Dividends, Share Repurchases, and the Substitution Hypothesis

51 Pages Posted: 26 Apr 2000

See all articles by Gustavo Grullon

Gustavo Grullon

Rice University - Jesse H. Jones Graduate School of Business

Roni Michaely

University of Geneva - Geneva Finance Research Institute (GFRI); Swiss Finance Institute

Date Written: April 2000


Over the past 20 years share repurchase programs have become an important payout method for US firms. Are these repurchases substitute for dividends? And if so, why has it taken so long to start to pay shareholders in a way that reduces their tax liability? Analyzing this trend we show that, unlike in the past, young firms have a strong tendency to pay cash through repurchases rather than dividends and that repurchases have become the preferred form of payout among firms initiating cash distributions to their equityholders. Large-established firms also show a higher propensity to payout cash through repurchases. Although we do not find that these firms have been cutting dividends, it seems that they have been financing their repurchase programs with funds that otherwise would have been used to increase dividends. These findings indicate that large-established firms have been gradually substituting repurchases for dividends. We also find evidence that suggests that investors view dividends and share repurchases as substitute payout methods. Specifically, we show that (1) the market reaction to dividend cuts is not significantly different from zero for repurchasing firms and (2) the market reaction surrounding share repurchase announcements is significantly more positive during periods where the benefit of substituting share repurchases for dividends is relatively large. Finally we address the question of why corporations have been waiting for so long to substitute repurchases for dividends. We present evidence consistent with the notion that regulatory constraints inhibited firms from aggressively repurchasing shares until 1982. Our findings may provide a partial explanation for the dividend puzzle.

JEL Classification: G35

Suggested Citation

Grullon, Gustavo and Michaely, Roni, Dividends, Share Repurchases, and the Substitution Hypothesis (April 2000). AFA 2002 Atlanta Meetings. Available at SSRN: https://ssrn.com/abstract=222730 or http://dx.doi.org/10.2139/ssrn.222730

Gustavo Grullon (Contact Author)

Rice University - Jesse H. Jones Graduate School of Business ( email )

P.O. Box 2932
Houston, TX 77252-2932
United States
(713) 348-6138 (Phone)
(713) 348-6331 (Fax)

HOME PAGE: http://www.ruf.rice.edu/~grullon/

Roni Michaely

University of Geneva - Geneva Finance Research Institute (GFRI) ( email )

40 Boulevard du Pont d'Arve
Geneva 4, 1211

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4

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