Why Has the Dividend Payout Ratio Increased?

Why has the dividend payout ratio increased in recent years? According to the article below, there are several possible reasons: (1) Concerns about future returns. When investors expect the market rate of return to exceed the internal rate of return for the firm, they would prefer to have dividends paid out instead of reinvested internally. Thus, as investors anticipate lower rates of return in the future, they will shift towards firms offering dividends and away from firms that use profits for internal reinvestment. (2) The tax act of May 2003 made dividends relatively more attractive from a tax perspective. (3) A change in corporate compensation law has led to a restructuring towards compensation packages that rely more heavily on dividends. (4) There has been a recent shift by investors towards assets with less risk, and historically firms with both solid growth and yield characteristics have less risky overall returns.

Besides the changes in tax law, there are two notable changes causing the shift towards dividends. The first is the fall in expected growth opportunities which causes the fall in expected rates of return. To the extent that the shift has been driven by investor’s perception of slower growth in the future, that is not a postiive sign for the economy. The second is the shift towards less risky assets. This may also signal uncertainty regarding future economic conditions. As noted below, historically firms with a history of solid growth and dividend payments have returns, as you would expect from their general health, that perform well in volatile markets. Thus, these types of firms provide a degree of insurance against uncertain future returns. Here's the story from the AP:

Dividend-Paying Stocks May Lead a Trend, By Meg Richards, AP: The emerging leadership of dividend-paying stocks has … renewed interest in what was once considered an old-fashioned investment. Dividends … The dividend revolution is most clear in the technology sector, where they've grown at a rate of 44 percent over the past two years. ... Historically, dividends have played a much more important role than they currently do, accounting for about 4 percentage points of the roughly 10 percent average annual return stocks have delivered since 1926. But their popularity waned during the bull market, and … struck an all-time low of 1.1 percent in 2000. ... Now that number has climbed to …1.9 percent. The rate of payout has been on the rise, as well …

… some of this [is due] to the tax act of May 2003, which lowered the rate for long-term capital gains and qualified dividends to 15 percent … Prior to that, dividends were taxed … at rates as high as 35 percent. … Why now, two years after the tax act was passed, are dividends taking the lead? … One of the reasons for the recent pullback in stocks was investors' concerns about earnings growth. … Another factor is the rush to restructure compensation packages before the end of the year, when corporations will be required to start expensing stock options at fair value. … On top of that, research suggests high-quality companies with both growth and yield characteristics are poised to produce market returns with meaningfully less risk. They're a safe place to seek shelter when volatility strikes… They've also performed well historically, …

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