1. COURSE TITLE: SEMINOR IN FINANCE COURSE CODE: MPH 622
Presentation on
Dividends and Stock Prices
By
Irwin Friend and Marshall Puckett, University of Pennsylvania
Published in: American Economic Review, September 1964, pp. 656-682.
May 15, 2011

2. Presentation Outline
 Purpose and motivation
 Theoretical & Empirical conclusions
 Justification of the problem
 Research Methodology
 Major Findings
 Critical appraisal

3. Purpose & motivation
Objective: To discuss the limitations of the previous
findings, describe various approaches to avoiding
those limitations, and present new results that seem
more in accord with theoretical preconceptions.
Motivation:
Controversy and confusion over the relative
importance of dividends and retained earnings in
determining the price-earnings ratios of common
stocks.
Next, a questionable statement that the statistical
studies claimed the strong market preference for
dividends.

4. Research Gap
Research Gap:
Market valuation
of RE is lower on
share price (“RE
effect”)

5. Justification of the problem
Guiding principle : A dollar of retained earnings
should be approximately equal in market value of
the dollar of dividends foregone.
Basic regression model used in statistical studies
Pt = a + b Dit + c Rit + eit
Where,
Pt = Stock price
Dit = Dividend per share of i company
Rit = Retained earnings of i company
eit = stochastic terms

6. Comments Loopholes
Omitted variables Risk variable and externally financed growth rate.
Regression weights Extreme values are much more important but
omitted
Random variations in
income
Short-run reporting of income and dividend
payout influence bias
Income measurement
errors
Diversity of accounting procedures employed in
business earning rise to measurement errors
Least-squares bias Assumes one way causality between dividends
and price, rather dual causality requires the use
of a complete model
Reasons of statistical studies yielded biased results:

7. Comments Modifications
Omitted variables The problem of omitted variables managed by
expanding the regression equation to include
these variables as separate effects (Fi) on price.
Regression weights Introduced firm effects and the multiplicative
relationship in regression model which curve the
regression weight biases.
Random variations in
income
Introduced the lagged price variable in the
regression model – the problem of random
income movement is managed.
Income measurement
errors
Market estimates for earning normalization is
used to meet the problem of short-run earnings
movements.
Least-squares bias The problem of least-squares bias handled by
specifying a complete model including a dividend
supply function as well as the customary price
relation.
Verification
Finally, the influence of dividend payout on stock
price subjected to time series analysis and its
validity were checked.
Someinterventionssuggestedtocurvetheproblemson
regressionmodelusedbythestatisticalstudies

8.  Population: Cyclical & noncyclical industries in US
 Sample: 5 industries
(chemicals, electronics, electric utilities, foods, and
steels)
 Data collection: Secondary sources
(Accounting data of selected firms was derived under
the sample industries)
 Study period: 1956 and 1958
 Focus of the study: Dividend and retained earnings effects
on stock price
Methodology

9. Major findings…..
Usual linear relationship - customary strong
dividend effect and relatively weak retained
earnings effect in three of five industries.
In growth industries (chemical, electronics
and electric utilities) more weights relatively
is given to retained earnings than in non-
growth industries (foods and steels) but the
evidence is not uniform. (ref. table 1)

10. Major findings…..
Holding the firms’ effects constant, dividends
have a predominant influence on stock prices.
(ref. table 2)
The price effects on dividend supply are
probably not a serious source of bias, in the
customary derivation of dividend and retained
earnings effects on stock price. (ref. table 3)

11. Major findings…..
Short-run adjustment in prices to current level of
income, the findings suggested that retained
earnings receive greater relative weights than
dividends in the majority of the cases. (ref. table
4)
Based on the normalized procedure on retained
earnings, the finding support the customary
results (ref. table 5). When, the firm effects hold
constant, the results again support the same
customary relation. (ref. table 6)

12. Major findings…..
The detailed analysis of chemical industry,
suggested that the retained earnings become
somewhat more important than dividends as a
price determinant. (ref. table 7)
The firms level analysis under chemical industry,
suggested that price-earnings ratio may have
some tendency to move inversely (12 of 20, -ve)
to the payout ratio in contrast to the customary
assertion and, it is significant. The inverse
movement indicated the strong evidence that the
customary results are invalid. (ref. table 8)

13. In summary…..
The study concluded that in unusual growth
stocks, (chemical industry) dividends has weak
effect on stock price than the retained earnings. In
non-growth industries, investor preferred
dividends.
The study also raised the issue of optimal payout
ratio when different profitability of investment
opportunities, risk, sources of financing, etc is
possible or whether an optimal payout ratio exists
which to some extent is independent of profit
prospects.

14. The in-depth analysis of commonly used regression
model has provide us the in-depth knowledge. The
study is useful for researchers who want to pursue
through the regression models. Similarly, it is very
much useful for early practitioners and
academicians.
On the other hand, weak points are; major
conclusion is derived from small sample (only 17
chemical companies) and overriding of regression
bias (omitted 3 chemical firms) which was
considered the weakness of previous studies.
Critical appraisal

15. Thank you.