Life Cycle Hypothesis: Dividend Policy

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2.2 Life Cycle Hypothesis
The life cycle hypothesis, first proposed as a concept in marketing, has been extended to other fields such as microeconomics, management and finance (Yan, 2006).When the theory is applied to dividend policy, it predicts that dividend payouts vary among different stages of firm’s life cycle. At first, firms tend to have high investments and exploit their opportunities so dividend payout is low or even not existent (Anthony & Ramesh, 1992). As firm matures and becomes bigger, dividend payout increases but it again decreases once profit decreases (DeAngelo & DeAngelo, 2006).

Grullon, Michaely, Swaminathan (2002), who conduct a study with a sample of listed firms on New York and American stock exchange during the period …show more content…

As the firms progress as a growing concern towards maturity, they lean towards paying dividends as well as limiting the availability of free cash flows at the control of management. The authors observe the earned/contributed capital mix (measured by the ratio of retained earnings to total equity or total assets) as a key determinant of dividend policy, controlling for profitability, growth, firm size, total equity, cash balances, and dividend history. The ratio is employed by DeAngelo, DeAngelo and Stulz (2006) to identify each firm position along its life cycle. When firms are in the high growth stage, they depend heavily on the external sources to fund their investments owing to their low earnings capacity. Thus ratio of retained earnings to total equity or total assets will be low for young high growth firms. In contrast, when firms are in mature stage, they have high free cash flows but few investment opportunities and will largely be self-financing. Hence, this ratio will be high for mature firms. They show that the mix of earned/contributed capital has a quantitatively greater impact than measures of profitability and growth …show more content…

Thanatawee (2011) conducts study on dividend policy of listed firms in Thailand over the period 2002 to 2008 and reports that larger and more profitable firms with higher free cash flows and have maintained high earnings relative to total equity are more likely to have a high payouts. Besides, their study shows that for firms those have higher growth opportunities, proxied by market-to-book ratio, tend to have lower dividend payout ratio but higher dividend yield. His study provides support for the free cash flow and life cycle hypotheses.
Studies of mentioned researchers contributed to introduce the earned/contributed capital mix as a basic measure for life cycle stage of firms. After that, most studies have used the mix of earned/contributed capital as firms’ life cycle measurement (Chay and Suh, 2009; Wang et al. 2011). In this study, I will employ the measurement of DeAngelo et al. (2006) who mainly conduct the test of life cycle theory among the American publicly traded industrial firms during the periods 1973 and 2002, I test whether the earned/contributed capital mix is still the determinant of the payout policy in Vietnamese

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