A Growth Type Explanation for Persistence in Retained Earnings and Propensity to Pay

40 Pages Posted: 2 Apr 2009

See all articles by Xueping Wu

Xueping Wu

City University of Hong Kong (CityU) - Department of Economics & Finance

Chau Kin Au Yeung

The Chinese University of Hong Kong (CUHK)

Date Written: March 9, 2009

Abstract

Recent research has found a positive relationship between firm propensity to pay (PTP) and retained-earnings-to-total-equity ratio (RE/TE). Motivated by a lifecycle theory of dividends, researchers have interpreted RE/TE as a proxy for firm maturity stage. This paper shows that the RE/TE ratios are surprisingly persistent. Consequently, while high-RE/TE firms always have a high PTP, low-RE/TE firms (more than 40% of all firms actually start with a negative RE/TE) always have a low PTP and typically do not pay dividends. We present a growth type explanation for this cross-sectional persistence. Firms with low RE/TE ratios tend to be high growth firms; low (and especially negative) RE/TE ratios reflect persistently heavy issues of new equity and large R&D investments that pay off slowly-a phenomenon related to high growth-type, consistent with the prediction by a generalized Myers-Majluf model. We postulate that low-RE/TE firms, if they start paying dividends, may confuse the market and be pooled with low-growth firms that usually pay dividends. Thus, the absence of dividend paying is consistent with high growth-type and does not hinder the investment plans of low-RE/TE or high-growth-type firms. We conclude that it is growth type and not lifecycle that best explains PTP persistence.

Keywords: Dividends, Propensity to Pay, Retained Earnings, Growth Type, Persistence

JEL Classification: G32, G35

Suggested Citation

Wu, Xueping and Au Yeung, Chau Kin, A Growth Type Explanation for Persistence in Retained Earnings and Propensity to Pay (March 9, 2009). Available at SSRN: https://ssrn.com/abstract=1355804 or http://dx.doi.org/10.2139/ssrn.1355804

Xueping Wu

City University of Hong Kong (CityU) - Department of Economics & Finance ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong
+852 3442 7577 (Phone)
+852 3442 0195 (Fax)

HOME PAGE: http://personal.cityu.edu.hk/~efxpwu/

Chau Kin Au Yeung (Contact Author)

The Chinese University of Hong Kong (CUHK) ( email )

Shatin, N.T.
Hong Kong
Hong Kong

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