FINANCING PAYOUTS. Joan Farre-Mensa Roni Michaely Martin Schmalz

Transcription

1 FINANCING PAYOUTS Joan Farre-Mensa Roni Michaely Martin Schmalz

2 BACKGROUND Payout literature has long argued that payouts are primarily funded with internal funds At the same time, tradeoff theories capital structure predict that firms should actively counteract unexpected decreases in leverage A possible disconnect!! The paper contributes to literature along three dimensions: systematically analyze how firms fund their payouts externally financed discretionary payouts have implications for the drivers of firms payout and capital structure policies paper relates to the on-going policy debate regarding the effects of monetary policy on corporate behavior 2

3 RESULTS Extent to which firms rely on the capital markets to fund their payouts: 42% of firms (89-12) that pay out also initiate debt or equity issues in the same year, 32% of aggregate payouts externally financed Most firms with simultaneous payouts and security issues do not generate enough profits to fund both Firms devote more external capital to finance share repurchases than to avoid dividend cuts Debt is the main source of payout financing Key driver: jointly manage capital structure and liquidity (tax or agency reasons) Market timing and investor activism also playing significant roles 3

4 AGGREGATE PAYOUT AND CAPITAL RAISING ACTIVITY Sample Selection: All public U.S. firms that appear in the Compustat-CRSP merged files from 1989 to ,198 unique firms and 86,609 firm-year observations Aggregate payout and capital raising activity 4

5 HOW COMMON AND LARGE ARE FINANCED PAYOUTS? In average sample year, 20% of all public U.S. firms both paid out capital and initiated a net debt or an equity issue 42% of payout payers raise capital in the same year and 46% of security issuers also pay out capital on average over our sample period, 32% of the aggregate capital paid out by public U.S. firms is proactively raised by the same payers during the same year The role of debt and equity issues: debt dominates (both nondiscretionary and discretionary payouts): 30%; while firm- and employee-initiated equity issues finance 3% and 11% 5

6 THE GAP BETWEEN PAYOUTS AND FREE CASH FLOW Simultaneous payouts driven by inability to fund: whenever a firm has a TPG, the firm needs to initiate a net debt or an equity issue while it simultaneously pays out Gap definition captures how much capital firms could avoid raising by decreasing their payout while maintaining their profitability and investment levels and at least a normal level of cash 41% of all payers, or 20% of all public firms, set payout levels that, given their investment level, they need to finance by raising capital 6

7 GAPS DRIVEN BY NON-DISCRET./DISCRET. PAYOUTS? 7

8 WHY DO FIRMS FINANCE THEIR PAYOUTS? The costs of financed payouts: NO cost in MM World. However, firms pay on average 0.6 cents in transaction costs for each $1 of payouts they finance by issuing debt Information frictions in the capital markets can cause the wedge between firms external and internal costs of funds to be larger. firms that conduct debt-financed payouts see their probability of default increase by 0.35 percentage points on average transaction costs associated with $1 of equity-financed payout average 4.9 cents 8

9 CHARACTERISTICS OF FIRMS THAT DEBT-FINANCE PAYOUTS 9

10 CHARACTERISTICS OF FIRMS THAT DEBT-FINANCE PAYOUTS Column 1: Probit model X includes controls for firm size, an indicator for whether the firm has an investment-grade credit rating, profitability, investment, excess leverage and excess cash, the tax cost of repatriating the firm s foreign profits, and market-to-book. Column 2: condition the sample on those firms that pay a discretionary payout and estimate a fractional logit model 10

11 JOINTLY MANAGE CAPITAL STRUCTURE AND CASH HOLDINGS Debt financed payouts result in increased leverage. Two unique implications: leverage increment effect is magnified without depleting their cash reserves 11

12 WHY DO FIRMS MANAGE THEIR CAPITAL STRUCTURE? Tax Benefits Percentile Tax Rate Tax Rate (firms without debt financed payout % 2.8% % 5.3% % 12.2% % 27.7% % 33.4% firm s probability of conducting a debt-financed payout increases by 2 p.p. following a tax increase in its headquarter state So, firms use debt financed payouts to jointly manage their leverage and cash holdings thereby minimizing their tax bill in a way that would be impossible to replicate if they funded their payouts internally. 12

13 INVESTOR ACTIVISM Firms that have been targeted by activist hedge funds tend to have higher payouts, thus raising the following question: To what extent are these payouts financed with simultaneous debt issues? Examined whether financed payouts are more common in industries that have been targeted by activist hedge funds. Consistent with the spillover effects, in industries with higher activism activity (as measured by the fraction of firms targeted by activists), firms are more likely to conduct debt financed discretionary payouts; conditional on paying out, they also tend to debt-finance a larger fraction of their payout. 13

14 MARKET TIMING Managers attempts to profit from situations in which they think their debt is overvalued relative to their equity Range of evidence. debt-financed payouts are: procyclical both more common and larger when the excess bond premium and term premium is low The fraction of the payout financed by debt are higher for firms with low market-to-book. Similarly, debt-financed payouts are more common and larger when stock sentiment is low. 14

15 GOVERNMENT DEBT POLICIES AND MARKET-TIMING MOTIVES unusually large divergence in the costs of debt and equity due in part to the cumulative effects of our LSAP [large-scale asset purchases] policies is likely to be one factor that makes debtfinanced repurchases of equity attractive. -Jeremy Stein, 2012 Higher government borrowing is associated with a lower propensity for firms to debt-finance their payouts Potentially unintended consequence of the QE program might have been to incentivize firms to hold higher leverage, thereby increasing the financial fragility of the economy 15

16 POTENTIAL BENEFITS OF EQUITY-FINANCED PAYOUTS 16

17 CONCLUSION Majority of firms engaging in payout-financing behavior do not generate enough operating cash flow to fund their investment and payouts without the proceeds most externally financed payouts are discretionary and can t be explained by firms desire to avoid regular-dividend cuts firms use debt-financed discretionary payouts to adjust their capital structure without depleting their cash reserves Tax Savings Market timed and influenced by investor activism The relation between payouts, cash, and capital structure is far from mechanical when one conditions on how payouts are financed. 17

18 THANK YOU 18