The effect of dividends on consumption

Brookings Papers on Economic Activity

Volumn , Issue 1, 2007, Pages 231-276

  Baker, Malcolm ^a   Nagel, Stefan ^b   Wurgler, Jeffrey ^c  

^a HARVARD UNIVERSITY   (United States)

^b STANFORD UNIVERSITY   (United States)

^c NEW YORK UNIVERSITY   (United States)

Author keywords

[No Author keywords available]

Indexed keywords

EID: 34848835474     PISSN: 00072303     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Conference Paper

References (41)

1. Miller and Modigliani ( 1961).
2. Mental accounting behavior of this sort is discussed in detail in Thaler and Shefrin (1981), Shefrin and Statman (1984), and Shefrin and Thaler (1988).
3. This data set was introduced by Barber and Odean (2000).
4. See Feldstein (1973), Feldstein and Fane (1973), Peek (1983), Summers and Carroll (1987), Poterba (1987), and Poterba (2000).
5. To our knowledge, the only paper to use micro data in this context is a contemporaneous paper by Rantapuska (2005). He analyzes Finnish investor registry data and finds that there is little reinvestment within two weeks after receipts of dividends or tender offer proceeds. His results are broadly consistent with and complementary to ours, but there are some important differences. In particular, the CEX data allow us to look at actual consumption, not just reinvestment. Moreover, reinvestment may occur over horizons much longer than two weeks, an issue that our brokerage account data allow us to investigate. Finally, automatic reinvestment plans are absent in Finland but common in the United States, so the effect of dividends on consumption and reinvestment could be quite different in any case.
6. For instance, Souleles (1999) finds that consumption responds to federal income tax refunds whether or not the household faces borrowing constraints, and Souleles (2002) documents that consumption responds to preannounced tax cuts. Related studies in this vein include Bodkin (1959), Kreinin (1961), Wilcox (1989), Parker (1999a), Stephens (2003), and Johnson, Parker, and Souleles (2006).
7. See Campbell (2006).
8. We use the average estimates in the interview survey of the CEX, not the more detailed records from the diary survey.
9. This definition follows Parker (2001).
10. The surveys do not ask respondents to include retirement assets, but they also do not ask explicitly to exclude them, so it is unclear whether some respondents include them.
11. To preserve the anonymity of respondents, the CEX administrators reset observations above certain thresholds on wealth, income, and some other variables to a cutoff threshold value. Before 1995 the topcoding level was $100,000 for many items in the survey. However, since the topcoding threshold applies to single items, the total value of variables such as income after tax, for example, which is calculated as the sum of many single items, can be much larger than $100,000. After 1995, the topcoding thresholds were raised.
12. Under the basic form of the permanent income hypothesis, permanent income determines consumption, and so the right-hand-side variables in equation 1 matter to the extent that they are correlated with permanent income. In models of buffer-stock saving with impatience, such as those of Deaton (1991) and Carroll (1997), consumption depends on cash on hand (liquid wealth plus current income) relative to its target level.
13. This approach follows Hayashi (1985), Carroll (1994), and Parker (1999b).
14. The quarterly interviews are conducted for overlapping ends of quarters, and so we need year-month fixed effects, not simply year-quarter fixed effects.
15. The income variable does not include capital gains (realized or unrealized), so we only need to subtract dividends. In specifications where dividends plus interest is the explanatory variable, we subtract dividends and interest.
16. See Graham and Kumar (2006) and references therein for clear evidence of dividend clienteles. Graham and Kumar show that the allocation to and trades of dividend-paying stocks depend on investor characteristics.
17. t-1 term in the residual is negatively correlated with dividend changes, and hence this should lead to a downward bias on the dividend change coefficient. This effect would bias the test against our hypothesis.
18. See Johnson, Parker, and Souleles (2006) for a similar dummy variable approach to analyze the effect of tax rebates on log consumption.
19. Dividends in our data are measured before tax. Our regressions therefore show the relationship between before-tax dividends and consumption. If one were to use after-tax dividends, the fraction that goes into consumption would exceed 16 cents of every dollar. At the same time, however, it is also not clear how households treat taxes on dividends in a mental accounting framework. Since taxes on dividends are not withheld, the before-tax dividend cash flow and the tax payment occur at different points in time. To what extent households "integrate" the before-tax dividend cash flow with the subsequent tax payment, and to what extent it is more appropriate to view them instead as separate income streams with possibly different effects on consumption, are interesting questions. Unfortunately, we cannot answer them with the data at hand. Our focus instead is on documenting that dividends have an independent effect on consumption, and showing that before-tax dividends affect consumption is sufficient for that purpose. The 0.16 unit consumption effect of 1 unit of dividends could in principle be compared with the coefficient on labor income. However, in our specifications we see income and wealth variables merely as controls for all the potential determinants of households' consumption rule that could be correlated with dividends. We would prefer not to claim that we have a complete and correct model that would deliver the marginal propensity to consume out of income. Nonetheless, for the interested reader, the total effect of current and lagged income is 0.18 in regressions 2-1 and 2-2, 0.71 in regression 2-5, and 0.70 in regression 2-6. So the effect of after-tax labor income is in the same range as that of before-tax dividends.
20. Winsorizing replaces all observations in the tails of the distribution (in this case the top and bottom 5 percent) with the observed values at the 5th and the 95th percentiles, respectively. In the base case nondurables regression (regression 2-1) in table 2, the coefficient on the total return drops to -0.02 with a standard error of 0.02. In the base case total expenditure regression (regression 2-5) in table 2, the coefficient rises to 0.01 with a standard error of 0.04.
21. In a paper that is similar in spirit, Choi and others (2006) use shifts in savings into 401 (k) plans to identify changes in consumption.
22. See Barber and Odean (2000) for more details about the data set.
23. This method follows DeAngelo, DeAngelo, and Skinner (2000).
24. The results below are robust to choosing different cutoffs. For example, they are quantitatively similar when 5 percent or 0.5 percent of the most extreme observations are eliminated. But some deletion of outliers is necessary: the most extreme single observation would otherwise account for about one-third of the sum of squared net withdrawals (even though there are close to 100,000 observations in total), making any regression analysis practically meaningless.
25. Data from the Survey of Consumer Finances for 1992 and 1995 show that 87 percent and 89 percent, respectively, of U.S. households with a brokerage account have only one brokerage account. This suggests that our brokerage account data often capture at least the entire wealth these investors have invested in brokerage accounts.
26. t and their lags, respectively, are uncorrelated. In our data these correlations are low, so both approaches lead to similar results. For simplicity, we report results from the summed lags approach.
27. A closely related, but behavioral, explanation for the high propensity to consume current income is hyperbolic discounting as in Angeletos and others (2001).
28. See Odean (1999) and Barber and Odean (2000) for more general arguments that investors trade too much and fail to properly consider transaction costs.
29. See Odean (1998).
30. Note that the issue of permanence of wealth shocks correlated with dividends is unrelated to the issue of whether companies set dividends equal to the permanent component of earnings. It is perfectly possible for a company's earnings to have a strongly transitory component while its stock returns are entirely permanent, and vice versa. The relevant issue here is the permanence of stock returns, not of earnings.
31. See Poterba and Summers (1988), Fama and French (1988), and Campbell and Shiller(1988).
32. See Lettau and Ludvigson (2004).
33. Vuolteenaho (2002) and Cohen, Polk, and Vuolteenaho (2006) find that only a small fraction of individual variation in stock returns around the market return is transitory.
34. See Shefrin and Thaler (1988).
35. See also Shefrin and Statman (1984).
36. See Shefrin and Statman (1984).
37. These numbers are from Poterba (2004).
38. See Auerbach and Hassett (2006) for a discussion of the two views on the investment effect of dividend taxes and of the evidence in the context of the 2003 tax cuts.
39. See Chetty and Saez (2005) and Poterba (2004).
40. See Brav and others (2007).
41. Baker and Wurgler (2004a, 2004b) study how investor sentiment affects dividend payment.