Dividend Reinvestment Plans: Evidence from Australian market

Abstract

This thesis examines new issue dividend reinvestment plans (“DRPs”) in the Australian market. A new issue DRP allows shareholders to have cash dividends on all or a portion of their shares automatically reinvested in the new shares issued by the firm. The thesis is motivated by the unique institutional setting of the Australian equity market under the dividend imputation tax system and the lack of research on DRPs in the Australian market. To carry out the empirical analysis we modify Finnerty’s (1989) model and show that a DRP under the Australian dividend imputation system can be the most cost effective way of raising new equity capital compared to retention-financed and new stock-financed equity capital. The thesis then investigates three empirical aspects of the DRP: (i) the factors that explain a firm’s decision to adopt a DRP, (ii) the firm characteristic variables and DRP features that explain the firm’s decision to underwrite its DRP, and (iii) the determinants of the existing shareholder’s decision to participate in a DRP. Our results show that: (i) The tax induced preference for the distribution of franked dividends results in firms increasing their use of DRPs to offset the increased distribution of earnings. Firms also adopt a DRP when they are faced with profitability constraints, and have high leverage. (ii) DRPs are more likely to be underwritten if the firm size is greater, leverage is higher, and the cash flow profitability is lower. (iii) The discount on the market price of new shares issued under the DRP increases the shareholder participation rate. The shareholder participation rate also increases in DRP firms with high growth and low profitability, which are characteristics of firms with lower agency costs.