The Impact of SEC Rule 10b-18 on the Ratchet Effect

SEC Rule 10b-18 in 1982 revised the Securities and Exchange Act of 1934 and led to a substantial rise in repurchase activity afterwards. We propose that this rise in repurchase activity may weaken the existence of the long-run target payout ratio, or ratchet effect, in the traditional terms of divid...

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Bibliographic Details
Published inBanking and finance review Vol. 8; no. 2; pp. 1 - 17
Main Authors Wann, Christi R, Long, D Michael, Brockman, Christopher M
Format Journal Article
LanguageEnglish
Published Windsor Central Connecticut State University 2016
Subjects
Dividends
Earnings per share
Rates of return
Ratios
Securities prices
Stock prices
United States > US
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Summary:SEC Rule 10b-18 in 1982 revised the Securities and Exchange Act of 1934 and led to a substantial rise in repurchase activity afterwards. We propose that this rise in repurchase activity may weaken the existence of the long-run target payout ratio, or ratchet effect, in the traditional terms of dividends and earnings. We find support for this hypothesis by demonstrating that pre-1982 payout ratios are mean reverting but post-1982 payout ratios are not mean reverting. This finding implies that SEC Rule 10b-18 has had a significant effect on the tradition of maintaining a target payout ratio. Regressions of future changes in earnings and dividends against target payout ratio deviations for both pre- and post-1982 periods reveal greater support for the ratchet effect before the adoption of SEC Rule 10b-18. These results should modify the long-standing view that all firms strive towards a long-term dividend payout ratio. Further, future dividend signaling research should account for this structural shift in dividends and repurchases.
ISSN:1947-7945
1947-6140