36 Chart 12 plots dividend payout behaviour among US firms during this period. Dividend reductions occurred just less than 50% of the time, as might be expected. Similar behaviour has been found among UK quoted firms during the 19th century. 37 Now fast forward a century. As Chart 13 illustrates, dividend behaviour has altered dramatically. Between 1980 and 2010, the world’s largest 200 companies reduced dividends only 8% of the time. This was despite dividends being greater than earnings in over 10% of cases – and, indeed, dividends being positive despite negative earnings in 5% of cases. Chart 14 plots the standard deviation of earnings and dividends across a panel of international firms. Over recent years, earnings have been more than six times more volatile than dividends. Berkshire Hathaway has again bucked the trend. Since 1967, it has paid dividends only once. And that may have been once too often for Buffett: “I must have been in the bathroom when the dividend was declared”. Patience and discounting A more direct test of short-termism would involve estimating directly the discount rate people assign to future outcomes. Conducting your own test is fairly simple. Ask your friends how they would feel if the price of their favourite luxury good were to rise by 10%. Then ask them how they would feel if the price of their house were to rise by 10%. The first is likely to meet with a frown, the second a smile. In general, people dislike goods price inflation, but like asset price inflation.
This feels rational right? Wrong. These perceptions suggest a sub-conscious myopia. Higher goods prices cut today’s disposable income. Higher asset prices cut tomorrow’s disposable income. So disliking goods price inflation and liking asset price inflation suggests a potential time-inconsistency in preferences. It is leaving as a bequest for your children the mortgage but not the house. 33  Several alternative explanations have been proposed including the signalling benefits of maintaining dividend ratios (Mann (1989)). 34  Stiglitz (1974). 35  For example, Skinner (2008). 36  Goetzmann, Ibbotson and Peng (2001). 37  Braggion and Moore (2008). BIS Review 114/2010  11  It is possible to test more formally the evolution of discount rates by extracting them from the prices of financial assets, such as equity prices, using asset pricing theory. 38 This suggests that discount rates in asset prices are higher, often much higher, than implied by rational expectations theory, consistent with short-termism. For example, in studies of UK companies it has been found that actual annual discount rates can be materially, perhaps as much as 300%, higher than their rational value. Or, put differently, cash flows four years ahead are discounted at rates more appropriate for cash flows 6 to 10 years ahead. Equivalently, studies have found that future cash flows are undervalued by investors. These effects compound over time. So if cash flows 5 months ahead are undervalued by 5% today, those occurring 5 years ahead are undervalued by 40% today. This finding is common, although not uniform, across countries.