Journal of Financial Economics 28 (1990) 9.5-125.

North-Holland

Dividend yield and expected returns

The zero-dividend puzzle *

William G. Christie
Vanderbilt Uniuersity, Nashuille, TN 37203, USA

Received December 1989, final version received December 1990

Previous research examining the relation between dividend yield and equity returns documents a
U-shaped pattern arising from the positive CAPM-adjusted average excess return of zero-
dividend firms. In contrast, this paper reports that zero-dividend firms earn negative average
excess returns relative to firms of similar size. Despite the apparent conformity of these results
to the predictions of after-tax asset pricing models, the negative size-adjusted excess returns
cannot be driven solely by tax effects. These excess returns, which are concentrated in the initial
zero-dividend years and approach - 1% per month, are attributed to possible dividend-expecta-
tion effects rather than taxes.

1. Introduction

The relation between expected equity returns and anticipated dividend

yields continues to interest financial economists. The tax penalty historically
associated with dividends relative to capital gains has led to the hypothesis

*This paper is based on chapters two through five of my doctoral dissertation at the University
of Chicago. I wish to thank committee members Merton Miller (chairman), Nai-Fu Chen,
Eugene Fama, John Hand, Robert Holthausen, and Richard Leftwich for their guidance
throughout the various phases of the research. I also wish to thank Richardson Pettit (the
referee) and John B. Long, Jr. (the editor) for their helpful comments and suggestions. The
paper has benefited from discussions with Kevin Geraghty, Michael Hemler, Roger Huang,
Andrew Karolyi, Mark Lang, Craig Lewis, Kelly McNamara, Paul Schultz, Hans Stoll, and
workshop participants at Columbia University, Emory University, University of Iowa, Ohio State
University, Queen’s University, Southern Methodist University, Vanderbilt University, Univer-
sity of British Columbia, University of North Carolina, University of Southern California, and
University of Texas at Austin. Financial support from the Social Sciences and Humanities
Research Council of Canada and the Dean’s Fund for Faculty Research at Vanderbilt University
is gratefully acknowledged. All errors remain the responsibility of the author.

0304-405X/90/$03.50 0 1990-Elsevier Science Publishers B.V. (North-Holland)

96 W G. Christie, Dividend yield and expected returns

that anticipated yields and expected returns are positively related. Previous
studies testing for before-tax return differentials across dividend yields typi-
cally estimate coefficients from cl), based on Brennan’s (1970) after-tax
formulation of the capital asset pricing model (CAPM),

(1)

The equation describes the relation between a firm’s before-tax equilibrium

expected return and its systematic risk (pi,> and anticipated dividend yield
(di,). Empirical studies whose conclusions are consistent with the hypothesis
that 6, is significantly positive include Litzenberger and Ramaswamy (1979,
19821, Bradford and Gordon (19801, Morgan (19821, and Elton, Gruber, and
Rentzler (1983). Others, notably Black and Scholes (1974) and Miller and
Scholes (19821, find no relation between equilibrium returns and dividend
yield.
Although the results of these studies are mixed, a peculiar empirical
regularity emerges when (1) is modified to isolate zero-dividend firms, as
formulated in eq. (21,

Eq. (2) includes the dummy variable Dj, taking the value 1 for zero-dividend
firms. Litzenberger and Ramaswamy (1980, 19821, Blume (1980), and Elton,
Gruber, and Rentzler (1983) report that 6, enters (2) with a significantly
positive coefficient and increases both the significance and magnitude of 6,.
This interaction implies that, across dividend-paying firms, there is a positive
linear relation between equilibrium expected returns and anticipated divi-
dend yields. Once zero-dividend firms are independently identified, however,
the linearity is destroyed, since these firms earn equilibrium returns exceed-
ing all but the highest-yielding corporations.
Since the observed nonlinearity appears to be inconsistent with tax-
induced differentials in equity returns, alternative hypotheses have been
offered. For example, the relation between expected returns and dividend
yield may be driven by differences in risk. Summers (1982) argues that if
dividends are relatively stable, changes in risk will be reflected in current
prices rather than movements in dividends. This implies a risk-induced
positive relation between ex ante expected returns and dividend yields
unrelated to tax effects. The nonlinearity could then arise if zero-dividend
firms are riskier than the lowest-yielding corporations. Consistent with this
explanation, Keim (1985) and this paper document that the estimated P’S of
 W. ti. Christie, Dividend yield and expected returns 97

zero-dividend firms significantly exceed those of dividend-paying corpora-

tions. ’
This paper demonstrates that the functional form of the yield-return
relation is sensitive to both the methods used to identify zero-dividend firms
and to the time periods studied. The paper is organized as follows. Section 2
outlines the criteria used to classify zero-dividend and dividend-paying firms.
Section 3 describes the model used to estimate excess returns. Keim (1985)
documents that both the zero-dividend and highest dividend-yield categories
contain a large percentage of small firms. The well-documented CAPM-
adjusted excess returns of these firms may confound attempts to detect the
presence of tax effects. To explicitly control for the size effect, expected
returns are estimated within a size-based framework. Specifically, the excess
return for a given firm is defined as the difference between the realized
return and the mean return of all firms of similar size but dissimilar dividend
yield. The advantages of this approach over the traditional CAPM methodol-
ogy are discussed in section 3. The empirical results are presented in section
4. In contrast to previous studies, zero-dividend firms earn significantly
negative average excess returns, and represent a natural extension of the
excess returns estimated across firms with positive anticipated yields. Section
5 explores whether the before-tax differential between zero-dividend and
dividend-paying firms can be attributed to potential tax effects, and concludes
that tax effects aIone cannot be responsible for the observed patterns. The
negative excess returns for zero-dividend firms are concentrated in the years
immediately following their zero-dividend designation, and approach - 1%
per month. These anomalous results are shown to be consistent with a
dividend-expectation effect rather than a tax effect. Concluding remarks are
contained in section 6.

2. Sample idectification
The dividend status of New York Stock Exchange (NYSE) firms with
ordinary common shares outstanding is examined between 1926 and 1985.
For each month, a firm is classified as a zero-dividend firm if no cash
dividends have been declared since listing or if the firm announced it will not
pay its next dividend. All other firms are classified as dividend-paying and are
assigned to yield quartiles.

‘An alternative explanation is offered by Elton, Gruber, and Rentzler (1983). They argue that
since zero-dividend firms generally sell for under $5 per share, the shares cannot be used to meet
margin requirements. To induce investors to hold these securities, they must offer higher
before-tax returns than firms in the lowest dividend-yield category. Similarly, Litzenberger and
Ramaswamy (1980, p. 482) contend that ‘in a capital market where short selling is restricted,
non-dividend paying stocks would have to pay a premium to attract [unrestricted] investors to
absorb the stock, which some investment units may be prohibited from acquiring.’
98 W. G. Christie, Dividend yield and expected returns

2.1. Identification of zero-dividend firms

Since the excess returns of zero-dividend firms are sensitive to the choice
of research design, considerable attention is paid to the identification and
description of this sample. Previous authors have defined d,, the annualized
dividend yield in month t, as

t-1 DIV,
d,= c p,
T=t-12 t-13

where DIV, is the cash dividend paid in month T and Pt_,3 is the price of
the firm’s shares at the end of month t - 13. Under this definition, firms
enter the zero-dividend sample when no cash dividends have been paid in the
preceding 12 months. This definition, however, generates the following mis-
classifications:
(1) Firms announcing an omission of their quarterly dividend three months
after the previous payment are incorrectly treated as dividend-paying for
the nine months following the omission. This implies that these firms
move into progressively lower dividend-yield categories before reaching
the zero-dividend sample.
0.1 This measure fails to include any of the zero-dividend months if firms
omit a dividend and resume payments within 12 months of their previous
distribution.
To minimize these misclassifications, this paper uses dividend initiation,
omission, and resumption announcement dates in assigning firms to
dividend-yield categories.
Since zero-dividend firms cannot be observed directly, their identification
requires an analysis of when cash payments do occur. These dividend
distributions are obtained from the Center for Research in Security Prices
(CRSP) at the University of Chicago. The procedure used to identify zero-
dividend months examines whether firms fail to declare a regular (that is,
monthly, quarterly, semiannual, or annual) cash dividend during some time
interval while trading on the NYSE. These firms can be classified into three
categories.
Non-dividend-paying firms: These are firms for which the CRSP distribu-
tion structure contains no regular cash dividends. In all, 349 firms satisfy this
requirement.
Dividend-initiating firms: Firms initiating cash dividends are identified
when the elapsed time between listing and the ex-dividend date of the first
regular cash dividend exceeds the payment frequency by more than two
months. For example, if the ex-date of the first quarterly dividend occurs
 W G. Christie, Dividend yield and expected returns 99

more than five months after listing, the period preceding the dividend
announcement is deemed a zero-dividend interval. (The ex-dividend date is
used since the announcement date is not available for 10.9% of all cash
distributions coded by CRSP.) A total of 896 dividend initiations are identi-
fied using this criterion.
Dividend-omitting firms: Cash dividend omissions are identified when the
elapsed time between ex-dates exceeds the firm’s payment schedule by more
than two months. For example, the ex-dates of adjacent quarterly cash
dividends must be separated by at least six months for a potential omission
interval to be included. This criterion also applies to the period between the
firm’s last regular dividend and either the delisting month or December 1985.
This procedure identifies a total of 2,899 intervals in which at least one cash
dividend is omitted. In addition, the intervals between adjacent regular
dividends with dissimilar payment frequencies are examined for potential
omissions. These intervals are retained if the ex-dividend dates fall more
than two months beyond the schedule implied by the longer of the two
frequencies. This criterion produces an additional 248 potential omission
intervals.
With these procedures 4,392 zero-dividend intervals are identified. The use
of regular cash dividends alone, however, ignores distributions whose pay-
ment frequency is either irregular (year-end, extra, special, or interim) or
unspecified (unknown at the time of coding). The impact of these distribu-
tions on the previously identified zero-dividend intervals is described in the
appendix and summarized in part A of table 1. These additional dividends
reduce the number of zero-dividend intervals by 1,440, to 2,952.
To confirm the absence of cash dividend payments during each sample
interval and to establish dividend-omission-announcement dates, the follow-
ing data sources are used: (1) Poor’s Cumulative, The Cumulative Daily
Digest of Corporation News (1925-39), (2) Moody’s Dividend Record
(1938-851, (3) Wall Street Journal Index (WSJZ) (1958-85), and (4) Moody’s
Manuals (1925-85X2 In certain cases, a dividend-omission-announcement
date could not be located. For firms declaring noncash dividends without
explicitly announcing the omission of cash payments, the announcement date
of these dividends serves as the omission date. If no additional noncash
payments are declared, firms then enter the zero-dividend sample 14 months
after their previous cash dividend payment. An additional complication may

*These sources fail to provide the announcement date for 58 resumptions and initiations. The
announcement month for these payments is determined from the ex-dividend date. If the ex-date
occurs beyond the 19th calendar day, the announcement is assumed to occur within the
ex-dividend month. Otherwise, the announcement is assumed to occur in the previous month.
The primary drawback of Moody’s Dividend Record is that actual omission-announcement dates
are not reported. Rather, it may be noted that a cash dividend due for payment on a particular
date is omitted. Therefore, announcement dates from this source are likely to lag the actual
omission month.
100 W.G. Christie, Dividend yield and expected returns

Table 1
Summary of the criteria used to identify zero-dividend NYSE firms in the 1926-1985 period.

Zero-dividend classification
Dividend- Dividend-
Non-dividend- initiating omitting Total
paying firms firms firms sample

Number of potential zero-dividend

intervals identified
using regular payment? 349 896 3,147 4,392
Part A: Incorporating irregular and unspeci$ed cash dividendsb
Number of additional intervals 516 562
Number of intervals eliminated _& (4::) (1,548) (2,002)
Subtotal 303 534 2,115 2,952
Part B: Intervals eliminated as a result of verification procedures
Dividend-paying at listing (80) (80)
In process of merger, & 0 (4:) (46)
takeover, or liquidation
Incorrect payment frequency (511 (51)
Interval eliminated because of & & (90) (97)
the presence of dividends not
contained in the 1987 CRSP
monthly stock master
No omission-announcement 0 0 (150) (150)
date and payments separated
by less than 14 months - -
Net sample 296 452 1,780 2,528
Additional intervals arising 0 4 0 4
from dividends not contained
in the 1987 CRSP monthly stock
master - -
Final sample 296 456 1,780 2,532

aRegular dividends are payments whose frequency is identified as monthly, quarterly, semian-
nual, or annual.
bIrregular and unspecified dividends are payments for which a regular frequency was not
assigned or could not be identified.

arise when firms announce future dividends prior to listing. Since these
payments may not be recorded by CRSP, the dividend history for non-
dividend-paying and dividend-initiating firms is examined for the 12 months
prior to listing. Finally, the corporation’s status as a continuing entity is
sought, with firms omitting payments because of an impending takeover,
merger, or liquidation removed from the sample.
Part B of table 1 summarizes the number of potential zero-dividend
intervals eliminated as a result of the verification procedures. In total, 424
intervals are removed, with errors in the assignment of payment frequencies
 W G. Christie, Dividend yield and expected refurns 101

70

60
/

30

20
i

L
10

1920 1930 1940 1950 1960 1970 1980 1990

Year

Fig. 1. The percentage of NYSE firms in the zero-dividend sample from 1926 to 1985. The
shaded area reflects the percentage of NYSE firms whose zero-dividend status results from cash
dividend omissions. The unshaded area depicts firms with no cash dividend payments since
listing. The top line represents the sum of these two categories, and reflects the entire
zero-dividend sample.

and the presence of dividends not coded by CRSP responsible for the
majority of the eliminations.3 The lack of an omission-announcement date
also resulted in the removal of 150 intervals. The final sample contains 2,532
zero-dividend intervals.4
The percentage of zero-dividend firms trading on the NYSE is shown in
fig. 1, which illustrates that the large percentage of zero-dividend firms
observed before 1945 is absent after World War II. The most striking feature
of fig. 1 is the increase in the percentage of firms having omitted cash
dividends during and immediately after the Depression. By 1933, nearly 50%
of all NYSE firms had omitted cash dividends in light of the extreme

‘These uncoded dividends are included in the monthly master for versions dated later than
1987.
40f the 1,780 omission intervals 1,551 firms publicly announce the withholding of cash
dividends [including 76 firms which simultaneously declare a payment in some form other than
cash]. A total of 55 firms declare noncash dividends without explicitly announcing the omission.
The remaining 174 firms enter the omission sample when 14 months elapse and no dividends
have been declared.
102 W.G. Christie, Dividend yield and expected returns

economic conditions. Equally dramatic is the sudden decline and subsequent

increase in this proportion during the latter years of the decade. Although a
portion of this variability results directly from the economic climate, Christie
(1990) concludes that the Undistributed Profits Tax (UPT) of 1936-1937
contributes to the volatility in the percentage of zero-dividend firms during
this period.

2.2. Categorizing dividend-paying firms

Dividend-paying firms are assigned to yield quartiles on the basis of their
anticipated yield estimated from (3). To better approximate the market’s
assessment of a firm’s annualized yield during its first year in the dividend-
paying sample, two modifications are required. First, the standard definition
implies that the anticipated yield increases as payments are added during the
12 months immediately following (1) the month dividend-paying firms are
listed and (2) an initial or resumed cash dividend declaration. In reality, the
expected annual cash distributions probably do not change. Therefore, all
dividends paid during a firm’s first year in the dividend-paying sample are
used to estimate yields for each of the first 12 months. After this period, the
standard definition is used. Second, firms that fail to announce a dividend
omission and enter the zero-dividend sample 14 months after their last
payment are excluded from the dividend-paying sample in months 13 and 14.
To retain these firms within the dividend-paying sample during these interim
months, the last coded payment is used in (3).

3. Estimation of excess returns

In contrast to previous studies applying a Fama and MacBeth (1973)

methodology to estimate CAPM-adjusted excess returns, this paper uses a
size-based expected-returns model. In each month t, firms are sorted into
size deciles based on their market value at the end of month t - 1. Within
each size decile, firms are assigned to yield categories based on their
anticipated yield at t - 1. These yield categories consist of (1) zero-dividend
firms and (2) yield quartiles for firms with positive anticipated yields. The
expected return for firm i is defined as the average monthly return of all
firms in the same size decile excluded from firm i’s yield category. Specifi-
cally, the expected return for firms in yield category yk (k = 0, . . . ,4) and size
decile sj (j = 1,. . . , 10)is calculated as

“’ (Ri,,lsj> Y;)
E(Ri,zlsj,
Yk) = C N. 7 (4)
i=l J,k
 W. G. Christie, Dividend yield and expected reiums 103

where yi denotes yield categories other than k and & is the number of
firms in size decile j excluded from yield category k. Excess returns are then
estimated by comparing the realized return (Ri,,Isi, yk) with its expectation.
The statistical significance of mean excess returns is calculated using the
standard deviation of the time series of monthly mean excess portfolio
returns weighted by the number of observations in each portfolio.
Since firms are assigned to yield categories in month t on the basis of their
dividend status at t - 1, the zero-dividend sample will contain any positive
announcement effects associated with dividend initiations and resumptions.
Similarly, the dividend-paying sample will contain any negative wealth effects
arising from dividend omissions. This procedure ensures that the results are
free of any ex post selection bias, since only information available at t - 1 is
used in assigning firms to dividend-yield portfolios for month t.
One major advantage of a size-based model is that newly listed zero-
dividend firms are included in their listing month, since they can be assigned
to size deciles based on their month-end market value. This differs from
Blume (1980) and Keim (1983, 19851, who require a 60-month return history

Table 2
Number of months firms remain in the zero-dividend sample (1926-1985).
The table describes, for each zero-dividend classification, the distribution of the number of
months firms remain in the sample. In the non-dividend-paying group, for example, firms remain
in the sample from 2 months to 682 months, Approximately 50% of all firms are removed from
the sample within 61 months of their listing date. Similar comparisons can be made for the
remaining classifications.

Zero-dividend classification
Non-dividend- Dividend- Dividend-
Percentile paying firm? initiating firmsb omitting firms”

Minimum 2 4 2
10% 13 9 8
20% 22 1.5 13
30% 32 23 18
40% 46 32 24
50% 61 43 32
60% 78 61 42
70% 107 91 56
80% 152 129 76
90% 185 196 125
Maximum 682 580 608

aMonth that firms are included in the sample: listing month on the NYSE. Month that firms
are removed from the sample: delisting month or December 31, 1985.
bMonth that firms are included in the sample: listing month on the NYSE. Month that firms
are removed from the sample: end of month containing the initiation announcement.
‘Month that firms are included in the sample: end of month containing the omission
announcement. Month that firms are removed from the sample: end of month containing the
resumption announcement or the delisting month or December 31, 1985.
104 W.G. Christie, Dividend yield and expected returns

Fig. 2. The percentage of NYSE firms in the zero-dividend sample partitioned by size (market
value of equity) from 1926 to 1985. Within each size decile, the number of zero-dividend firms is
expressed as a percentage of all NYSE corporations in that decile. The smallest firms are located
in size decile 1 and the largest firms in decile 10.

to compute p coefficients. To gauge the importance of these excluded

intervals, table 2 summarizes the number of months firms remain in the
zero-dividend sample. The table indicates that including firms in their listing
month rather than five years after listing restores 50% of the non-dividend-
paying sample and 60% of dividend-initiating firms omitted from previous
studies.
A second major benefit of the size-based framework is its ability to control
for the well-documented size effect. Fig. 2 illustrates the large concentration
of zero-dividend firms in the smallest size deciles. The use of size as a proxy
for risk explicitly controls for the size effect, since excess returns are mea-
sured in relation to the average returns of firms within the same size decile.
Since :his paper uses size as a proxy for risk, it is informative to document
the changes in this risk measure surrounding dividend omissions. Fig. 3
reveals that dramatic shifts in market value are observed immediately before
cash dividends are omitted. The figure illustrates the size-decile assignments
of firms omitting cash dividends after 1945 for the ten years surrounding the
 W. G. Christie, Dividend yield and expected returns 105

125

25

Fig. 3. The movement of firms among size deciles surrounding cash dividend omissions from
1946 to 1980. The vertical axis measures the number of firms in each size decile for each month.
Month is defined in relation to the omission-announcement month. Firms must have a history of
five years of continuous cash dividend payments prior to the omission and trade on the NYSE
for five years after the omission. These criteria ensure that the number of firms in the sample
remains constant across months. The smallest firms are located in size decile 1 and the largest
firms in decile 10.

omission announcement.5 The size distribution depicted in fig. 3 is noticeably

different for months - 60 through - 6 than in the period immediately before
and after the omission. Omitting firms tend to cluster in the smaller capital-
ization deciles up to 12 months before the omission, though not to the degree
observed in fig. 2. This striking pattern arises primarily from the reduction in
market value during the six months preceding the omission announcement,
resulting in a migration of firms into the smallest size deciles. The monthly
reassignment of firms to size deciles explicitly controls for the dramatic shifts
in market value across dividend policy regimes.

50mission announcements before 1946 are examined and discarded because the distribution
of zero-dividend firms among size portfolios during this period is so dispersed that information
about size movements surrounding omissions is lost (see fig. 2).
106 W. G. Christie, Dividend yield and expected returns

The differences in risk between zero-dividend and dividend-paying regimes

can also be observed when risk is measured using portfolio p’s. Part A of
table 3 provides these estimates during nonoverlapping five-year intervals.
The estimates are obtained from the market-model regression

R,, = ap + PpRmt+ spt>

where Rpt is the equally-weighted mean return on the zero-dividend portfo-

Table 3
A comparison of market-model coefficients between portfolios formed from zero-dividend and
dividend-paying firms (1926-1985).
Estimates are derived from the market model l?,, = ap +PpAimr + Ept, where I?,, is the
equally-weighted mean return on the zero-dividend portfolio in month t (part A) o_r the
equally-weighted mean return on the portfolio of dividend-paying firms in t (part B), and R,, is
the equally-weighted mean return of all NYSE firms in month t. The table contains the
parameter estimates, their standard errors, the adjusted R-squares, and the average number of
firms per month from which the mean returns for the zero-dividend and dividend-paying samples
are formed.

Mean number
of firms
Time interval 46,) A dip) R2 per month

Part A: Zero-dividend firms

1926-1930 - 0.46 0.208 1.30 0.031 0.968 214
1931-1935 0.31 0.281 1.22 0.015 0.991 409
1936-1940 -0.16 0.340 1.37 0.030 0.972 308
1941-1945 -0.17 0.501 1.78 0.079 0.896 170
1946-1950 - 0.55 0.310 1.47 0.060 0.912 126
1951-1955 -0.99 0.235 1.41 0.066 0.885 109
1956-1960 -0.74 0.223 1.42 0.064 0.892 129
1961-1965 - 0.50 0.168 1.38 0.040 0.954 172
1966-1970 - 0.41 0.336 1.46 0.060 0.909 160
1971-1975 -0.30 0.337 1.45 0.048 0.939 267
1976-1980 - 0.36 0.281 1.51 0.047 0.945 186
1981-1985 - 0.99 0.290 1.36 0.061 0.892 249

Part B: Dividend-paying firms

1926-1930 0.23 0.113 0.84 0.017 0.977 393
1931-1935 -0.41 0.436 0.62 0.024 0.921 297
1936-1940 -0.01 0.279 0.73 0.025 0.937 454
1941-1945 0.09 0.152 0.78 0.024 0.947 639
1946-1950 0.10 0.048 0.93 0.009 0.994 818
1951-1955 0.11 0.031 0.95 0.009 0.995 928
1956-1960 0.09 0.031 0.94 0.009 0.995 938
1961-1965 0.10 0.029 0.93 0.007 0.997 998
1966-1970 0.09 0.057 0.93 0.010 0.993 1,087
1971-1975 0.15 0.093 0.88 0.013 0.987 1,153
1976-1980 0.05 0.058 0.92 0.097 0.994 1,300
1981-1985 0.20 0.063 0.94 0.013 0.988 1,212
 W.G. Christie, Diuidend yield and expected returns 107

lio in month t and R,, is the equally-weighted mean return of NYSE firms
in month t. The table provides the estimated coefficients, their standard
errors, and the average number of firms per month from which Rpt is
calculated. For comparison, part B reports the market-model parameter
estimates for the portfolio of dividend-paying firms.
The estimates in table 3 indicate that, for each five-year interval, the p
coefficients for the zero-dividend portfolio are significantly greater than 1.0.
Further analysis reveals that the large differences in p’s between zero-
dividend and dividend-paying portfolios are not a function of firm size or of
zero-dividend classification. The estimated p coefficients for the portfolio of
zero-dividend firms (independent of their cash dividend histories) are consis-
tently greater than 1.0 and exceed the corresponding coefficient for
dividend-paying firms at high levels of statistical significance across all capi-
talization levels.
Therefore, using size as a measure of risk provides an alternative method
for estimating expected returns, relative to the traditional p-based models,
when (1) prior data is scarce, (2) the sample contains a large proportion of
small firms, or (3) risk is known to change dramatically across different policy
regimes. In the context of this paper, the size-based model does not require
any data prior to listing, permitting an analysis of the full complement of
zero-dividend months. It also explicitly controls for the size effect, and
incorporates changes in risk when firms enter the zero-dividend sample by
resorting firms into size deciles monthly.

4. Risk, return, and dividend yield

This section describes the empirical results bearing on the functional form
of the yield-return relation for firms listed on the NYSE between 1946 and
1985. Restricting the analysis to the post-war years is necessary because the
absence of dividend-paying firms in some size deciles during the Depression
does not permit estimation of an expected return for zero-dividend firms. In
fact, the second smallest size decile does not contain any dividend-paying
firms for 11 months during this period.

4.1. Zero-dividend firms

The excess returns for the sample of zero-dividend firms are reported in
table 4 and presented graphically in fig. 4. A summary of the results is
provided below.

(1) Zero-dividend firms suffer an average loss of -0.41% per month in

relation to dividend-paying corporations of similar size.
 Table 4
Average excess returns for zero-dividend firms across size deciles and months (1946-1985).
Excess returns are defined in relation to the equally-weighted mean return of dividend-paying firms in the same size decile. The t-statistics are
formed using the standard deviation of the time series of monthly mean excess returns weighted by the number of observations in each portfolio.
The absolute value of the t-statistic is shown in parentheses.
___~_ ~~ __ ~~~ __ ~~
Size All
decile Jan. Feb. March April May June July Aug. Sept. Oct. Nov. Dec. months

Smallest 4.59% - 0.23% -0.47% -0.84% - 0.59% - 1.11% 0.07% -0.03% -1.25% -1.93% -0.78% - 1.24% -0.33%
(6.21) (0.49) (0.88) (1.88) (1.22) (3.16) (0.15) (0.06) (2.18) (4.08) (1.37) (1.73) (1.96)
2 3.62% -0.46% -0.62% -0.76% -0.65% -0.55% 0.23% 0.51% -1.20% -1.05% -0.33% -0.48% -0.15%
(4.82) (0.94) (1.10) (1.58) (1.17) (1.26) (0.50) (0.87) (2.37) (1.95) (0.60) (0.93) (0.91)
3 1.92% -0.21% -0.10% -1.79% -1.16% -1.62% -0.59% -0.48% -2.00% -1.36% -0.76% -0.26% -0.71%
(3.01) (0.40) (0.18) (3.10) (2.39) (3.37) (0.99) (0.90) (4.50) (2.07) (1.57) (0.48) (4.39)
4 1.77% -0.58% -0.40% -1.44% -0.76% -1.18% -1.07% -0.29% -1.35% -2.60% 0.40% - 0.52% - 0.68%
(1.93) (1.04) (0.59) (2.46) (1.43) (2.51) (1.67) (0.58) (2.27) (4.45) (0.65) (0.86) (3.71)
5 1.60% - 1.69% 0.61% -0.60% - 1.43% - 1.71% 0.02% 0.22% - 1.23% - 1.34% -0.60% 0.11% - 0.49%
(1.79) (3.67) (0.95) (0.79) (2.52) (3.28) (0.03) (0.31) (1.87) (2.26) (0.98) (0.12) (2.51)
6 2.38% -0.90% -0.75% -0.07% -0.91% -1.36% -0.05% -0.09% -1.12% -1.71% 0.23% - 0.73% - 0.43%
(3.14) (1.25) (1.07) (0.09) (1.47) (1.98) (0.07) (0.15) (1.69) (1.92) (0.30) (1.59) (2.06)
7 1.43% 0.18% -0.47% -0.85% -1.18% -1.54% 0.39% 0.57% - 1.50% - 1.36% 0.29% -0.18% -0.36%
(1.48) (0.36) (0.75) (1.27) (1.89) (3.08) (0.39) (0.82) (2.28) (1.52) (0.40) (0.24) (1.69)
8 0.76% 0.10% -0.19% -0.50% -1.21% -1.01% -1.31% -0.50% -0.90% -0.00% 0.63% - 0.79% - 0.40%
(0.74) (0.14) (0.22) (0.73) (1.52) (1.27) (1.85) (0.78) (1.24) (0.00) (0.75) (1.22) (1.75)
9 - 0.39% - 1.56% 1.48% 0.09% 0.70% -0.75% -1.11% -0.99% -1.70% -0.93% -1.07% -0.85% -0.57%
(0.34) (1.69) (1.06) (0.08) (0.77) (0.66) (1.11) (1.16) (1.89) (1.14) (1.08) (1.33) (1.98)
Largest - 1.39% - 0.80% 0.49% 1.56% 0.92% - 1.87% 0.16% - 0.35% - 0.85% 0.62% 2.30% - 1.78% -0.11%
(0.93) (0.79) (0.47) (1.17) (0.81) (1.84) (0.15) (0.42) (0.89) (0.46) (1.73) (1.43) (0.34)
All 2.95% -0.44% -0.31% -0.90% -0.79% -1.17% -0.17% -0.01% -1.35% -1.55% -0.39% -0.70% -0.41%
sizes (4.53) (1.20) (0.69) (2.25) (2.05) (3.54) (0.38) (0.03) (3.01) (3.41) (0.83) (1.41) (2.96)
_~~~__ --
 W.G. Christie, Dividend yield and expected returns 109

Fig. 4. Seasonal analysis of monthly size-based excess returns for the zero-dividend sample from
1946 to 1985. Excess returns are defined in relation to the equally-weighted mean return on
dividend-paving firms in the same size decile. Positive excess returns are denoted by pyramids
and negative values by cubes. The smallest firms are located in size quintile 1 and the largest
firms in quintile 5.

(2) The negative average excess returns are experienced by firms in every size
decile and every month other than January. Excluding January, the
number of size/month combinations yielding negative average excess
returns dominates those with positive values by a factor approaching 4
to 1.
(3) The behavior of average January returns across size deciles indicates a
number of interesting features. First, zero-dividend firms outperform
dividend-paying corporations in the smallest size decile by an average of
4.59%. Second, the superior performance of zero-dividend firms in
January is not restricted to the smallest firms, as average excess returns
remain positive at a 10% level of significance through the sixth size
decile.

Fig. 4 illustrates the universally poor performance of zero-dividend firms

relative to dividend-paying firms of similar size for months other than
110 W.G. Christie, Dividend yield and expected returns

January. If equilibrium equity returns are governed by both size and market-
model betas, these negative excess returns would surpass -0.41% per
month.6 Since zero-dividend portfolio betas exceed those of dividend-paying
firms through time, imposing higher expected returns on the zero-dividend
sample relative to dividend-paying firms of similar size would only serve to
widen the mean return spread documented above.

4.2. Reconciliation with previous results

The negative mean excess return of -0.4% contrasts sharply with the
positive values reported in previous studies. For example, Keim (1983)
reports that zero-dividend firms earn an average CAPM-adjusted return of
0.27% per month. To reconcile these differences, Keim’s data requirements
are imposed on the zero-dividend firms identified in this paper. Specifically,
non-dividend-paying and dividend-initiating firms enter the sample on the
fifth anniversary of their listing month and are retained until (1) the month
before delisting or December 198.5 (for non-dividend-paying firms) or (2) the
month of the initial payment. Dividend-omitting firms enter the sample when
12 months elapse without a cash dividend payment. If an omission is
identified within five years of listing, the firm is included in the zero-dividend
sample on its five-year listing anniversary if cash dividends have not been
reinstated. Omitting firms are retained until (1) December 1985, (2) the
month before delisting, or (3) the month of the resumed payment. Finally,
returns are restricted to the period between January 1931 and December
1978.
On the basis of Keim’s selection criteria, the sample of zero-dividend firms
identified in this paper yields a positive mean excess return of 0.36% per
month, although 56.7% of the excess returns are negative. Table 5 reconciles
the estimated mean excess return of 0.36% per month with the -0.41%
reported in section 4.1. Imposing Keim’s methodology on the interval used in
this paper (1946 through 1985) produces an average excess return of - 0.20%.7
When firms enter the sample in their listing month, the average return falls
to - 0.32%, with the - 0.41% value recovered once all omission months are
used. Therefore, the positive abnormal returns for zero-dividend firms re-
ported by previous authors are driven primarily by returns before 1946.8

6The use of size deciles appears to control adequately for size betas. The average market
value of zero-dividend and dividend-paying firms within each size decile is very similar. Further,
the use of 20 size portfolios produces the identical result.
‘If Keim’s methodology is imposed from 1946 to 1978. the average excess return is reduced
from 0.37% to - 0.12% per month. Therefore, the dramatic reduction in average excess returns
is driven by the period before 1946 rather than by returns generated after 1978.
‘The dichotomy between the return behavior of zero-dividend firms before and after World
War II is also noted by Blume (1980, p. 572), who states: ‘The analysis by decade shows that
most of the superiority of non-dividend-paying stocks to dividend-paying stocks as a group
 &KG. Christie, Dividend yield and expected returm 111

Table 5
A reconciliation with previous results documenting the monthly excess returns associated with
zero-dividend firms.

Mean
excess Sample
returna t-statisticb size %<O

Results reported by Keim (1983) 0.27% 2.59 97,131 n/a

covering 1931-1978’
Replication using size-based excess returns 0.36% 1.33 87,757 56.7
and Keim’s data restrictions
Modijca#ions in time interuald
Excess returns measured between 1946 and 1985 - 0.20% - 1.48 56,849 57.2
Modifications in methodology
Keim’s methodology Modification

Non-dividend-paying and Non-dividend-paying and - 0.32% - 2.27 73,761 57.2

dividend-initiating firms dividend-initiating firms
enter after five years enter in the month they
of trading on the NYSE are listed on the NYSE
Dividend-omitting firms Dividend-omitting firms - 0.40% - 2.87 83,802 57.5
enter after 12 months enter in the month of the
elapse with no cash omission announcemenP
payments
Delisted firms are Delisted firms are removed - 0.41% - 2.96 84,092 57.5
removed in the month in the month of delisting
before delisting if a return is available
_
“Figures are expressed as the mean excess return per month. Excess returns are defined in
relation to the equally-weighted mean return of all dividend-paying firms in the same size decile.
bThe t-statistics are formed using the standard deviation of the time series of monthly mean
excess returns weighted by the number of observations in each portfolio.
‘The data for Keim (1983) are generated using a Fama-MacBeth methodology.
dThe impact of each modification is cumulative.
‘Firms enter the zero-dividend sample at the end of the month in which they are identified as
having omitted cash dividends.

A closer examination of the data suggests that the previously reported

results arise from an asymmetry in extreme returns. Specifically, sharehold-
ers’ downside losses are limited to - lOO%, while upside returns are un-
bounded. This feature appears particularly relevant during the Depression,
when firms traded at a small fraction of their pre-Depression levels. In fact,
many corporations traded at prices so low that monthly returns in excess of

stemmed from the decade from 1936 through 1946. In these last three decades, there was
little difference in the average quarterly returns for a given beta between non-dividend-paying
and all dividend-paying stocks as a group.’
112 W.G. Christie, Dicidend yield and expected returns

100% were not uncommon, with some firms experiencing monthly returns
between 500% and 700%.9 It is these extreme observations that produce a
positive mean even though 57% of all excess returns fall below zero.
To formally assess the impact of these extreme return asymmetries on the
results in table 5, a naive filter is applied to the returns by excluding all firms
trading for under $2 per share. In replicating Keim (19831, this elimination
criterion reduces the mean excess return from 0.36% to -0.09% per month.
Interestingly, the mean excess return of - 0.41% observed from 1946 through
1985 is virtually unaffected by the exclusion of the extreme observations.
Therefore, the previous finding that zero-dividend firms earn positive
CAPM-adjusted excess returns can be partially traced to an asymmetry in the
returns generated during and immediately following the Depression, arising
primarily from movements around historically low share values.

4.3. Completing the dividend-yield curve

This section incorporates the excess returns for zero-dividend firms with
those of firms whose anticipated dividend yield is positive. The results are
presented in table 6, while fig. 5 graphs the average excess returns for each
yield category. The figure illustrates that, consistent with previous research,
the positive relation between excess returns and dividend yield is observed
across firms with positive yields. [These results are unaffected if P,_ 1 is used
in (3).] However, introducing the mean excess return for zero-dividend firms
no longer generates the U-shaped nonlinearity. In contrast, the behavior of
zero-dividend returns is consistent with the pattern observed across the other
yield categories. Fig. 6 displays the excess returns partitioned by month. The
U-shaped relation in January reported by Keim is still present, but the
upward-sloping relation between excess return and yield is observed in most
other months.

5. Before-tax return differentials in equiiy returns:

Tax-based or information-based?

The results in section 4 suggest that the postwar yield-return function is

generally consistent with the presence of a tax-induced differential in equity
returns. This section examines whether the reported before-tax return dif-
ferential produces a reasonable estimate of the marginal rate of taxation on
dividend income. The relation between the marginal tax rates on dividends
and capital gains which is necessary to equate after-tax returns between

‘The prices generating these returns were not necessarily trade prices. In many cases, returns
were recorded using the averages of bid and ask prices, suggesting that investors might have had
difficulty in actually realizing these returns.
 Table 6
Average excess returns across all dividend-yield categories (1946-1985).
3
Excess returns are defined in relation to the equally-weighted mean return of all firms in the same size decile excluded from the firm’s yield i;‘,
portfolio. The t-statistics are formed using the standard deviation of the time series of monthly mean excess returns weighted by the number of 0
observations in each portfolio. The absolute value of the l-statistic is shown in parentheses. F
E.
-2,
Yield All
portfolio Jan. Feb. March April June July Aug. Sept. Oct. Nov. Dec. months !Z
May &
____~ I_ __- ___~ ^___ .~__ _-~
0 2.95% -0.44% -0.31% -0.90% -0.79% -1.17% -0.17% -0.01% -1.35% -1.55% -0.39% -0.70% -0.41% $_
(4.53) (1.20) (0.69) (2.25) (2.05) (3.54) (0.38). (0.03) (3.01) (3.41) (0.83) (1.41) (2.96) g,
- 1.22% - 0.14% 0.09% - 0.10% 0.11% -0.07% -0.31% -0.33% -0.48% -0.25% 0.80% -0.02% -0.16% ?C
?lowest) (4.80) (0.53) (0.46) (0.35) (0.49) (0.29) (0.85) (1.31) (1.85) (0.79) (2.66) (0.11) (2.01) g
2 -0.38% 0.15% 0.08% 0.12% - 0.05% 0.19% 0.10% 0.04% 0.22% 0.12% - 0.05% 0.29% 0.07% 8
(2.56) (1.23) (0.80) (0.89) (0.39) (1.85) (0.73) (0.33) (1.72) (1.01) (0.33) (2.10) (1.80) R
3 - 0.02% 0.23% 0.23% 0.39% 0.12% 0.21% 0.17% 0.23% 0.52% 0.32% -0.19% 0.31% 0.21% g
(0.07) (1.65) (1.75) (2.04) (0.82) (1.26) (0.89) (1.63) (2.83) (1.66) (0.94) (1.95) (4.11) $
4 0.08% 0.08% - 0.24% 0.10% 0.27% 0.35% 0.10% 0.08% 0.45% 0.67% - 0.48% - 0.36% 0.10% 2
(highest) (0.20) (0.25) (0.60) (0.26) (0.93) (1.33) (0.21) (0.21) (1.34) (1.66) (1.24) (1.44) (0.94)
 114 W.G. Christie, Dividend yield and expected returns

0.3

: -0.1:
2
1
x

::
P
zl
s -0.3

%
a -0.2:
-0.4 i__:___

-0.51
I I I r

0 1 2 3 4

Fig. 5. Average monthly size-based excess returns across all dividend-yield classifications from
1946 to 1985. Excess returns are defined in relation to the mean return of all firms in the same
size decile excluded from the firm’s yield category. Yield portfolio 0 contains the sample of
zero-dividend firms. Portfolios 1 through 4 are the yield quintiles for firms with positive
anticipated dividend yields. The highest-yielding firms are in yield portfolio 4.

dividend-paying and zero-dividend firms is given by

In (6), 4d and 4, are the marginal tax rates on dividends and capital gains,
respectively, P is the current price per share, D is the annualized dividend,
and K is the annualized before-tax return differential. The marginal tax rates
estimated from (6) must be interpreted with caution because the derivation
ignores important factors such as transactions costs, the taxation of short-term
gains as dividends, etc. [see Kalay (1982) for a related discussion].
To obtain $d, the following values are used:
(1) The anticipated dividend yield, D/P, is set at 5.77%, which represents
the average yield on dividend-paying firms in the size deciles used to
generate the return differential of -0.41% per month. This yield is
 W. G. Christie, Dividend yield and expected returns 115

2.5

3 2.0
e
“L
t 1.5
a
_ 1.0
B
&
t 0.5
s: 0.0
P
2 -0.5
5
B -1.0
0
6e -1.5

-2.0

DividendYield
Portfolio

Fig. 6. Seasonal analysis of monthly size-based excess returns across all dividend-yield classifica-
tions from 1946 to 1985. Excess returns are defined in relation to the mean return of all firms in
the same size decile excluded from the firm’s yield category. Yield portfolio 0 contains the
sample of zero-dividend firms. Portfolios 1 through 4 are the yield quintiles for firms with
positive anticipated dividend yields. The highest-yielding firms are in yield portfolio 4.

higher than the average across all dividend-paying firms (4.8%), since the
smaller dividend-paying firms with which the returns of zero-dividend
firms are typically compared have higher-than-average yields.

(2) K is set at 4.92% per year (ignoring compounding), given the before-tax
return differential between zero-dividend and dividend-paying firms of
0.41% per month.
If 4, is zero, the marginal tax rate on dividend income is 85.3%, with the
95% confidence interval extending from 28% to 142%. If the capital gains
rate is increased to 15%, c$~ rises to 87.5%. Although tax rates in the lower
tail of the confidence region appear plausible, the bulk of the distribution
places the implied tax rate above the levels observed after 1945. This suggests
that a tax-based explanation for the differential return between zero-dividend
and dividend-paying firms is incomplete.
Additional evidence inconsistent with a tax-based explanation emerges
when the return differential is examined during annual intervals relative to
116 &KG. Christie, Dividend yield and expected returns

the firm’s entry into the zero-dividend sample. Tax-induced differentials

should be insensitive to the number of years firms maintain their zero-
dividend status. To test this hypothesis, the excess returns for non-dividend-
paying and dividend-initiating corporations are sorted into annual intervals
based on their listing month. Similarly, the excess returns for dividend-omit-
ting corporations are sorted relative to the omission month. The results
appear in table 7. Part A reveals that non-dividend-paying and dividend-ini-
tiating firms suffer an average loss of - 0.47% per month, with these negative
excess returns concentrated in the first four years of trading. In fact, during
each of the first three years, these firms earn negative excess returns
(significant at the 1% level) varying between -0.76% and -0.95% per
month. Although the size of the average excess return diminishes in year 4, it
remains significant at the 10% level. Similar results are observed in part B,
which reports the performance of firms after omitting cash dividends. These
firms suffer a mean excess return of -0.80% per month during the first year
following the omission, with excess returns of - 0.24% and - 0.45% observed
in years 2 and 3. Fig. 7, which graphs the results from table 7, illustrates that
average excess returns remain well below zero during each of the first three
years firms remain in the zero-dividend sample.”
The abnormal returns observed during the initial zero-dividend years are
anomalous. The average before-tax return differential of approximately 10%
per year between zero-dividend and dividend-paying firms during the first
year zero-dividend firms remain in the sample implies a marginal tax rate of
158% if (6) were to hold. I1 These results strongly suggest that the negative
excess returns of zero-dividend firms cannot be attributed to tax effects.

5.1. Dividend-expectation effects

One possible explanation for the reported intertemporal pattern of zero-

dividend excess returns focuses on the market’s expectation that cash divi-
dends will be introduced or resumed. Newly listed zero-dividend firms will
typically have traded on smaller exchanges, eventually managing to satisfy the

“To examine whether the results for newly listed zero-dividend firms are driven by those
corporations that never declare cash dividends, the intertemporal distribution of excess returns is
examined separately for non-dividend-paying and dividend-initiating firms. The results indicate
that the negative excess returns observed in part A of table 7 are independent of future dividend
payments. Firms in each classification suffer significant negative average excess returns during
the first three years of trading. Beyond this period, the patterns diverge as dividend-initiating
firms earn positive excess returns in the years with the heaviest concentration of initiation
announcements.
“This figure is derived by using an annual before-tax return differential of 0.83% per month
and an anticipated yield of 6.3%. This yield represents the average yield on dividend-paying
firms in the size deciles used to generate the return differential during the first year of
zero-dividend activity. The standard error on the estimated tax rate is 29%, with the 95%
confidence interval extending from 100% to 217%.
 Table 7
An analysis of the size-based excess returns measured during annual intervals following a firm’s entry into the zero-dividend sample (1946-1985).
Excess returns are measured in relation to the equally-weighted mean return of all dividend-paying firms in the same size decile. The f-statistic is
estimated using the standard deviation of the time series of monthly mean excess portfolio returns weighted by the number of observations in each
portfolio. The sample size denotes the number of monthly observations.

Part A: Non-dividend-paying and dividend-initiating firms

si
Year during which returns occur in relation to the firm’s month of listing Z?.
All _g
1 2 3 4 5 6 7 8 9 lo+” years 8
Monthly K
9
mean (%) - 0.90 - 0.95 -0.76 - 0.53 -0.01 0.04 - 0.22 - 0.22 0.21 - 0.30 - 0.47
t-statistic -3.40 -3.78 - 2.86 - 1.90 - 0.02 0.13 - 0.59 - 0.58 0.55 - 1.52 -2.68 ;
Sample size 4,754 3.935 3,291 2,751 2,225 1,887 1,540 1,291 1,169 8,583 31,426 IZ
%
Part B: Dividend-omittingfirms k

Year during which returns occur in relation to the omission announcement month hR
R
All B
1 2 3 4 5 6 I 8 9 lo+” years 2
Monthly 4
Z
mean (%) - 0.80 - 0.24 - 0.45 - 0.21 - 0.22 - 0.37 -0.16 -0.10 0.52 - 0.24 - 0.37
t-statistic -5.04 - 1.39 - 2.30 - 0.99 - 0.93 - 1.39 - 0.52 -0.33 1.43 - 1.32 - 2.83
Sample size 12,119 8,719 6,407 4,798 3,601 2,833 2,176 1,745 1,431 8,837 52,666

aReturns in this category correspond to those estimated during year 10 and all subsequent years.
 118 W G. Christie, Dividend yield and expected returns

0.75$

!
0.50:
H
:
0.25:
k
B __-.
z 0.00 \ / \\

/,
:
,' “\ \
i .__.___ /' '\
: -0.25' A/ ,,,..I'4' \
:
?
x
2

li
-0.50
2
“s ,/”
B -0.75
t /
,*’
2 ---___,I /"
-l.OOj

-1.25i, / / ,
I I I I I I

1 2 3 4 5 6 7 8 9 10

Fig. 7. Average monthly size-based excess returns during 12-month intervals following a firm’s
entry into the zero-dividend sample from 1946 to 1985. Excess returns are defined in relation to
the equally-weighted mean return on dividend-paying firms in the same size decile. The nonzero
solid line denotes the average excess returns after cash dividend omissions. The broken line
provides the average excess returns for firms with no cash dividend payments since their listing
on the NYSE. The horizontal axis corresponds to the year in which excess returns are observed
relative to the firm’s entry into the zero-dividend sample. Year 10 also includes excess returns
for all subsequent years.

NYSE listing requirements. Market participants may view these newcomers

with a heightened expectation of a forthcoming cash dividend program.
Therefore, at the beginning of each month, the market assigns a positive
probability that newly listed zero-dividend firms will initiate cash dividend
payments. Similarly, there is a positive probability that firms in the dividend-
paying benchmark portfolio will announce a cash dividend omission. When
neither action is taken and these probabilities fall to zero, a divergence in the
two return series may be anticipated. This expectations effect, which is
strongest in the early zero-dividend years, would be expected to diminish
through time and leave a progressively smaller trace in the data. A similar
argument can be made for dividend-omitting firms in the months immediately
following an omission.
 Table 8
An analysis of the size-based excess returns measured during annual intervals following the initiation or resumption of cash dividends (1946-1985).
Excess returns are measured in relation to the equally-weighted mean return of all firms in the same size decile excluded from the firm’s
dividend-yield category. The t-statistic is estimated using the standard deviation of the time series of monthly mean excess portfolio returns weighted
by the number of observations in each portfolio. The sample size denotes the number of monthly observations.

Part A: Dividend-initiatingfirms c,
Year during which returns occur in relation to the initiation-announcement month ?
Z
All .J
1 2 3 4 5 6 7 8 9 10+a years $
F.Z.
Monthly ?C
mean (%) 0.20 0.33 0.30 0.43 0.02 0.31 -0.17 0.19 - 0.21 0.10 0.14 g
t-statistic 0.99 1.61 1.36 1.97 0.11 1.58 - 0.88 0.99 - 1.04 2.01 2.53 8
Sample size 3,125 2,845 2,498 2,261 2,148 2,090 1,904 1,744 1,584 20,971 41,170 ,”
8.
Part B: Firms resuming cash dividends
Year during which returns occur in relation to the resumption-announcement month kS
x
All IZ
1 2 3 4 5 6 7 8 9 10+a years 2
P
Monthly 2
mean (%) 0.40 0.12 0.07 0.17 0.07 0.21 0.18 0.08 0.14 0.08 0.12
t-statistic 3.28 0.97 0.61 1.44 0.55 1.75 1.59 0.70 1.21 2.19 3.99
Sample size 8,587 7,367 6,353 5,832 5,379 5,213 5,286 5,201 4,881 89,726 143,825

aReturns in this category correspond to those estimated during year 10 and all subsequent years
 120 W.G. Christie, Dividend yield and expected returns

0.5

0.4
s
B 0.3
%
E,
_ 0.2
a
1
2 0.1
z
I
m 0.0
x
a
';
P -0.1
t
E
B -0.2

-0.3

-0.4
1

1 2 3 4 5 6 7 8 9 10

Fig. 8. Average monthly size-based excess returns during 12-month intervals after the initiation
or resumption of cash dividends during the 1946-1985 period. Excess returns are defined in
relation to the mean return of all firms in the same size decile excluded from the firm’s yield
category. The nonzero solid line denotes the average excess returns following cash dividend
initiations. The broken line provides the average excess returns for firms resuming cash
dividends. The horizontal axis corresponds to the year in which excess returns are observed in
relation to the firm’s entry into the dividend-paying sample. Year 10 also includes excess returns
for all subsequent years.

To test this hypothesis, the excess returns are examined for firms once they
move from the zero-dividend to the dividend-paying sample. Because the
market may require several dividend payments to be convinced that a policy
of regular cash distributions has been established, corporations continuing to
declare payments may experience positive excess returns after they enter the
dividend-paying sample. This hypothesis is tested by tracking excess returns
following the initial or resumed dividend announcement for firms remaining
in the dividend-paying sample during nonoverlapping 1Zmonth intervals.
The results are presented in table 8 and shown graphically in fig. 8.
Dividend-initiating firms experience positive excess returns during their first
four years in the dividend-paying sample ranging from 0.20% to 0.43% per
month, though only returns in the fourth year are significant at conventional
levels. Similarly, firms resuming cash dividends earn positive excess returns
 W. G. Christie, Dividend yield and expected returns 121

during the first year of 0.40% per month, which are significant at the 1%
level. In addition, the positive excess returns experienced by firms after they
enter the dividend-paying sample are smaller than the negative excess returns
they earn during their early years in the zero-dividend sample. In summary,
firms initiating or resuming cash dividends appear to earn positive excess
returns over approximately the same trading period as they earn negative
excess returns after entering the zero-dividend sample. The positive excess
returns, however, do not fully offset the negative excess returns accumulated
in the zero-dividend sample.
These results suggest that if differential tax effects are responsible for the
overall negative excess returns experienced by zero-dividend firms, the
anomalous return behavior depicted in fig. 7 may be attributable to a
dividend-expectation effect. One aspect of these results remains puzzling.
Why should the market require three years to discount the probability of a
cash dividend initiation, and a similar period to recognize that a dividend
program has been established?
If other market forces are influencing equilibrium returns during these
initial years, abstracting from these periods may provide a better estimate of
the differential tax effects of dividends relative to capital gains. To obtain this
estimate, excess returns are excluded during the first four years after listing
and the first year following cash dividend omissions. This criterion produces a
mean excess return of -0.22% per month (t-statistic of - 1.57). If capital
gains taxes are ignored and the dividend yield is set at 6.7% (the average
yield for firms whose returns are used to generate the excess returns), the
implied marginal tax rate from (6) is 39%, with the 95% confidence interval
extending from - 11% to 90%. Introducing a capital gains tax of 15%
increases the marginal rate to 48%. Therefore, the excess returns of divi-
dend-paying firms relative to their zero-dividend counterparts produce rea-
sonable estimates of marginal tax rates when the initial years of trading are
excluded. These estimates, however, are no longer reliably different from
zero, suggesting that the before-tax return differential of -0.41% per month
(estimated using all zero-dividend months) may reflect a combination of a
dividend-expectation effect and random sampling variation.

6. Summary and conclusions

This paper examines the unique role of zero-dividend firms in the empiri-
cal relation between excess equity returns and anticipated dividend yields.
Using a size-based expected-returns model and all relevant zero-dividend
months, these firms earn negative excess returns of -0.41% per month over
the 1946-1985 period. The negative excess returns associated with zero-
dividend firms are common to all size deciles and all months other than
January, and differ significantly from the results reported by Blume (1980)
122 W.G. Christie, Dividend yield and expected returns

and Keim (1983, 1985). These differences are traced to both the period
studied and the inclusion of firms either in their listing month or the month a
dividend omission is announced. When the mean excess returns for zero-
dividend firms are combined with those for firms with positive anticipated
yields, the yield-return function does not display the U-shaped pattern
previously reported. Rather, the mean return of zero-dividend firms becomes
a natural extension of the yield-return function estimated across firms with
positive anticipated yields. The U-shaped function reported in previous
studies is driven largely by extreme positive returns for zero-dividend firms
during and immediately following the Depression, when share prices were
rebounding from all-time lows. Therefore, including or excluding returns
before 1946 has a material effect on inferences about the potential role of
taxes in stimulating differential returns across yield categories.
Despite the general conformity of the yield-return function during the
postwar years to the predictions of after-tax models of equilibrium returns,
the observed patterns cannot be attributed solely to tax effects. The bulk of
the negative excess returns associated with zero-dividend firms are concen-
trated during their initial years in the sample. The magnitude of these excess
returns is anomalous since they approach - 1% per month, implying that
other market forces must be influencing expected returns. Evidence is pre-
sented suggesting that a dividend-expectation effect may be driving the
observed before-tax return differential. Excluding the initial years that firms
remain in the zero-dividend sample, under the assumption that other market
forces are priced during this period, reveals an average return differential of
- 0.22% per month. This translates into an implied marginal tax rate of 39%,
with the 95% confidence interval extending from - 11% to 90%. Distilling
the analysis to this level removes the statistical significance of the estimated
marginal tax rate. Therefore, the apparent conformity of the excess return
results with a tax-based explanation may actually reflect nothing more than a
dividend-expectation effect and random sampling variation.

Appendix

This appendix describes the role of cash dividends with irregular or

unspecified payment frequencies in the identification of zero-dividend inter-
vals. The effect of these payments on the original sample of 4,392 zero-
dividend intervals can be organized into three categories.12

“The importance of irregular and unspecified dividend distributions to the identification of

zero-dividend intervals can be measured by their relative frequency in the total population. Of
the 211,750 cash dividend distributions recorded by CRSP for NYSE firms between 1926 and
1985. 78% are classified as regular, 4.5% as irregular, and 17.5% as unspecified. The majority of
the unspecified payments occur between 1936 and 1960, with unspecified dividends accounting
for over one-half of all cash distributions between 1936 and 1950.
 W. G. Christie, Dividend yield and expected returns 123

A.1. Elimination of the sample interval

If the irregular or unspecified payments are declared continuously through-

out the zero-dividend interval, the interval is removed from further study.
This can apply to payments declared from listing through the initial dividend,
to payments between two regular dividends, or to payments between the last
regular dividend and removal of the firm from the sample. For example,
consider the omission interval associated with Fawick Corp.

Dividend Payment
announcement date Ex-date Amount frequency
Dec. 14, 1960 Dec. 20, 1960 $0.15 Semiannual
June 23, 1961 June 29, 1961 0.15 Irregular
Dec. 18, 1961 Dec. 22, 1961 0.15 Semiannual

The selection criterion identifies an omission, because the ex-dividend

dates of the semiannual dividends declared in December 1960 and 1961 are
separated by more than eight months. The presence of a dividend with an
irregular payment frequency, however, reveals that no omission occurred.13

A.2, Altering the starting or terminal dates of an existing interval

If the irregular or unspecified dividends occur immediately before or after

a regular cash distribution, but not throughout the entire interval, the
number of zero-dividend months may be reduced, but not eliminated. For
example, consider the dividend-initiation interval for Collins Radio.

Listing Dividend Payment

month announcement date Ex-date Amount frequency
Dec. 1959 June 4, 1963 June 19, 1963 $0.20 Unspecified
Dec. 10, 1963 Dec. 18, 1963 0.20 Unspecified
June 16, 1964 June 24, 1964 0.20 Unspecified
Dec. 15, 1964 Dec. 23, 1964 0.60 Semiannual

Using regular payments alone, the initial dividend is announced in Decem-

ber 1964. The actual initial dividend, however, is announced in June 1963,
reducing the interval to the period from December 1959 through June 1963,
rather than December 1964.

A.3. Generation of additional initiation and /or omission intervals

When the irregular or unspecified payments are not declared continuously

throughout the interval, additional zero-dividend months associated with

13This example illustrates a coding error, since Moody’s Dividend Record correctly identifies
the payment as semiannual.
124 W.G. Christie, Dividend yield and expecfed returns

initiations and/or omissions may be present. For example, Berkey Photo Inc.
is identified as a non-dividend-paying firm, since no regular cash dividends
are observed from listing through the study’s conclusion in December 1985.
An examination of irregular or unspecified payments, however, reveals the
following distributions:

Listing Dividend Payment

month announcement date Ex-date Amount frequency
Nov. 1966 Sept. 17,1973 Oct. 9, 1973 $0.50 Unspecified
Dec. 14,1973 Jan. 9, 1974 0.50 Unspecified
Mar. 20,1974 April 8, 1974 0.50 Unspecified
June 13, 1974 July 9, 1974 0.50 Unspecified
Sept. 12, 1974 Oct. 8, 1974 0.50 Unspecified

The presence of cash payments with an unspecified frequency eliminates

this firm from the non-dividend-paying sample. These distributions also
reveal zero-dividend intervals associated with both a dividend initiation
(announced September 1973) and a dividend omission (after the payment
declared in September 1974).

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