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Propensity to pay dividends and catering incentives in Thailand

posted Jul 13, 2013, 1:01 AM by Nopphon Tangjitprom
This is summarized from the paper published in "Studies in Economics and Finance" by Nopphon Tangjitprom in 2012. 

Dividends is a reward to investors holding shares of a company. It is a fraction of a firm's profit that is paid to shareholders proportionally to the shares they own. However, after dividends are paid, retained earnings will be lower. This may affect a firm's ability to reinvest and restrict the future growth of the firm. Consequently, potential capital gain is reduced by dividends income. Additionally, income from dividends is immediately taxed in most countries while capital gain taxation can be delayed. This tax difference between dividends and capital gains will vary from jurisdiction to jurisdiction, but in general capital gains have a clear tax advantage. In Thailand, dividend incomes are subject to tax but the capital gains are exempted. As dividends have tax disadvantages, it is also interesting to explain why Thai firms pay dividends. 

This creates a doubt why firms should pay dividends. Many theories try to explain this phenomenon. Agency theory explains that dividend payment can reduce agency problem in a firm. One of the recent theory proposed during the last decade is the catering theory of dividends by Baker and Wurgler (2004). In this theory, firms pay dividends in order to cater investors' demand for dividends. This demand can be gauged by dividend premium, which is the different between market-to-book ratio of dividend paying firms and non-paying firms. 

The finding from this paper show that investors in Thailand prefer dividends and pay relatively higher price for the stocks of firms paying dividends, which can be seen by positive dividend premiums. The evidences in this paper have shown that more number of firms will pay dividends if there are catering incentives from positive dividend premiums. Moreover, dividend premiums play the important role to discourage managers to cut dividend payment; especially they are far from omitting dividends when dividend premiums are high.

You can read the full article from here