Sexy dividends

In this age of massive stock repurchases, dividends have a distinctly stodgy, old-fashioned air about them, despite the fact that over the past few years they've been taxed at the same rate as capital gains. Yet, according this paper (PDF) published by fund manager Tweedy, Browne Company (ed. man, that's about the stodgiest, WASPiest name I've come accross in a long while).
(Hat tip: Abnormal Returns)

It concludes that there's plenty of evidence that high dividend yield stocks outperform market averages. (Not surprisingly, Tweedy, Browne recently launched a fund with this investmen strategy).

Needless to say, this is interesting. I must confess that I'm rather partial to dividends, as they're the most transparent way to return cash to investors. However, the paper solely emphasizes correlation and does not delve into causation, which is very unsatisfactory.

There are many possible explanations to account for the apparent success of a high dividend yield strategy. Maybe it's a sector effect. That is, perhaps firms in successful sectors happen to pay dividends. Or it could be that dividends are indicative of some positive trait, such as high capital spending discipline. I'm sure the academic literature has many other theories.

Also, the paper neglects to present studies that fail to support this conclusion (such as this this one).

As always, beware of research with deep conflicts of interest, no matter how academic it may look.

Rating agencies: Déjà vu all over again

As was to be expected, the bond rating agencies are catching a lot of (deserved) flack over their (abysmal) performance in the subprime mortgage mess (see here). But then again, what else is new? Ratings have been lagging indicators for as long as I can remember. After every crisis --Mexican, Asian, Russian, Enron, etc.--there's been an outcry over why S&P, Moody's and Fitch where asleep at the wheel.

The answer is obvious: incentives. Issuers pay for ratings. Thus, the agencies have a vested interest in being as nice to them as possible to keep the fees rolling in (this Portafolio piece describes this point well). As Barry Ritholtz notes, it's fundamentally the same problem that brought disrepute to sell-side research after the dot com bubble burst (if you think things have changed, just read this).

What can be done? Politicians may huff and puff, but research can't be regulated, other than by inserting ever longer and totally useless disclaimers after each report.

The only possible solution is for large institutional investors to bankroll serious buy-side ratings research. Of course, putting this into practice wouldn't be easy, as there are obvious collective action/free rider problems, but they're much smaller than those faced by individual investors (hence the private equity racket). If they can't do this, the same old rotten ratings system will continue after the storm passes and politicians get back to the latest Middle East crisis.

So why haven't they stepped up? Fear of changing a century-old system? Fear of retaliation by issuers and the investment banks (both profit from the current arrangement? Your guess is as good as mine.