.52
Explanations:
1Annual percentage growth rate of GDP at market prices based on constant local currency. Aggregates are based on constant 2000 U.S. dollars. GDP is the sum of gross
value added by all resident producers in the economy plus any product taxes and minus any subsidies not included in the value of the products. It is calculated without
making deductions for depreciation of fabricated assets or for depletion and degradation of natural resources. 2Inflation as measured by the consumer price index reflects the annual percentage change in the cost to the average consumer of acquiring a basket of goods and services
that may be fixed or changed at specified intervals, such as yearly. The Laspeyres formula is generally used. 3Stocks traded refers to the total value of shares traded during the period. 4Stocks traded refers to the total value of shares traded during the period. This indicator complements the market capitalization ratio by showing whether market size is
matched by trading. 5Turnover ratio is the total value of shares traded during the period divided by the average market capitalization for the period. Average market capitalization is
calculated as the average of the end-of-period values for the current period and the previous period. 6The CGQ index is a simple average of three indicators, called Accounting Standards (AS), Earning Smoothing (ES), and Stock Price Synchronicity (SPS). These
indicators are constructed from accounting and market data for samples of non-financial companies listed in stock markets taken from the Worldscope and Datastream
databases.
7
Methodology
The two major methods used in my study are previous study research and regression.
The purpose of applying regression is to find out the level and stability of dividend payment in USA,
Mainland China.
In order to investigate the level of dividend payment, an equation which represents the relationship
between dividend payout and the selected ratios is set up:
Div =a + β1*SGR + β2*TD/TA + β3*RE/TE + β4*CASH+ β5*ROA+ β6*SIZE
Where Div: Dividend payout to sales;
SGR: Sales growth rate;
TD/TA: Total common equity to total assets;
RE/TE: Returned equity to total common equity;
CASH: Cash to total assets;
ROA: Return to assets
SIZE: Natural logarithm of total assets
a: Intercept
β: the coefficients between dividend payout and the selected ratios.
R Square and p-value are used to test the accuracy and signification of coefficients when applying this
equation.
Secondly, the smoothness of dividend in different regions is discussed, applying Lintner empirical
model. There are two inter-related equations in this model( for firm i):
(1)ΔDit = ai + ci ( D*it-Di(t-1)）+uit
Where D*it: the target dividendat time t;
Di(t-1) : the lagged actual dividend;
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ci: the speed of adjustment (0< ci <1);
ΔDit: the change in the dividend
ai : the difference of the last dividend from the target, an adjustment to the target dividend
uit: random error term
(2) Dit = ait + b NI + d Di(t-1) + uit
Where b = cr and d =(1-c) (r: payout ratio)
Dit: the current actual dividend;
NI : the current earning;
b: the coefficient on current earnings;
d: the coefficient on lagged dividends
R Square, p-value are used to test the accuracy and signification when applying this model.
In order to conduct the regression, a sample pool is constructed. These firms are from China and USA.
They are pooled under consideration of factors including company size, use of external financing,
growth, profitability, liquidity, life cycle, net income and so on. The sample space is pooled by firms
from different industries, crossing manufacturing to service, including consumer and producer goods.
All data are treated in the SAS System and are analyzed by applying Excel.
Because of the limitation of resources, only part of companies in each area are selected as
representatives to pool the sample space. In addition, the limited time scale in this research is also a
restriction.
Data and Variables
Section 1: Level of dividend payment
Sample
My sample is derived from Data source Compustat Data set, which contains a large scale of information about
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finance, statistic and market for companies all around the world. American company data are from Compustat
North America, and Chinese company information are found in Compustat Global. The analysis uses
annual company data recorded from 1991 to 2007 for the USA firms. However, since numerical
information of Chinese companies is not sufficient in early time, the time scale applied to analyze them
is shorter, from 1998 to 2007.
At first, the sample space is constructed by 95045 American companies and 5365 firms from China.
The number is cut down dramatically after conducting several times of filters. Specifically, I exclude
companies with abnormally level of dividend payments, and those with negative return on assets
(ROA). By deleting companies with "6" as the first digit of Standard Industrial Classification (SIC)
codes, I restrict analysis to nonfinancial sectors. The main reason is that the dividend payments of
financial sectors fluctuate a lot.
Finally, there are 11673 samples from the USA with an interval of 17 years and 1680 observations in China
from 1998 to 2007 remain in the pool and being analyzed.
Dependent and independent variables
Panel A in table 2 remains definitions and data sources for all variables used in regression analysis for
dividend level.
Notably, I use dividends-to-sales ratio to represent the dependent variable: Dividend payout ratio. It is
because La Porta( 1999) suggested that sales are relatively more object than other income measures
such as cash flow and earnings, since they are less dependent on accounting conventions thus less
sensitive to accounting practices.
The 6 proxies selected as variables are growth, as measured by sales growth rate(SGR); leverage, total
liability to total assets(TD/TA); life cycle, retained equity to total common equity(RE/TE);liquidity, cash to
total assets(CASH) ; profitability, return on total assets( ROA), and size, natural logarithm of total assets(SIZE).
I assume that these 6 factors are the key determinants of the decision to pay dividends.
Descriptive statistics
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Panel A in Table 3 presents summary statistics for my variables. All of the variables are winsorized at
the 5% level to reduce particularly abnormal cases. Of the firms in our sample, approximately 88% of
the observations are from the USA, while only 12% are Chinese firms. Observing and comparing
country medians and mean of these variables, I have the following findings.
1. With similar size( mean SIZE around 0.5 for both countries), Chinese companies pay more
dividends than the USA ones.
2. Overall, the USA firms are more profitable (average higher ROA), reserve more capital
within the company (higher RE/TE), and hold less debt(lower TD/TA) than Chinese firms.
3. On average, Chinese firms own better growth opportunity (higher SGR), and more cash.
Panel B in Table 2 indicates the sample distributions across industries. Industry classification is based
on the first digit of the SIC codes. Obviously, for both countries, companies from manufacturing sector
take up the largest portion in the sample. The second most is wholesale trade, retail trade, followed by
service industry. The least observations is in Agriculture,Forestry,and Fisheries, with an insignificant
number of 82 in total.
Panel C in Table 3 shows numbers of observations by years. While the USA firms are distributed
equally into each year ( around 680 per year), the Chinese observations see an increase in numbers over
years, with only 8 firms in 1998 yet 319 companies in 2007.
Section 2: Smoothness of dividend payment
Sample
Basing on the same database: Compustat Data set as dividend level observations, the sample space is
constructed by 119981 American companies and 11166 firms from China. This sample is also filtered by
excluding financial firm.
In Panel A in table 2, I reveal definitions and data sources for all variables used in regression analysis
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for dividend payments smoothness.
Dependent and independent variables
The dependent variable is the expected dividend, and variables are lagged dividends and net income.
Descriptive statistics
Similarly, all of the variables are winsorized at the 5% level to reduce particularly abnormal cases.
There are just over 90% firms from USA, and the remaining 10% are Chinese companies. From the
reported means and medians, we can observe that Chinese firms pay average more dividends and have
higher level of current earnings. However, these data by themselves doesn't reveal the stability of
dividend payments.
Regression Analysis
Section 1: Level of dividend payment
The effects of various explanatory variables on the decision of dividend payouts are represented in the
regression model below:
Div =a + β1*TD/TA + β2*SIZE + β3*SGR + β4*ROA+ β5*RE/TE+ β6*CASH
The regression results of the six coefficients, which are symbolized by β, are the central of this study.
They indicate the relationship between these proxies and dividend payment.
I conduct three regressions in total for this section. The first one shows the general results basing on
data of all firms( USA:11673,China:1680) from each country during the sample years. The coefficients
are put into t-test to find out the statistical significance of the variables, which is indicated by p-value in
this research. Table 4 presents the results of the first regressions.
Secondly, companies are distributed into each year of the selected period. The coefficients of variables
in each year are reported in detail in the Table 5, and the time-series average and standard derivative of
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Table 2 Variables
Panel A: for Level
Variable Definition Source
Div dividend to sales Compustat Data set-NA&Global
SGR sales growth rate Compustat Data set-NA&Global
TD/TA leverage, total liability to total assets Compustat Data set-NA&Global
RE/TE retained equity to total common equity Compustat Data set-NA&Global
CASH cash to total assets Compustat Data set-NA&Global
ROA profitability,return on total assets Compustat Data set-NA&Global
SIZE Natural logarithm of total assets Compustat Data set-NA&Global
Panel B: for smoothness
Dit the target dividendat time t Compustat Data set-NA&Global
NI Compustat Data set-NA&Global
Di(t-1) the lagged actual dividend Compustat Data set-NA&Global
Table 3 Summary statistics
Panel A: Firm-level data
Variable USA China All
N Mean Median N Mean Median N
For
Level
Div 11673 0.046 0 1680 0.062 0.038 13353
TD/TA 11673 0.457 0.487 1680 0.524 0.517 13353
SIZE 11673 5.612 5.584 1680 5.516 5.466 13353
SGR 11673 0.164 0.117 1680 0.2 0.173 13353
ROA 11673 0.117 0.051 1680 0.047 0.034 13353
RE/TE 11673 0.217 0.397 1680 0.012 0.141 13353
CASH 11673 0.145 0.063 1680 0.173 0.141 13353
For Stability
Dit 119981 29.776 0 11166 118.518 28.859 131147
NI 119981 56.3 1.224 11166 210.561 37.521 131147
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Di(t-1) 119981 27.554 0 11166 97.996 26.514 131147
Table 3 Summary statistics
Panel B:Industry definition
SIC Industry definition The first digit of SIC N
USA CHI TOTA
L
Agriculture,Forestry,and Fisheries 0 56 26 82
Construction Industries 1 632 102 734
Manufacturing 2 3268 520 3788
Manufacturing 3 3830 556 4386
Transportation, Communications 4 868 195 1063
Wholesale Trade,Retail Trade 5 1702 120 1822
Service Industries 7 979 61 1040
Service Industries 8 310 20 330
Service Industries 9 28 9 37
Panel C:Years Observations
Years 1991 1992 1993 1994 1995 1996 1997 1998 1999
Number of observations by years
USA 706 724 728 833 869 839 797 747 710
China 8 15
Years 2000 2001 2002 2003 2004 2005 2006 2007
Number of observations by years
USA 633 512 492 588 619 649 627 600
China 20 51 90 107 256 327 415 319
Panel D: Number of observations by country
Country N N
Level Stability
USA 11673 119981
China 1680 11166
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each coefficient appear in the bottom of the table.
To address the potential concern that the relationship between dividend payment and the six variables
may be influenced by industry specific factors, I add one more regression after grouping companies by
industry according to the SIC definition. The relevant information can be found in Table 6.
Regression 1:
Considering first the regression that uses all data without any classification, I have the following
discoveries. First of all, as what is expected, the level of dividend payment is positively related to size,
yet negatively related to growth in both of the countries. On one hand, the coefficient on SIZE is
positive and significant, implying that in the USA and China, firms with more total assets tend to pay
more dividends. One the other hand, the coefficient on the SGR, while statistically significant, is
negative, suggesting the tendency of capital retention for companies with sound expansion
opportunities. Secondly, the relationship between leverage and dividend payouts is also obvious and
applies to the two countries under observation. Seeing negative coefficients on TD/TA of the same
magnitude, we can conclude that firms depending more heavily on external financing are less likely to
pay high dividends. Thirdly, the prediction provided by previous researchers that the degree of
profitability positively affect dividend payment is proved again here. The estimated parameter on ROA
is positive and monotonic for firms from the two countries, yet the coefficient on ROA of China is
bigger than the one of the USA, so we expect with the same amount of increase in profit, Chinese
companies more bigger proportion to their shareholders than American companies. Fourthly, also
more interesting is the observation of relationship between cash and dividend policy. In the USA, the
coefficient on CASH is positive and significant, suggesting a more liquid firm is expected to pay more
dividends. In contrast, Chinese firms holding more cash tend to pay fewer dividends to shareholders.
Lastly but not the least importantly is the impact of retained earnings on the probability of paying
dividends. While companies with higher RE/TE ratio pay more dividends in the USA, the relationship
15
Table 4 Regressions 1-Regressions of dividends on six proxies(USA all firms & China all firms)
USA
Variable Coefficient Standard Error p-value R square
Intercept -0.00125 0.00075899 0.1008 0.159
TD/TA -0.00391 0.00099187 <.0001
SIZE 0.00186 0.00009598 <.0001
SGR -0.01339 0.00091478 <.0001
ROA 0.11453 0.00373 <.0001
RE/TE 0.00039831 0.00021792 0.0676
CASH 0.01497 0.00132 <.0001
China
Variable Coefficient Standard Error p-value R square
Intercept 0.02902 0.00407 <.0001 0.1337
TD/TA -0.02077 0.00448 <.0001
SIZE 0.00203 0.00067165 0.0026
SGR -0.0155 0.00318 <.0001
ROA 0.23315 0.01863 <.0001
RE/TE 0.00129 0.00145 0.3756
CASH -0.01822 0.0051 0.0004
Table 5 Regressions 2-Regressions of dividends on six proxies(different years)
USA China
Years Intercept TD/TA SIZE SGR ROA RE/TE CASH Intercept TD/TA SIZE SGR ROA RE/TE CASH
1991 -0.0010 -0.0120 0.0029 -0.0188 0.1218 -0.0004 0.0069
1992 0.0015 -0.0142 0.0027 -0.0142 0.0964 0.0008 0.0031
1993 0.0002 -0.0119 0.0028 -0.0136 0.0794 0.0008 0.0117
1994 -0.0023 -0.0107 0.0031 -0.0163 0.0959 0.0001 0.0128
1995 -0.0021 -0.0057 0.0024 -0.0145 0.1058 0.0003 0.0218
1996 -0.0013 -0.0073 0.0022 -0.0071 0.1181 0.0010 0.0059
1997 -0.0015 -0.0034 0.0017 -0.0129 0.1242 0.0012 0.0056
1998 -0.0006 -0.0031 0.0017 -0.0158 0.1173 0.0004 0.0004 0.1833 0.0859 -0.0324 -0.1258 0.5957 -0.1774 -0.1833
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1999 0.0011 -0.0044 0.0017 -0.0094 0.1010 0.0002 0.0015 0.0878 -0.0045 -0.0067 0.0097 -0.4669 -0.0120 0.0363
2000 0.0015 -0.0015 0.0013 -0.0018 0.1143 -0.0008 0.0028 0.0613 -0.0060 -0.0070 0.0081 -0.0345 0.0177 0.0252
2001 -0.0043 0.0061 0.0012 -0.0132 0.1095 0.0035 0.0164 0.0338 -0.0277 0.0003 -0.0141 0.0848 0.0111 0.0257
2002 -0.0034 0.0089 0.0007 -0.0245 0.1523 0.0008 0.0143 0.0444 -0.0409 -0.0003 0.0025 0.3432 -0.0449 -0.0128
2003 0.0017 0.0065 0.0005 -0.0082 0.1028 0.0021 0.0098 0.0480 -0.0218 -0.0001 -0.0179 0.0885 -0.0131 0.0089
2004 -0.0041 0.0048 0.0014 -0.0278 0.1507 0.0001 0.0272 0.0435 -0.0155 -0.0010 -0.0128 0.2304 -0.0225 0.0006
2005 0.0031 -0.0051 0.0015 -0.0170 0.0730 0.0006 0.0362 0.0327 -0.0257 0.0025 -0.0312 0.3310 0.0032 -0.0436
2006 0.0023 -0.0017 0.0010 -0.0130 0.1207 -0.0012 0.0332 0.0196 -0.0149 0.0027 -0.0120 0.2842 -0.0009 -0.0181
2007 0.0027 -0.0071 0.0014 -0.0146 0.1724 -0.0069 0.0311 0.0178 -0.0329 0.0057 -0.0185 0.2093 0.0006 -0.0332
Average -0.0004 -0.0036 0.0018 -0.014 0.1150 0.0002 0.0142 0.0572 -0.0104 -0.004 -0.021 0.1666 -0.0238 -0.019
Standard
error 0.0024 0.0069 0.0008 0.0061 0.0254 0.0021 0.0117 0.0488 0.0357 0.0108 0.0389 0.2822 0.0568 0.063
Table 5 Regressions 3-Regressions of dividends on six proxies(different industries)
USA China
Industry TD/TA SIZE SGR ROA RE/TE CASH TD/TA SIZE SGR ROA RE/TE CASH
0 -0.0585 0.0007 -0.0067 -0.0599 0.0021 -0.0150 -0.0187 0.0018 0.0078 0.3978 0.0666 -0.0111
1 -0.0287 0.0006 -0.0037 0.0150 0.0008 -0.0102 0.0293 0.0021 -0.0350 0.3902 -0.0121 -0.0042
2 0.0000 0.0039 -0.0250 0.1659 0.0006 0.0259 0.0157 -0.0030 -0.0072 0.2540 0.0012 -0.0027
3 -0.0089 0.0015 -0.0154 0.0913 0.0013 0.0237 -0.0003 -0.0027 -0.0163 0.1678 0.0038 -0.0086
4 -0.0140 0.0010 -0.0165 0.1498 0.0003 -0.0391 -0.0106 0.0045 -0.0220 0.2324 0.0053 -0.0430
5 -0.0072 0.0003 -0.0097 0.0550 0.0006 0.0087 0.0207 -0.0040 0.0004 0.0743 0.0044 -0.0243
7 0.0035 0.0011 -0.0099 0.0985 0.0008 0.0136 -0.0044 0.0044 -0.0394 0.5928 -0.0004 -0.0197
8 0.0057 -0.0003 -0.0103 0.1806 0.0019 0.0409 -0.1035 0.0023 -0.0174 0.1326 0.0491 -0.0353
9 -0.0062 0.0027 0.0027 -0.1012 -0.0023 0.0750 -0.0279 0.0122 -0.0211 0.1766 -0.0017 -0.0182
17
is not so obvious in China, since the coefficient on RE/TE, though positive, is insignificant with a p-
value bigger than 10%.
Regression 2:
After conducting the second regression by dividing the full sample into years, similar results are
obtained. However, there is one important difference. The coefficient on RE/TE for Chinese firm, while
positive in the previous regression, turn out to be negative on yearly average. It implies an ambiguous
relationship between earned/contributed capital mix and the decision of dividend payment.
Regression 3:
Another regression is practiced after splitting the sample into different industries. It shows a more
detailed picture for the results from Regression 1. We can see that while all industries in China have
positive coefficient on ROA , the same coefficient is negative for some American firms from the
Agriculture,Forestry,and Fisheries Industry and Service Industry. It can to some extend explain the
more significant relationship between profitability growth and dividend increase in China than in the
USA. Another thing noteworthy is that while dividend payment is positively related to RE/TE for the
USA firms cross industries, the relationship is less consistent among industries in China. Finally, the
negative relationship between cash and dividend for Chinese firms can be explained by the negative
coefficients on CASH in all 8 industries in China. But the situation is reversed in the Manufacturing
Industry and Service Industry in the USA.
Section 2: Smoothness of dividend payment
In this section, I applied the Lintner empirical model to test the smoothness of dividend payment in
China and the USA. The model is expressed by the following equation:
Dit = ait + b NI + d Di(t-1) + uit
Where the coefficient on current earnings (b )=the speed of adjustment(c) * target payout ratio ( r)
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the coefficient on lagged dividends (d )=1- the speed of adjustment
Then main target of this regression is to find out the values of d to compare the adjustment rate of firms
in the two companies.
The Lintner results for my sample are presented in Table 7. We can say that results for Chinese firms,
with R squares of 95%, is more reliable than results of US firms, with lower R squares value of 61%.
The coefficient on lagged dividends is 0.72 for US firms and 0.45 for Chinese firms. This implies a
slower speed of adjustment of 0.28 for US companies when compared with the one of 0.55 for Chinese
Companies. In another words, US current dividend is less sensitive to current earning shock, thus more
stable in terms of dividend policy than Chinese firms.
Discussions
Section 1: Level of dividend payment
In this section, I'm going to provide some possible explanations for the regression results above.
Firstly, the fact that a firm pays dividends is significantly and positively related to size, and negatively
related to growth can be explain by Life Cycle theory, which is developed by Fama and French(2001).
At the early stage of growth, companies hold better prospects, thus prefer to reserve rather than
distribute. When stepping into mature stage, a large size firm becomes more willing to share its profit
to earn reputation from investors than the ones in self-developing stage.
Secondly, the monotonic and negative relation between TD/TA and dividend payout can be understood
by pecking order theory. Myers(1984 suggest that when there is a need for capital, a firm will use
internal resources firstly, since it is cheaper than external financing method such as debt borrowing, by
which way flotation fees and interests should be paid. A firm with a high level of leverage is considered
to hoard little earned capital within the company, thus is lack of capability to pay dividends.
Another variable is ROA, a measure of how effectively assets are used to generate a return. In my test,
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the relationship between dividend payout rates and ROA is consistently positive across both of the two
regions. However, the positive relationship is stronger in China than in the USA. This implies that with
the same increase in profitability, Chinese firms pay larger portion of earnings as dividend. The
interpretation may be that Chinese firms have more need in using dividend payment to reduce agency
costs.
The relationships between cash and dividend payouts are opposite in the two countries. As introduced
in the National Environment section of this paper, Chinese capital market is less developed than the
one in USA. This may help to explain the cash-hoarding behavior of Chinese companies. Unlike the
USA, where external fund can be easily raised in the developed capital market, in China, cash is harder
to be get. Another possible interpretation is that the surplus cash is largely misused or disinvested by
managers.
Finally, I find no single-directional impact of RE/TE on dividend policies in China. This may be caused
by the tradeoff between benefits and cost of retention. The advantage of retained earnings is the quicker
reaction and more ability for positive NPV projects. So that firms valuing the further investment
opportunities a lot will prefer reserve earnings rather than distribute them as dividend. However, if the
disadvantages, which include the increasing probability to steal and misuse, outweigh the advantage,
firms will not want to hold the earnings in managers' hands.
Section 2: Smoothness of dividend payment
Lintner(1956) found that managers in USA are reluctant to make significant dividend changes that
might have to be reversed in the future, because a stable dividend payment helps in minimizing agency
costs and signal manager's expectation of the firm's future profitability. However, the asymmetric
information problem is less concerned by Chinese firms. The regression results suggest that the
Chinese firms have less stickier dividend policy than the USA firms, which implies a less significant
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Table 6 Regressions of dividends on current income and lagged actual dividend
USA
Variable Coefficient Standard Error t-value p-value R square
Intercept 6.344991739 0.435045409 14.58467 3.87E-48 0.612262
NI 0.060806325 0.000667027 91.16024 0
Di(t-1) 0.726143972 0.002246784 323.1926 0
China
Variable Coefficient Standard Error t-value p-value R square
Intercept 17.83378933 2.652151141 6.724273 1.85E-11 0.951941
NI 0.266392931 0.002380604 111.9014 0
Di(t-1) 0.455041523 0.00660499 68.8936 0
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role played by dividend policy in signaling and agency models in China than it does in the USA.
The inconsistency with signaling effect theory may be caused by the influence of insider ownership.
Many Chinese firms are privately owned by insider shareholders such as founding family. It is
reasonable to expect that sometimes dividend increasing is just the outcome of the pressure from big
insiders. Similarly, if these insiders are persuaded to reduce their dividends dramatically to financing
for the good investment opportunity, the dividend reduction doesn't affect the company's reputation and
prospects in their mind at all. In another words, the smoothness of dividend policy doesn't signal
manager's expectation to a large extent.
As for the agency problem, the function of dividend payment can be substituted by other alternatives.
For example, the excess cash can be debt to banks to gain a good relationship with them, which is
important for firms relying heavily on debt financing. In addition, in the previous introduction, we have
known that in China, the legal system is not such transparent and disclosed, so that the capital for
dividend payment may be used to employing external supervision, such as independent auditor, in
reduce the severity of agency problems.
Conclusions
This paper examines and compares the level and stability of dividend policy in China and the USA.
The sample space is pooled by selected US firm from 1991 to 2007 and selected Chinese firms from
1991 to 2007. The following observations were found after conducting regression analysis:
For level of dividends:
1. It is the same for firms from both of the countries that dividend payouts are positively related to
size, yet negatively related to growth and debt level.
2. While dividend payouts are positively related to cash in US firms, the relationship is reversed in
China.
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3. An ambiguous relationship between retained earnings and dividend payout is found for Chinese
firms. But the level of retained earnings significantly and positively affects dividend policy in
US firms.
For stability of dividends:
US firms have more stable dividend payments than Chinese firms. The possible explanation is that
dividend policy plays a more important role in signaling and agency models in the US than it does in
China. The insider ownership, less transparent corporate governance and legal system may also
contribute to the fluctuation of Chinese dividend payouts.
Limitation
In order to quantify the relationship between dividend payment and the firm-level variables, I selected
several ratios to indicate the firms' characteristics. For instance, sales growth rate represents growth,
return on asset implies profitability. However, these measures can be inaccurate thus impact the results
of the regression.
In addition, because of the limitation of resources, only a specific period of time is picked to conduct
the analysis. The time may be the business cycle for a specific industry in a country thus makes the
results special. Although several filters and winsorize are performed, I can't make sure about the
universal relationship, which is left for further study.
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