15.1How Much of u.S. Corporate Earnings Is Distributed to Shareholders?Aggregate Share Repurchases and Dividends

Exhibit 15.1 summarizes aggregate dividend and repurchase behavior for publicly traded

firms in the United States between 1972 and 1998. The exhibit reveals that the ratio of

dividends to earnings, the dividend payout ratio, declined over this time period from

about 22 percent to about 14 percent. Over this time period the ratio of share repur-

chases to earnings increased from about 3 percent to about 14 percent. As a result, the

total payout of cash to shareholders was relatively stable at about 25 percent of earnings.

EXHIBIT15.1Dividend and Repurchase Payout Ratios

35%	Dividend Payout
	Repurchase Payout

	Total Payout
30%

25%

20%

15%

10%

5%

0%

19801982198419861988199019921994199619982000

Source: Gustovo Grullon and Roni Michaely, 2000, “Dividends, Share Repurchases and the Substitution Hypothesis,”Rice Universityworkingpaper.

²In addition, as Chapter 21 discusses, the taxes and transaction costs associated with distributing cash

also provide an important motive for why firms hedge their cash flows.

Grinblatt1081Titman: Financial	IV. Capital Structure	15. How Taxes Affect	© The McGraw1081Hill
Markets and Corporate		Dividends and Share	Companies, 2002
Strategy, Second Edition		Repurchases

534Part IVCapital Structure

The emergence of share repurchases, as a method of distributing earnings to

shareholders, is relatively recent. Share buybacks were rare and generally negligi-

ble in size in the United States prior to 1971, when President Nixon imposed wage

and price controls that placed restrictions on dividend payouts. These restrictions

induced a number of firms that wanted to increase the cash distributed to share-

holders to consider repurchases. The repurchase alternative received a further boost

at the end of 1982, when SEC rule 10b-18 was adopted. This rule provided guide-

lines for firms that wished to repurchase shares on the open market. Because of the

clarification provided by this rule, open market repurchases became increasingly

important starting in the mid-1980s and accounted for the substantial increase in

repurchases observed since then. Subsequently (mainly in the 1990s), similar regu-

lations that allowed repurchases were adopted in most countries with well-developed

stock markets.

Bagwell and Shoven (1989) reported that the first billion-dollar share repurchase

by a major corporation was the $1.4 billion repurchase by IBM in 1977. Since that

time IBM as well as many other well-known companies, among them Union Car-

bide, Goodyear, Teledyne, and Exxon, repurchased over half of their outstanding

shares.

Dividend Policies of Selected U.S. Firms

Exhibit 15.2 provides a representative sample of well-known U.S. corporations and

their dividend yields, the ratio of the dividend per share to the price per share, and

dividend payout ratios,the ratio of the dividend per share to the earnings per share

(income before extraordinary items) for 1993 and 1999. The exhibit reveals major

differences in the dividend policies of various types of firms. The high-tech growth

firms have both low dividend yields and low payout ratios. In 1999, Microsoft and

Apple paid no dividends while Hewlett-Packard had a payout ratio of about 20 per-

cent and a yield of less than 1 percent. However, the old economy companies like

Deere, Dow Chemical, Minnesota Mining & Manufacturing, Philip Morris, and Tex-

aco pay out over half of their earnings in dividends. Also note from Exhibit 15.2 that

both dividend yields and payout ratios have fallen for most firms. This is partly due

to the continuing trend of firms substituting share repurchases for dividends.