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Ch15.pdf
1.
Chapter 15: Rational
Managers and Irrational Investors Powerpoint Slides to accompany Behavioral Finance: Psychology, Decision-making and Markets by Lucy F. Ackert & Richard Deaves ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part. 1
2.
Mispricing and goals
of managers • Three conflicting goals in presence of potential mispricing: 1. Maximize rationally-calculated present value of future cashflows. 2. Maximize current share price relative to value. – This goal can be pursued by undertaking various actions which “cater” to a range of investor desires unrelated to (rational) value-enhancement 2 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
3.
Mispricing and goals
of managers cont. • Examples of catering: – Investors believe that certain kinds of investment (e.g., in computer technology in late 90s) creates more value than should really be the case. – If certain investor groups with particular dividend preferences (e.g., those desiring high, low, or no payout) exist, and if not enough firms currently satisfy the desires of these investor groups, catering may operate as firms alter their dividend payout in response. – Miscellaneous discrete actions: • accounting changes • earnings management • name changes 3 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
4.
Mispricing and goals
of managers cont. ii. 3. Take advantage of current mispricing so as to benefit current and holding shareholders. • Done by issuing stock when it is overvalued • Doing so benefits current shareholders at expense of new shareholders • This can be done to “pay for” hard assets in a merger • Or buying stock back when it is undervalued • Doing so benefits holding shareholders at expense of selling shareholders 4 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
5.
Share issues and
repurchases: Evidence • Evidence exists that firms time purchases and sales of stock. • Around the world, high issuance activity leads to low future returns in 12 out of 13 major markets. • Using U.S. data from 1935-1972, five-year returns that are below market returns by 21- 35% have been documented. 5 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
6.
Mergers and acquisitions: Conventional
theory • It makes sense for even correctly priced firms to combine when synergies exist, with both firms sharing in the spoils. • Firm A: Value = $200 million. • Firm B: $100 million. • Firm A+B = $400 million. • A could acquire B paying $150 million. 6 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
7.
Stock acquisitions using
overvalued stock • Suppose a firm is overvalued by market. • Further investors perceive that synergies can be gained form a merger (though in reality they do not truly exist). • This can often explain stock acquisitions in overheated markets. • This can be true even if all managers (bidder and firm to be acquired) understand this. 7 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
8.
Why would managers
of acquired firms go along? 1. Target managers may have short horizons. – Since they plan to get out before the long run comes, their only concern is the short run – Managers who want to sell out (perhaps because they are nearing retirement) would fit the bill – Acquisition allows them to cash out overvalued equity 2. Target managers may expect to be paid for their acquiescence. – In form of acceleration in the exercise of stock options, generous severance pay, or retaining management positions. – Same incentive does not exist with cash acquisitions of undervalued assets. 8 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
9.
Catering by changing
company’s name • Some companies changed their names to “dotcom” names during internet craze of late 90s. • Sample: 147 firms that changed their names in this fashion from June 1998 to July 1998. • Share prices appreciated after announcement (and often dramatically so) – even when their underlying business had little or nothing to do with internet. • This dotcom effect on average led to average cumulative excess returns of 74% during a 10-day announcement window. 9 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
10.
Dividend policy and
perfect markets • In a world of perfect markets, dividend payout should be irrelevant. – Required: no taxes, transaction costs and information asymmetries; hold constant firm’s financing and investment policy • Suppose that a firm currently pays out all of its free cashflows in the form of a dividend, but it is now considering eliminating its payout. • Say investor actually desires 10% cashflow yield that currently comes in form of dividend. 10 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
11.
Dividend policy and perfect
markets cont. • She could employ process known as “home-made” dividends. • Done by selling off shares in lieu of receiving a cash dividend and using the proceeds to “pay” herself an amount of cash equivalent to the former dividend. • Conversely, if an investor holds a dividend-paying stock but does not desire cashflow, an automatic dividend reinvestment program is answer. 11 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
12.
Dividend policy and
perfect markets cont. ii. • Bottom line: investor “sets” own dividend yield. • But real world is much more complicated than this. • Frictions such as taxes and transaction costs exist. • Because of these frictions managers accommodate the dividend stability that investors seem to desire, and only as a last resort cut dividends. 12 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
13.
Disappearing dividends • Researchers,
focusing on NYSE, AMEX, and NASDAQ firms from 1972 to 1999, have documented that for much of this period percentage of firms paying dividends was on decline. – In 1973 52.8% of publicly-traded non-financial non-utility firms paid dividends – Percentage rose until 1978 by which time it hit 66.5%, before falling to 20.8% by 1999 • Is it because characteristics of firms changed, tilting towards the characteristics that non-payers embody? 13 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
14.
Disappearing dividends cont. •
Conclude was that this was about half of explanation for declining propensity to pay dividends. • Larger, more profitable firms with fewer investment opportunities tend to be payers, and it turned out that many of the newly listed firms were smaller and less profitable with an array of investment opportunities. • Many of new listers in 70s tended to quite profitable: – earnings of new lists averaged 17.8% of book value (vs. 13.7% for all firms) – earnings of new lists during 1993-98 averaged 2.1% (vs. 11.3% for all firms) 14 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
15.
Is there a
behavioral story? • Catering motive may be best explanation. • Evidence is based on time-variation in so-called dividend premium. • One way in which this premium can be proxied is by difference between average market-to-book ratio of dividend-payers and nonpayers. • Then investigate whether dividend initiations and omissions are related to time-variation in this premium. 15 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
16.
Dividend premium and
initiations 16 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part. Source: See Baker, M., and J. Wurgler, 2004, “Appearing and disappearing dividends,” Journal of Financial Economics 73, 271-88.
17.
Interpretation • When dividend
premium rises, reflecting increased investor preference for dividends, initiations tend to subsequently rise. • On the other hand, when dividend premium falls, reflecting decreased investor preference for dividends, initiations tend to subsequently fall. 17 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
18.
Four distinct payout
periods • Going back in time there are four distinct trends: 1. Increasing trend in the mid 1960s 2. Decline falling into negative territory through 1969 3. Positive trend in 1970 staying in positive territory till 1977 4. Well-known “disappearing dividends” period after that • Each of these trends lines up with a corresponding fluctuation in dividend premium. 18 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
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