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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 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 1 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. 2 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 firmspecific 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, 3 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 4 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 5 Table 1 National environment Group 1: macro-economy environment 1 GDP growth (annual %) Inflation, consumer prices (annual %) Group 2:financial system development 2 3 Stocks traded, total value (current US$) Stocks traded, total value (% of GDP) 5 Stocks traded, turnover ratio (%) Group 3: legal system 4 6 CGO Average 98-07 USA 2.859 2.711 China 10.189 1.320 Average 98-07 USA 2.63E+13 230.274 167.309 China 1.45768E+12 58.764 111.392 Average 00-03 USA 0.77 China 0.52 Sources World Bank national accounts data, and OECD National Accounts data files. International Monetary Fund, International Financial Statistics and data files. Sources Standard & Poor's, Global Stock Markets Factbook and supplemental S&P data. Standard & Poor's, Global Stock Markets Factbook and supplemental S&P data. Standard & Poor's, Global Stock Markets Factbook and supplemental S&P data. Sources Explanations: 1 Annual 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. 2 Inflation 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. 3 Stocks traded refers to the total value of shares traded during the period. 4 Stocks 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. 5 Turnover 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. 6 The 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. 6 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; 7 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 8 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 9 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 10 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 11 Table 2 Variables Panel A: for Level Variable Div SGR TD/TA RE/TE CASH ROA SIZE Definition dividend to sales sales growth rate leverage, total liability to total assets retained equity to total common equity Source Compustat Data set-NA&Global Compustat Data set-NA&Global Compustat Data set-NA&Global Compustat Data set-NA&Global Compustat Data set-NA&Global Compustat Data set-NA&Global Compustat Data set-NA&Global cash to total assets profitability,return on total assets Natural logarithm of total assets Panel B: for smoothness Dit Compustat Data set-NA&Global Compustat Data set-NA&Global Compustat Data set-NA&Global the target dividendat time t NI Di(t-1) the lagged actual dividend Table 3 Summary statistics Panel A: Firm-level data Variable USA N For Level 11673 Div TD/TA 11673 11673 SIZE 11673 SGR 11673 ROA 11673 RE/TE 11673 CASH For Stability 119981 Dit NI 119981 Mean Median China N 0.046 0.457 5.612 0.164 0.117 0.217 0.145 0 0.487 5.584 0.117 0.051 0.397 0.063 1680 1680 1680 1680 1680 1680 1680 0.062 0.524 5.516 0.2 0.047 0.012 0.173 0.038 0.517 5.466 0.173 0.034 0.141 0.141 13353 13353 13353 13353 13353 13353 13353 29.776 56.3 0 1.224 11166 11166 118.518 210.561 28.859 37.521 131147 131147 12 Mean Median All N Di(t-1) 119981 27.554 0 11166 97.996 26.514 131147 N USA CHI 56 632 3268 3830 868 1702 979 310 28 26 102 520 556 195 120 61 20 9 TOTA L 82 734 3788 4386 1063 1822 1040 330 37 1996 1997 1998 1999 839 797 710 15 2005 2006 747 8 2007 649 327 627 415 600 319 Table 3 Summary statistics Panel B:Industry definition SIC Industry definition Agriculture,Forestry,and Fisheries Construction Industries The first digit of SIC 0 1 2 3 4 5 7 8 9 Manufacturing Manufacturing Transportation, Communications Wholesale Trade,Retail Trade Service Industries Service Industries Service Industries Panel C:Years Observations 1991 1992 1993 1994 1995 Years Number of observations by years USA 706 724 728 833 869 China 2000 2001 2002 2003 2004 Years Number of observations by years USA 633 512 492 588 619 China 20 51 90 107 256 Panel D: Number of observations by country Country N N Level Stability USA 11673 119981 China 1680 11166 13 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 14 Table 4 Regressions 1-Regressions of dividends on six proxies(USA all firms & China all firms) USA Variable Coefficient Standard Error p-value Intercept -0.00125 0.00075899 0.1008 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 Intercept 0.02902 0.00407 <.0001 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 Intercept TD/TA SIZE SGR ROA RE/TE CASH Years 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 15 R square 0.159 R square 0.1337 China Intercept TD/TA SIZE SGR ROA RE/TE CASH 0.1833 0.0859 -0.0324 -0.1258 0.5957 -0.1774 -0.1833 1999 2000 2001 2002 2003 2004 2005 2006 2007 Average Standard error 0.0011 0.0015 -0.0043 -0.0034 0.0017 -0.0041 0.0031 0.0023 0.0027 -0.0004 0.0024 -0.0044 -0.0015 0.0061 0.0089 0.0065 0.0048 -0.0051 -0.0017 -0.0071 -0.0036 0.0069 0.0017 0.0013 0.0012 0.0007 0.0005 0.0014 0.0015 0.0010 0.0014 0.0018 0.0008 -0.0094 -0.0018 -0.0132 -0.0245 -0.0082 -0.0278 -0.0170 -0.0130 -0.0146 -0.014 0.0061 0.1010 0.1143 0.1095 0.1523 0.1028 0.1507 0.0730 0.1207 0.1724 0.1150 0.0254 0.0002 -0.0008 0.0035 0.0008 0.0021 0.0001 0.0006 -0.0012 -0.0069 0.0002 0.0021 0.0015 0.0028 0.0164 0.0143 0.0098 0.0272 0.0362 0.0332 0.0311 0.0142 0.0117 0.0878 0.0613 0.0338 0.0444 0.0480 0.0435 0.0327 0.0196 0.0178 0.0572 0.0488 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 0 -0.0585 0.0007 -0.0067 -0.0599 0.0021 -0.0150 -0.0187 1 -0.0287 0.0006 -0.0037 0.0150 0.0008 -0.0102 0.0293 2 0.0000 0.0039 -0.0250 0.1659 0.0006 0.0259 0.0157 3 -0.0089 0.0015 -0.0154 0.0913 0.0013 0.0237 -0.0003 4 -0.0140 0.0010 -0.0165 0.1498 0.0003 -0.0391 -0.0106 5 -0.0072 0.0003 -0.0097 0.0550 0.0006 0.0087 0.0207 7 0.0035 0.0011 -0.0099 0.0985 0.0008 0.0136 -0.0044 8 0.0057 -0.0003 -0.0103 0.1806 0.0019 0.0409 -0.1035 9 -0.0062 0.0027 0.0027 -0.1012 -0.0023 0.0750 -0.0279 16 -0.0045 -0.0060 -0.0277 -0.0409 -0.0218 -0.0155 -0.0257 -0.0149 -0.0329 -0.0104 0.0357 SIZE 0.0018 0.0021 -0.0030 -0.0027 0.0045 -0.0040 0.0044 0.0023 0.0122 -0.0067 -0.0070 0.0003 -0.0003 -0.0001 -0.0010 0.0025 0.0027 0.0057 -0.004 0.0108 SGR 0.0078 -0.0350 -0.0072 -0.0163 -0.0220 0.0004 -0.0394 -0.0174 -0.0211 0.0097 0.0081 -0.0141 0.0025 -0.0179 -0.0128 -0.0312 -0.0120 -0.0185 -0.021 0.0389 -0.4669 -0.0345 0.0848 0.3432 0.0885 0.2304 0.3310 0.2842 0.2093 0.1666 0.2822 ROA 0.3978 0.3902 0.2540 0.1678 0.2324 0.0743 0.5928 0.1326 0.1766 -0.0120 0.0177 0.0111 -0.0449 -0.0131 -0.0225 0.0032 -0.0009 0.0006 -0.0238 0.0568 RE/TE 0.0666 -0.0121 0.0012 0.0038 0.0053 0.0044 -0.0004 0.0491 -0.0017 0.0363 0.0252 0.0257 -0.0128 0.0089 0.0006 -0.0436 -0.0181 -0.0332 -0.019 0.063 CASH -0.0111 -0.0042 -0.0027 -0.0086 -0.0430 -0.0243 -0.0197 -0.0353 -0.0182 is not so obvious in China, since the coefficient on RE/TE, though positive, is insignificant with a pvalue 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) 17 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, 18 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 19 Table 6 Regressions of dividends on current income and lagged actual dividend USA Variable Coefficient Standard Error Intercept 6.344991739 0.435045409 NI 0.060806325 0.000667027 0.726143972 0.002246784 Di(t-1) China Variable Coefficient Standard Error Intercept 17.83378933 2.652151141 NI 0.266392931 0.002380604 0.455041523 0.00660499 Di(t-1) 20 t-value 14.58467 91.16024 323.1926 p-value 3.87E-48 0 0 R square 0.612262 t-value 6.724273 111.9014 68.8936 p-value 1.85E-11 0 0 R square 0.951941 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. 21 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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