The effect of fiduciary standards on institutions' preference for dividend-paying stocks

Many researchers apparently believe that some institutional investors prefer dividend-paying stocks because they are subject to the "prudent man" (PM) standard of fiduciary responsibility, under which dividend payments provide prima facie evidence that an investment is prudent. Although this was once accurate for many institutions, during the 1990s most states replaced the PM standard with the less-stringent "prudent investor" (PI) rule, which evaluates the appropriateness of each investment in a portfolio context. Controlling for the general decline in dividend-paying stocks, we find that institutions reduced their holdings of dividend-paying stocks by 2% to 3% as the PI standard spread during the 1990s. Studies of asset pricing and corporate governance should no longer consider dividend payments when evaluating the actions of institutional investors.

Institutional investors play a prominent role in US equity markets by making investment choices on behalf of many savers. These institutions' share of US equity ownership has risen from 11% in 1960 to more than 50% in 2000, and they account for an even larger proportion of equity trading volume (Griffin, Harris, and Topaloglu, 2003). Historically, a "prudent man" (PM) standard of fiduciary care caused some institutional investors to avoid holding shares that did not pay cash dividends. The PM standard judged the appropriateness of each security position on a stand-alone basis, and the payment of regular dividends became a "safe harbor" indicator of a stock's "prudence." The literature contains clear evidence that the PM standard caused bank trust departments to shun non-dividend-paying stocks (Del Guercio, 1996; Schanzenbach and Sitkoff, 2007). Moreover, PM restrictions probably had effects far beyond their narrow applicability to trusts. Legal precedents encouraged other fiduciaries to make similar choices as protection against judicial review of their investment decisions. Yet during the 1990s, most states replaced the PM standard of fiduciary care with the less-stringent "prudent investor" (PI) standard, which evaluates the appropriateness of each investment in a portfolio context. These changes should have weakened or eliminated a restriction on many institutional investors' opportunity sets.

Given the importance of institutional investors to the equity market, researchers must understand the extent to which their behavior was (is) subject to special restrictions. Institutions are typically viewed as rational, informed, and profit-oriented investors. They can provide important monitoring (governance) services to firms whose stock they hold (Shleifer and Vishny, 1986; Allen, Bernardo, and Welch, 2000). Institutions are also viewed as arbitrageurs who will seek profits by offsetting "irrational" asset price movements. Researchers have suggested that constraints on institutional holdings of nondividend-paying shares limited their ability to arbitrage apparent market inefficiencies (Badrinath, Kale, and Noe, 1995). Mauer and Senbet (1992) indicated that institutional preferences for dividend-paying shares limited their ability to speculate against IPOs' high initial returns. Kamara (1997) asserted that investing constraints limited the ability of well-informed institutions to correct the "Monday effect" in stock returns caused by the irrational behavior of smaller investors. Chung (2000) noted that institutions exhibit a preference for high-quality companies because of prudence concerns.

Corporate finance issues are also interwoven with constraints on institutional investing. Allen et al. (2000) speculated that the PM restriction might be turned to the firms' advantage if introducing dividend payments serves to attract additional institutional investors, which provide valuable monitoring services. In their 2002 survey, Brav, Graham, Harvey, and Michaely (2005) asked 166 executives at dividend-paying firms whether institutional preferences affected their dividend decisions, and reported,

   The CFOs do not indicate that institutions as a class prefer
 dividends over repurchases, except perhaps the existence of a small
 dividend payout that is needed to attract certain types of
 institutions. (p. 509, emphasis added)

Grinstein and Michaely (2005, p. 1390) examined the institutional ownership proportions of traded stocks from 1980 to 1996 and presented "clear evidence that institutions prefer dividend-paying firms." They further concluded that "institutions do not show any preference for firms that pay high dividends.... In fact, we find some evidence that institutions prefer low-dividend stocks to high-dividend stocks." Gompers and Metrick (2001) and Bennett, Sias, and Starks (2003) also concluded that a stock's institutional holdings varied inversely with its dividend yield over 1980-1996 and 1983-1997, respectively.

Although the PM standard of fiduciary care once applied to many institutional investors, that standard has been largely replaced in state statutes and Employee Retirement Income Security Act (ERISA). Since 1992, 43 states have substituted the less-restrictive PI standard of fiduciary responsibility, which uses modern portfolio theory to assess an investment's prudence in the context of the overall portfolio. If PM biased institutions toward dividend-paying stocks, the change to PI removed this constraint and should have increased their appetite for non-dividend-paying shares. We present evidence here that the states' removal of PM restrictions led institutional investors to expand their holdings of non-dividend-paying stocks during the 1990s.

Do-it-yourself diversity

VisionPoint's Just Be F.A.I.R. is one of the best self-contained video programs I have seen. The first tape, Just Be F.A.I.R., is a good overview of diversity. It explains what it means to be "culturally competent" and introduces the F.A.I.R. concept (feedback, assistance, inclusion, and respect). It also defines how diversity is different from affirmative action and EEO policies. It not only covers the obvious categories that you'd expect--race, ethnicity, gender, age, religion-but also diversity created by the organization, such as titles, hierarchy, salaries, division, and so on. The video makes a good point that diversity is about relationships. A business case is made that organizations need to pay attention to the business environment, change, and diversity to achieve organizational goals. The second tape, F.A.I.R in Action, is a series of four vignettes that highlight the main points of Just Be F.A.I.R. The first situation involves the importance of communicating and not being "color blind" at the expense of recognizing individual identities. The second vignette, featuring an IT worker assisting another employee, focuses on the potential pitfalls of stereotypes. The third is an appropriate example of a person whose religious faith is overlooked at work when its holidays aren't treated with the same seriousness as mainstream holidays. The last situation involves a new team member' who isn't included in evening meetings because child care makes that difficult. The vignettes are all plausible and serve as great discussion points for the application of the principles brought up in the workshop. The real strength of this program lies in the second video introducing common workplace issues that might not be perceived as diversity issues. The excellent facilitator's guide has a series of well-thought-out participant exercises that can get trainees personally involved with the issues. The guide is clear and easy to navigate, and provides a lot of flexibility for the trainer. There are three different programs, ranging from one hour to a full day, and all are coded by numerical steps to the guide so that customization is straightforward. The PowerPoint presentation is also useful. The guide includes a full transcript of the video dialogue. Matthew Reis is manager of organizational development at Babson College in Wellesley, Massachusetts; reis@babson.edu. Product evaluations are provided by Training Media Review and do not imply endorsement by T+D or ASTD. For more information, contact TMR at 87Z532 1838; www. tmreview.com GOT TO WWW.LEARNINGCIRCUITS.ORG to access TMR's reviews of e-learning materials, including e-courses, authoring software, learning management systems, and more.

Do-it-yourself diversity

VisionPoint's Just Be F.A.I.R. is one of the best self-contained video programs I have seen. The first tape, Just Be F.A.I.R., is a good overview of diversity. It explains what it means to be "culturally competent" and introduces the F.A.I.R. concept (feedback, assistance, inclusion, and respect). It also defines how diversity is different from affirmative action and EEO policies. It not only covers the obvious categories that you'd expect--race, ethnicity, gender, age, religion-but also diversity created by the organization, such as titles, hierarchy, salaries, division, and so on.

The video makes a good point that diversity is about relationships. A business case is made that organizations need to pay attention to the business environment, change, and diversity to achieve organizational goals.

The second tape, F.A.I.R in Action, is a series of four vignettes that highlight the main points of Just Be F.A.I.R. The first situation involves the importance of communicating and not being "color blind" at the expense of recognizing individual identities. The second vignette, featuring an IT worker assisting another employee, focuses on the potential pitfalls of stereotypes. The third is an appropriate example of a person whose religious faith is overlooked at work when its holidays aren't treated with the same seriousness as mainstream holidays. The last situation involves a new team member' who isn't included in evening meetings because child care makes that difficult. The vignettes are all plausible and serve as great discussion points for the application of the principles brought up in the workshop.

The real strength of this program lies in the second video introducing common workplace issues that might not be perceived as diversity issues. The excellent facilitator's guide has a series of well-thought-out participant exercises that can get trainees personally involved with the issues. The guide is clear and easy to navigate, and provides a lot of flexibility for the trainer. There are three different programs, ranging from one hour to a full day, and all are coded by numerical steps to the guide so that customization is straightforward. The PowerPoint presentation is also useful. The guide includes a full transcript of the video dialogue.

Matthew Reis is manager of organizational development at Babson College in Wellesley, Massachusetts; reis@babson.edu.

Product evaluations are provided by Training Media Review and do not imply endorsement by T+D or ASTD. For more information, contact TMR at 87Z532 1838; www. tmreview.com

GOT TO WWW.LEARNINGCIRCUITS.ORG to access TMR's reviews of e-learning materials, including e-courses, authoring software, learning management systems, and more.